Many business owners have the best intentions for delivering their product or service to the masses. Unfortunately, many struggle with cash-flow restrictions at some point during the business lifecycle that hampers those efforts.
Cash flow can be limited due to seasonal dips in business, a change in product or service offerings, or customers who simply do not pay on time. When cash flow becomes an issue, a merchant cash advance may be an option for businesses that meet the qualification criteria.
What is a Merchant Cash Advance?
A merchant cash advance is a type of business financing that helps a company raise capital quickly. Unlike a traditional bank loan, a merchant cash advance provides access to funding in as little as a few days, even if the business has little-established credit or the business owners have a lackluster credit history. Merchant cash advances are meant to be temporary cash-flow solutions as opposed to long-term financing tools because they carry high fees and require daily repayment.
Here’s a guide on how merchant cash advances work, their benefits, risks, and alternatives.
How Do Merchant Cash Advances Work?
A merchant cash advance is designed to assist businesses that receive their primary revenue from credit card and debit card sales, like retailers or restaurants. This financing vehicle is not structured as a loan in the conventional sense. Instead, it gives qualified businesses an upfront sum of cash in exchange for a cut of future credit and debit sales.
Merchant cash advances are repaid through daily or weekly withdrawals from the business, calculated as a percentage of total daily sales. The lender assigns a “factor fee,” or multiplier rate, at the time of approval. That fee dictates the total amount to be repaid, and payments remain in place until the original lump sum is fully repaid.
Businesses may repay with a fixed daily or weekly withdrawal, or as a percentage of sales. With fixed payments, the amount owed each day or week does not change. The method of using a percentage of sales means payments could fluctuate along with daily credit and debit sales.
For example, a business that receives a merchant cash advance of $50,000 with a factor rate of 1.4 owes a total of $70,000 back to the lender ($50,000 x 1.4). The typical repayment period for a merchant cash advance is one year, so a percentage of credit card sales are siphoned off from the business each day to repay the debt.
The percentage used is also assigned by the lender at the time the agreement is put in place. If a business with the example above had a repayment rate of 10 percent, that percentage of sales would go back to the lender every day until the full $70,000 was repaid.
Businesses that apply for a merchant cash advance can do so online with most lenders, but they need to provide detailed information regarding their credit and debit card sales and average revenue per month. Credit history and score does not necessarily matter in getting approval, but the financial track record of the business is important.
What Are the Risks of Using a Merchant Cash Advance?
Merchant cash advances can be a smart way for businesses to get quick access to capital that may be needed to cover a large inventory purchase, buying equipment, expanding to a new location, or even developing a new product or service. The fast turnaround for funding, simplified application process, and substantial advance amounts are all benefits to consider in conjunction with the risks of merchant cash advances.