In the business world, to be successful requires a healthy cash flow.
When cash runs out during economic slumps or business off-seasons, it can be difficult to stay afloat. The lengthy borrowing process from banks and other traditional lending institutions has become highly restrictive when working capital is needed quickly.
As a result, more and more businesses are turning to easier sources of funding like a merchant cash advance. By submitting basic information and documentation, businesses can be approved for a merchant cash advance within 24 to 48 hours and have cash in hand within 7 to 10 days.
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A merchant cash advance is a type of funding that is not a loan. Rather, it is a purchase and sales agreement.
The fund provider buys the right to take money from your business credit and debit card transactions and sells those rights back to you for a fee. With a merchant cash advance, a lender provides unsecured capital to business owners in exchange for a percentage of future debit and credit card sales.
The cash advance amount is predetermined based on a business’s average monthly volume of credit card sales. There is no interest, only a provider’s fee that is agreed upon by the lender and the borrower from the start. There is likewise no preset time to pay back. Repayment is determined by a set percentage the lender will receive of future sales transactions. MCA is risky for the provider, so you can expect to pay a steep premium for funds (sometimes as much as 40%).
A merchant cash advance can be used for almost any business expense, including:
Business owners in need of quick access to capital now have a growing industry eager to fund them: merchant cash advance providers. Seeing as it has become more difficult to secure a traditional loan, many companies are turning to this type of funding to save their business. With a merchant cash advance, businesses can to turn tomorrow’s credit or debit card sales into today’s cash flow.
Any business that accepts credit or debit cards is qualified for a merchant cash advance. In fact, most fund providers approve about 95 percent of qualified applications.
To determine their fee, merchant cash advance providers use a factor rate instead of an interest rate. In return for a lump sum, the customer agrees to pay back the balance with a percentage of their daily credit and debit card sales. There is no interest on the money borrowed, just a provider’s fee that is agreed upon by the provider and the customer right from the start.
In order to figure out the total amount to be paid back, you would multiply the advance amount by the factor rate to get the total repayment fee. The factor rate typically ranges from 1.14 to 1.48. Converted to APR, these rates often start at 15% but can move all the way into triple digits.
As an example, your restaurant needs $50,000 to buy a new oven. You apply and get approved for the full amount through a merchant cash advance. Your fee will then be determined by the factor rate. After you multiply the advance amount by the factor rate to get the total repayment fee, you are simply subtracting the advance amount from the total amount of repayment to determine the MCA fee:
In the case of the example above, a business that averages around $100,000 in credit/debit card revenue monthly could deduct 10 percent of their monthly credit and debit card sales. This would make the monthly repayment around $10,000 and give you the ability to completely repay the balance in 7 months.
The average length of repayment will be around 8 or 9 months, but the repayment term can be as short as 4 months and as long as 18 months. Overall, the higher the percentage of your credit or debit card sales, the more you are repaying the lender, and the shorter your repayment time will be.
Keep in mind, lenders may want to know how you plan to use the funds from the merchant cash advance. Some lenders are flexible on use, provided you maintain a steady flow of credit card transactions. On the other hand, some providers will only allow you to use the money to grow your business. These companies will require proof that your business is actively working on paying off the advance by increasing sales. Make sure you have a plan in place before seeking funding.
Part of the appeal of a merchant cash advance is its simplicity. As opposed to a traditional loan, which more often than not requires collateral or a personal guarantee, a merchant cash advance is far less restrictive.
To qualify a business must show:
Although a strong credit rating isn’t required for approval, a solid financial history allows the lender to be able to offer better rates and even larger advances in some cases.
Over the past decade, economic conditions have made it increasingly difficult for small business owners to get approved for a traditional bank loan or line of credit. Rather than let their businesses go under, many are turning to a merchant cash advance to stay afloat during down cycles. You may be wondering if a merchant cash advance is right for your business.
Here are the benefits of utilizing this type of funding.
Almost any business can use a merchant cash advance.
For high mortality businesses like restaurants or retail, a merchant cash advance can provide immediate funding when a traditional loan is not possible. The immediate funding of a merchant cash advance, also makes its appealing to seasonal businesses, because it ensures they’re ready when customers return during the busy season.
However, while there are many benefits to consider when pursuing a merchant cash advance, there are some things to be aware of as well. You may not want to pay such high rates or give control of your incoming credit card revenue to a provider. Also, you don’t want to get in the habit of relying on merchant cash advances, since its higher cost can make it very difficult to manage future cash flow.
Pros and Cons of Merchant Cash Advance
Since the merchant cash advance industry is still new, there are a variety of businesses already claiming their stake in the growing market.
As the market expands, it’s giving rise to both responsible lenders, as well as, unscrupulous ones. Providers can range anywhere from large corporate providers who offer this MCA funding as a secondary part of their financial services, to small, independent companies whose primary focus is merchant cash advance. So how do you choose the best provider?
Here are 4 key factors to consider when seeking a merchant cash advance.
No matter which provider you choose, evaluate all of your options before making a decision. Comparing terms and rates from different providers can be the best way to find out if you are getting the best deal available for your business.
When dealing with non-traditional financing options, like a merchant cash advance, you need to understand what you’re giving and what you’re getting. So, while it may be boring and tedious, it is important to thoroughly read your merchant cash advance contract. Every provider is going to do things slightly differently. Make sure you know exactly what you are agreeing to. A good provider will be upfront about their contract terms, but some will try to sneak in hidden fees. Learn common contract terms and avoid overpaying for your MCA.
Know the “real” cost of funding. On top of the factor rate, some providers will try to include an origination fee in their merchant cash advance contracts. These fees can run anywhere from 2% or higher and are based on the amount of the advance.
For example: if a merchant offered an advance with a factor rate of 112%, this would project the lender to pay back $1.12 for every dollar advanced. But if they also add a 3% origination fee, that would have the lender paying back $1.15 for every dollar advanced. For advances that exceed $100,000, this origination fee can end up being very costly!
Many people will simply reply on a sales pitch, as opposed to thoroughly reading through the merchant cash advance contract. This can lead to paying more than necessary in hidden fees. A merchant cash advance is pretty basic: a provider gives you money that you pay back through business sales. This means if you don’t get paid, neither does the provider. Notice the lack of extra fees? If a borrower tries to charge you extra, they are more than likely out to get your money.
Here are a few common hidden fees to look out for in your merchant cash advance contract
There are very few companies that you want to have direct access to your business bank account, and a merchant cash advance provider is not one of them. A MCA provider with direct access to your business bank account has contractual permission to withdraw money without prior notification. In a day an age with such widespread cases of fraud, you never know if your information is completely safe. What if the funding company you choose hires an individual who turns out to be a scammer or a criminal? Are you willing to risk your business capital? If your business has a flexible withholding rate, this means the provider would be able to change how much they withdraw without telling you (meaning you will never be 100% sure what amount you will be charged or when).
Most merchant cash advances are established either directly through a merchant account provider or through that provider’s third-party affiliate. If a merchant cash advance provider cannot work with your merchant account provider or if they ask you to switch, be very careful. Although it is necessary for credit card processors to work with merchant cash advance providers to correctly route debit and credit card sales, it is the provider’s responsibility (not yours) to work out the method by which they integrate their services.
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