What Is a Merchant Cash Advance
A merchant cash advance is financing for companies that permit patrons to utilize credit or debit cards as payment. Unlike typical funding that is usually on a set schedule such as weekly or monthly merchant cash advances are repaid daily based on a percentage of the businesses credit or debit card sales.
The repayment percentage is determined by a factor rate that is then multiplied by whatever the amount of the merchant cash advance was. Whatever the applicable percentage is determined to be is then refunded to the financier to recover their money until the agreed-upon amount is repaid in full.
How can the money from a Merchant Cash Advance be used?
Merchant Cash Advances can be used for any business related expenses, including but not limited to:
Day To Day Business Operations – A merchant cash advance can be used for payroll, travel, training, and research and development.
Business Assets – A merchant cash advance can be used to purchase equipment, maintain inventory, pay vendors, purchase vehicles, and update technology.
Cost Management – A merchant cash advance can be used for seasonal downturns, property renovations, business improvements, when conducting mergers, when making acquisitions, and when the opportunity arises for business expansion and growth.
Advantages of a Merchant Cash Advance’s
Credit History – Businesses don’t have to have perfect credit to be eligible for the service. Instead, they are required to have strong credit and debit card transactions.
Businesses that generally don’t qualify for bank loans will qualify for merchant cash advances if they have strong credit and debit card transactions.
Unsecured – Merchant cash advances are basically unsecured business loans so they don’t require collateral; therefore, the likelihood of a business being foreclosed on is very low.
Repayment is based on sales – Repayment is based on a fixed percentage of a business’s plastic transactions so repayment is adjusted daily to reflect credit and debit card transactions each day.
Therefore, if debit and credit card transactions are low the daily payment will be as well, but in contrast, if debit and credit card transactions are high the daily payment will also be higher.
Flexible repayment terms – Essentially, the flexibility of merchant cash advance repayments works with a business’s cash flow and help prevent them from being thrown into financial crisis and forcing them into choosing what the most important day to day operations are going to be.
Automatic Payments – Payments are done automatically when a business processes credit and/or debit card transactions, giving busy them one less thing to worry about.
No Set Maturity Date – This loan doesn’t have to be repaid within a certain amount of time because repayment terms are solely based on the number of a business’s daily credit and debit card transactions.
Quick Approval – Merchant cash advances typically have less stringent approval processes because their approval and rejection criteria are much different than a typical small business loan.
Businesses are usually approved or denied within about a week because instead of looking into a business’s assets and such lenders mainly focus on bank records and credit and debit card receipts during the application process to determine if a business has the ability to repay the money they are requesting.
Although, merchant cash advances are a good option for new and less established businesses who have strong sales, but don’t have a lot of assets that can be used as collateral they also have their disadvantages:
- Can be more expensive than a typical small business loan – With merchant cash advance businesses could have an annual percentage rate well into the triple digits once all fees and interest is factored in.
This will depend on the lender, the amount of the merchant cash advance, the amount of time that it takes to repay the money and the strength of the business’s credit and debit card sales.
Higher sales equal higher annual percentage rates – Unlike traditional small business loans merchant cash advances annual percentage rates fluctuate because they not only depend on the total amount of fees paid they also depend on how fast the loan is repaid. If the loan is repaid too quickly annual percentage rates can skyrocket and the businesses have no control because payments are automatic.
Early payoff comes with a penalty – With a traditional small business loan business aren’t penalized for repaying the debt early; in fact, they are given incentives by allowing them to save money on interest if they do pay the debt off early. However, with merchant cash advances this isn’t the case because repayment is solely based on the strength of sales and if a business wishes to refinance; it will still be responsible for all the initial agreed-upon fees. We have done a more in-depth piece on the the pros and cons here
Based on strong sales – For new and less established business merchant cash advances are the equivalent of a game of Russian roulette because young businesses haven’t had time to establish a loyal and steady customer base.
Lack of uniform federal regulations – Merchant cash advances are structured the same as normal commercial transactions instead of small business loans and are regulated in each state by the Uniform Commercial Code rather than the Truth in Lending Act that governs traditional lending institutions.
Can create a debt cycle – If a business doesn’t qualify for traditional financing the borrower could find himself in a financial bind requiring him to take on another merchant cash advance soon after taking out the first one just to keep his business afloat. The costs of merchant cash advances can be high and result in cash flow problems.