Business Financing: Merchant Cash Advance

Small businesses often struggle with funding. Money could be an issue to upkeep the business, purchase raw materials, implement necessary innovations, make urgent repair of machines and equipment, cover unexpected large expenses, meet deadlines for other payments. Whatever the case is, a small business could end up in need of finances and bank loans may not always be the answer. Banks and alternative financial organizations usually offer customized loans for the small business but the terms and conditions may be unaffordable for a small business. Merchant cash advance has gained popularity as a possible solution.

Merchant cash advance originated as a type of financial aid for small businesses that do not qualify for a standard bank loan. It is a form of upfront financing for a certain amount where the small business undertakes to pay a daily portion of its credit card sales directly to the provider of the merchant cash advance. The repayment is set off immediately, often from day one after the merchant cash advance is granted and utilized. Direct payment of the advance means that the company processing credit/debit card payments for the merchant is deducting the percentage due to the provider and it is distributing it straight to the provider until full repayment. The remaining portion of the sale remains at the merchant’s disposal.

A merchant cash advance is not a loan. At least not in the traditional sense of the word and it definitely works differently. It is exactly what its name states to be – an advance. It is based on the daily credit card revenue of a merchant and his future sales serve as a tool for repayment. Providers of merchant cash advance evaluate the receivables of the business to assess whether the merchant would be able to repay the advance timely. That assessment is also made to determine the sum which the merchant could obtain in advance. So, the easiest way to describe a merchant cash advance would be to say that it is a kind of sale of future receivables.

What is the procedure of requesting and receiving a merchant cash advance?

Usually, the merchant applies to the provider for a certain amount of needed capital. The application contains the merchant’s business tax ID, the amount of funding, intended term of repayment, evidence of the credit card receipts of a couple of months back (or another period as deemed appropriate). Banks statements may also be enclosed for reviewing.

Processing of your information is typically a lot faster compared to any traditional loan application. Most merchant cash advance providers approve or decline your request in as soon as 24 hours of submission along with all additional documents allowing for assessment of your application.

It is important to know that you may be required to switch your credit card payment processor as a condition to obtaining the merchant cash advance. This is done only if your provider is usually working with a certain one. This could cause the slight inconvenience that can be quickly resolved.

Once all details are in place, your merchant cash advance provider deposits the advance you are approved for into the small business account. Repayment is most often set to start immediately, depending on your arrangements with the merchant cash provider and the credit card payment processor.

How much does it cost to repay the merchant cash advance?   

Restrictions on interest rates applicable to the conventional business loans do not apply for the merchant cash advance because, as stated above, it is not considered a loan. Providers have more freedom to determine the interest rate and that makes a merchant cash advance more expensive in terms of payback. Sometimes the percentage of what you return against what you borrowed may range somewhere between 20% and 40 %. This is also known as factor rate and displayed in figures such as 1.20 and so on.

You should be aware that there is a difference between what your account is charged daily from your credit card sales and what your percentage of full repayment is. For example, your withholding percentage deducted from your every credit receipt may be between 13% – 18%, while your total percentage for repayment of the merchant cash advance debt may be 30% – 40 % (or lower, depending on the policies of your provider and your capacity). This distinction is of significance and should be well known by the merchant to avoid complications and misunderstandings when paying off.

How is the withholding percentage of your daily sales determined?

The monthly receivables of your small business from credit/debit cards sales are reviewed and assessed when applying for the merchant cash advance. Given the profit, an estimation is made how much your business could be charged daily. This is done in consideration with your terms of repayment set by both you and your merchant cash provider in your agreement. Of course, the amount of the received upfront payment also matters.

How is the total amount of repayment calculated?

As stated, this is a different calculation that needs to be included in your agreement with the cash advance provider. If you received capital around USD 10,000, your full repayment of that obligation may end up to be around USD 13,000. This should also be stated in your agreement.

Advantages of a merchant cash advance

The greatest advantage is perhaps the fast procedure providing a quick access to funds. Small businesses that have difficulty with the banks may turn to merchant cash advances. If the small business has a steady flow of sales, financing should not be a problem. Repayment is also considered an advantage. Instead of chasing deadlines every month and saving up to make the installment (as done in an installment loan), the merchant practically does nothing. All of that is taken care of automatically by the credit card processor and the merchant has his daily profit after deduction of the withholding percentage free for use.

Disadvantages of merchant cash advances

Being more expensive than the usual small business loans may be seen as a disadvantage. A merchant cash advance is not reflected in the credit score of your business and cannot serve as a future reference for debt. So even you pay off your merchant cash advance on time, this will not serve you for other loans. Another disadvantage is that if your small business faces a slow season and sales are slower than expected, daily deductions keep going as agreed. You may end up with significantly smaller profit. This could be problematic in the long run if the business does not get back on track.

Should you are thinking of financing your small business with a merchant cash advance, all the above should be carefully considered. You should be aware of the eventual consequences on your business. A merchant cash advance can be a top solution for the time being but it is a lasting engagement and you should make a sound financial decision after careful consideration.