Cash Advances for Merchants

It opens the doors to the financial world for many retailers. The merchant cash advance industry is growing at an astonishing rate. This growth is due to the fact that 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 an asset purchase, such as recovery rate and discount rate instead of interest rate. It’s a lot like factoring, but it’s a sale that hasn’t happened yet.

A cash advance provider gives merchants a lump sum cash advance in advance. In exchange, merchants agree to return the principal and fee, giving the business an agreed-upon percentage of their credit card sales until their balance is zero. This percentage is between 12%-24%. The repayment term is only 5-12 months.

Merchants generally must use the vendors credit card processor because the advance is automatically returned as a percentage of the proceeds from each batch. A small number of merchant cash advance companies do not require the merchant to switch credit card processors. So if this is an issue, be sure to ask the merchant cash advance company you’re thinking of working with.

Cash advances are very different from traditional financing programs. In essence, merchant cash advance providers buy a small percentage of future MasterCard and Visa revenue, and the merchant pays this as a daily percentage of that revenue.

Obtaining cash from traditional financial institutions can be difficult for some businesses, particularly retail, restaurant, franchise or seasonal businesses. These merchants primarily use credit card processing, so merchant cash advance programs offer a number of benefits.

Why merchants like it

Cash is often available more quickly than with traditional loans. These programs are especially appealing to restaurant and retail businesses, not only because these types of businesses are rarely able to obtain traditional financing, but also because of the immediate liquidity.

Most cash advance providers advertise that cash can be available in about 10 days. Unlike a loan with a fixed interest rate, an amount due, and a 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 slow seasonal periods. Traditional loans and leases require a fixed payment every month, whether or not the business has made a sale. Because payments are calculated as a percentage of sales, if sales grow, payback may be faster, but if the owner experiences a business interruption or downturn, payments will be lower.

In most cases, business owners do not offer a personal guarantee or personal guarantee.

How providers make money

Finance charges can vary widely, not only from provider to provider, but also from advance to advance. As an example, the funding range for a $10,000 advance could be as low as $1,500 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 goes well and sales increase, the advance provider collects the money sooner and the interest rate is quite high. Since there is no time limit to repay the loan, the effective annual rate decreases as the payments are spread out over time, although the cash provider usually forecasts a fairly short period for repayment, usually less than a year.

There is no doubt that the merchant’s cost for this type of financing will be higher than for a conventional loan, but it is practically a foregone conclusion that a conventional bank will turn this merchant down for their much-needed loan.

Merchants interested in a program like this may have incomplete or struggling credit histories. They will have things like past tax problems, a list of delinquencies, collection issues, liens, or judgments that would be an automatic red flag for a conventional bank. The merchant cash advance industry caters to businesses that are unable to obtain traditional financing.

A risk worth taking

There is a risk to cash advance providers and a fairly high risk (hence the higher cost to the merchant for the money), but they use sophisticated models to determine likely future credit card purchases. They also offer cash with relatively short payback periods to help mitigate risk.

Although approval is not as difficult as it is for most bank loans, few cash advance providers will approve new merchants without a history of credit card transactions. Even fewer will approve sums greater than what merchants can reasonably expect to earn from credit card transactions in a year.

The merchant cash advance provider bears all the risk, the risk is high, but since it is paid out of projected future sales, it is usually a risk worth taking. Seasonal businesses that need cash to get them through lean seasons or merchants experiencing an unexpected downturn in business (for example, due to road construction, building repairs, or prolonged illness) may find a need for an advance of cash until the business recovers.

However, commercial cash advance companies say troubled businesses aren’t the only merchants interested in this type of program. Many types of businesses are often underserved by traditional financing institutions. Let’s take a restaurant as an example, it could be a very successful business, but a traditional bank wants to see tangible assets. Perishable food or used restaurant equipment just won’t cut it, even if that restaurant is full every night.

There are many examples of times when healthy small business owners could use cash to help build their businesses, but are unable to obtain the necessary traditional financing. These include franchisees who have exhausted their savings to purchase their first franchise and want to open a second; merchants whose competitors have closed and have the opportunity to purchase their competitor’s old inventory or move to a new location; expansions; acquisitions; or simply the desire to move quickly on a new perceived opportunity.

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