Merchant Cash Advances
Opens Doors to the Financial World for Many Retailers. The merchant cash advance industry is growing at an astonishing clip. This growth cash advance is because traditional banks are not meeting the needs of small businesses.
This product is very unique. It’s a purchase of an asset, not a loan, so we have to use specific language consistent with a purchase of an asset, like retrieval rate and discount rate instead of interest rate. A lot like factoring but it’s of a sale that hasn’t yet happened.
A cash advance provider gives merchants a lump sum cash advance up front. In exchange, merchants agree to pay back the principal and fee, by giving the company an agreed percentage of their credit card sales until their balance is zero. This percentage is between 12%-24%. The payback time-frame is only 5-12 months.
Merchants generally must use the providers’ credit card processor because the advance is paid back automatically as a percentage of each batch’s proceeds. A small number of merchant cash advance companies do not require the merchant to change credit card processors. So if this would be a problem, make sure to ask the merchant cash advance company you are thinking about working with.
Cash advances are very different from traditional funding programs. In essence merchant cash advance providers purchase a small percentage of future MasterCard and Visa revenues, and the merchant repays this as a daily percentage of those revenues.
Getting cash from traditional financing institutions can be difficult for some businesses, particularly retail, restaurant, franchisees or seasonal businesses. These merchants most heavily use credit card processing, so merchant cash advance programs offer a number of benefits.
Why Do Merchants Like It
The cash is usually available more quickly than it is with traditional loans. These programs appeal especially to retail and restaurant merchants not only because these types of businesses can rarely get traditional funding, but also because of the immediate liquidity.
Most cash advance providers advertise that the cash can be available in about 10 days. Unlike a loan with a fixed rate of interest, amount due and set due date each month, with merchant cash advances the money is paid back as credit card receivables come in.
Merchant Cash Advance programs are cash flow friendly, especially during seasonally slow periods. Traditional loans and leases require a set payment every month, whether the business has made a sale or not. Because payments are calculated as a percentage of sales, if sales are growing, the amortization could be quicker, but if the proprietor experiences some interruption or downturn in business, the payments will be lower.
In most cases, business owners put up no personal collateral and make no personal guarantee.
How Providers Make Money
Finance charges can vary widely, not just from one provider to another, but from one advance to another. As an example, the range of financing on a $10,000 advance could be as low as $1500 or as high as $4,000. That’s a 60% difference.
There is no fixed interest rate; the effective interest rate varies depending on the business. If the merchant’s business is doing well and sales are up, the advance provider collects the money sooner and the interest rate is rather high. Since there is no time limit on paying back the loan, the effective annual rate decreases as the payments are extended over time, although the cash provider typically forecasts a fairly short period for payback, usually less than a year.
There’s no question that the merchant’s cost for this kind of financing is going to come in more than a conventional loan, but it’s pretty much a foregone conclusion that a conventional bank will reject this merchant for their much needed loan.