A merchant cash advance is an alternative funding option for business owners that need additional access to cash. The cash is usually used to fund start-up costs, expansion or even unexpected expenses. It’s important to note that a merchant cash advance is not a loan. It is a unique agreement in which the business owner receives a lump-sum cash advance in exchange for a percentage of the business’ future credit and debit card sales.
How Does a Merchant Cash Advance Differ From a Bank Loan?
The merchant cash advance industry was born when banks started to decline and prolong the availability of cash to business owners. As this trend continues to worsen, it’s become evident that, “business owners have no chance of getting a loan from a bank. Even with the backing of an SBA guarantee, banks do not want to fund any loan that has unwarranted risk. Instead, they’d prefer to focus on a pristine deal with a long track record (2+ years in business), superior personal credit score (680+), and solid financials (cash-flow positive)”, explains an article published by Forbes. Therefore, merchant cash advances have become the only alternative financing option to satisfy the need for immediate funding.
Unlike traditional bank loans, the approval of a merchant cash advance is based on the merchant’s monthly cash flow, as well as the volume of monthly transactions. Access to cash without the scrutiny over the merchant’s past credit history, make merchant cash advances an attractive, and sometimes the only, alternative for merchants.
Another advantage to keep in mind when asking, “what is merchant cash advance” and how it differs from traditional loans, is that the repayment term is flexible. The repayments are based on a fixed percentage of your monthly credit and debit card sales. If your sales are down one month, the amount repaid that month will be reduced to match what you brought in. Similarly, if your sales are up one month, the percentage repaid will also go up. Therefore, merchant cash advance companies understand that cash flow fluctuates, and do not require merchants to pay a fixed amount every cycle.
In addition to bank loans being increasingly difficult to obtain, they also require a great deal of paperwork that can take weeks or even months to complete. In contrast, merchant cash advance companies “usually have processes and technology in place to fund more quickly. In many cases, the entire underwriting process is automated through online technology platforms”, says an article published by Forbes.
When asking, “what is merchant cash advance” and why are more and more businesses are choosing it over a bank loan, remember that banks demand that merchants put up their assets as collateral. “A new study points to one of the biggest reasons why it’s still tough to get a traditional loan: Small businesses are short on collateral. And collateral is what banks like to see when they make a business loan”, explains Entrepreneur.com.
Anyone who’s ever owned their own business knows what a small business loan is. But how many are familiar with merchant cash advances and their benefits?
A merchant cash advance is a financing solution for businesses that receive most of their income via credit and debit cards. It offers access to quick cash, typically much faster than a loan. There’s very little paperwork involved, collateral is rarely required and business owners with low credit scores or limited business history can still obtain an advance. In this respect, merchant cash advance providers compensate for the unwillingness of most banks to lend money to small businesses.
When a business owner takes out a merchant cash advance (or MCA), the provider gives them a certain amount of money based on their monthly revenue. The owner agrees to pay back the advance, plus a fee, by providing the MCA provider with a percentage (known as the withholding rate) of the business’s credit and debit card sales until everything is paid off. This percentage varies from one provider to the next.
When determining how much a business repays, the merchant cash advance provider assigns a factor rate to the advance, usually between 1.14 and 1.44. The advance total is multiplied by this rate to calculate exactly how much must be repaid. So if a restaurant obtains a merchant cash advance of $20,000 with a factor rate of 1.25 and 10% withholding rate, they will be paying back a total of $25,000 by remitting 10% of daily credit and debit card sales to the lender. This means they will pay more during busier days and less when business is slower.
Average repayment times are 8 to 9 months, but can be shorter or longer. The higher the fixed percentage of credit and debit card sales being remitted, the shorter the repayment time frame will be.
Merchant cash advances offer several benefits to small businesses:
- The application process is easy. Unlike banks, there is no evaluation of financial statements and business plans. All a business owner has to provide is proof of regular income and length of time in business.
- Approval rate is high. Applicants are evaluated based on business performance, not credit rating, so most stable businesses qualify for funds.
- Perfect credit is not a prerequisite. Because MCA providers offer an cash advance in exchange for future sales, poor or bad credit scores are rarely a hinderance. The advance also has no effect on credit rating, as it is considered a sales transaction.
- Money is received quickly. While bank loans can take months, merchant cash advance funding is typically available within three days, which is important if money is needed quickly.
- No loss of collateral. Nothing is required up front, so business owners are never at risk of losing collateral.
- No interest is charged. Because MCAs are not loans, no interest or late fees apply.
- Repayment is performance-based. While loans must be repaid using fixed monthly payments, MCAs are repaid based on sales volume, which does not deplete limited funds.
Merchant cash advances can provide smaller businesses with working capital quickly and with little to no hassle, providing an immediate solution to cash flow needs.
If you’re still asking yourself, “what is merchant cash advance”, contact us here. We will gladly walk you through every step.