What is a merchant cash advance?
A merchant cash advance is a lump sum of money that the borrower repays with a portion of his daily credit card transactions. This is a quick and easy way to get a business cash advance. There is no collateral involved even if the borrower doesn’t have a good credit score. The repayment is automatically deducted daily from the client’s merchant account. Common factor fee is between 1.14 – 1.18 with a funding period of one week.
How does a merchant cash advance work?
A merchant cash advance is usually used by businesses whose revenue comes primarily from credit and debit card sales which are most common in restaurants or retail shops. Today, merchant cash advances are also available to various businesses that don’t rely heavily on credit card or debit card sales. Merchant cash advance providers claim that this financing product is technically not a loan. A merchant cash advance provider transfers a sum of cash in exchange for a portion of your future sales.
Merchant cash advance repayments can be structured in one of these ways:
The client can be provided upfront with cash in exchange for a portion of his future credit and debit card sales. The repayment period usually ranges from 3 to 12 months. The higher the client’s credit card sales, the faster he’ll repay the merchant cash advance.
Alternatively, he can be provided with upfront cash that is repaid by remitting fixed daily or weekly debits from his bank account. The payment is based on an estimate of his monthly revenue. This is known as automated clearing house withdrawals. Unlike the repayment structure tied to a credit card or debit sales, the payment, in this case, does not fluctuate in accordance to the sales. That means he’ll pay the same amount regardless of whether sales are going as planned.
This second option has become the most common type of merchant cash advance and it allows providers to market to businesses that aren’t primarily tied to credit and debit card sales.
Instead of making a monthly single fixed payment through a bank account over a set repayment period, repayments for a merchant cash advance are made daily or weekly, inclusive of fees, until the advance is fully repaid.
Advantages of merchant cash advances:
- The merchant cash advance provides quick access to funds and has an easy approval process. The borrower can often get an advance within a week or so without any heavy paperwork. Providers usually check a business’s daily credit card receipts to determine if the owner is able to repay.
- The client doesn’t have to worry about losing his home. Cash advances are unsecured, so there is no need for collateral. No personal or business assets would be forfeited if the client’s sales plunge and he fails to repay. Nevertheless, the provider may require a personal guarantee in the form of a written agreement that makes the client personally responsible for repaying the advance.
- The payment is flexible and connected to the sales. As the repayment schedule is based on a fixed percentage of the client’s sales, repayments can be adjusted based on the sales.
- Lenders accept bad credit.
- Lastly, it is very suitable for a wide range of businesses.
Disadvantages of merchant cash advances:
Merchant cash advance loans have higher fees than traditional loans. The APR (Annual Percentage Rate) could be extremely high. Considering all fees and interest included, it typically ranges from about 40% to 350%, depending on the lender, size of the advance, extra fees, how long it takes to fully repay the advance and the flow of the business’s credit card sales. This makes a merchant cash advance far more expensive than a bank loan whose APR is typically 10% or less. Online small business loans have APRs from 7% to 108%. Business credit cards have APRs from 12.9% to 29.9%.
- It is less flexible. This means that it is harder to switch merchant service providers.
- Another disadvantage is that daily deduction of credit card receipts leads to a significantly reduced cash flow for the business owner.
- Higher sales mean a higher APR. APR not only depends on the total fees paid but also on how fast the loan is repaid. If sales are slow, payments are spread out over a greater length of time and the APR drops. If credit card sales are up, the merchant cash advance is repaid faster and the APR goes up.
- Early repayment has no benefits because there is a fixed amount of fees. This is different from a traditional “amortizing” small-business loan in which early repayment would result in less interest paid. If the borrower decides to refinance, he’ll still have to pay for all the fees and may also have to pay an early repayment penalty.
6. There’s no federal regulation concerning the merchant cash advance industry because they’re structured as commercial transactions and not as loans. Merchant cash advances have their own set of regulations in each state.
- Although merchant cash advances are typically provided to business owners with bad credit, that doesn’t mean the provider companies don’t check the borrower’s credit score during the application process. If the provider’s credit inquiry results in a hard credit check, it can hurt the applicant’s credit score.
- The speed and ease of merchant cash advances may put the client in a debt cycle, especially if he doesn’t qualify for other types of financing. Borrowers may find themselves in need of a new advance soon after taking out the first one due to the high costs and frequency of repayments of merchant cash advances. For example, a daily repayment of several hundreds of dollars could adversely affect the normal cash flow of many small businesses.
- Merchant cash advances contracts can be confusing because the costs and repayment structure can make them difficult to understand. In addition, they are often loaded with unfamiliar terms and do not provide APRs. That makes it hard to compare a merchant cash advance with other financing alternatives which is crucial to smart shopping.
Why is a merchant cash advance useful?
Often, a private business enterprise would need some extra capital. However, applying for business loans takes time and the application may be declined. Therefore, merchant cash advances are very suitable for various kinds of business owners who don’t have the time to wait for a typical loan to be approved or don’t qualify for one. Merchant cash advances may be approved and funded in just a day or two and they involve almost no paperwork.
Nevertheless, there is one caveat concerning merchant cash advances. In return for the lump sum advance, the borrower agrees to repay the lender with a percentage of his daily credit card sales.
This means that while a merchant cash advance is definitely one of the fastest financing options in the market, it is also one of the most expensive to borrow.
Factor rates of merchant cash advances
Merchant cash advance providers define their fees using a factor rate instead of an interest rate. They typically range from 1.14 to 1.48. The loan amount is multiplied by the factor rate and the result is the total the borrower owes. If converted to an annual percentage rate, these factor rates often start at 15% but can get much higher.
How long does it take to repay a merchant cash advance?
The usual repayment period for a merchant cash advance is 8 or 9 months. Nevertheless, the term can be as short as 4 months or as long as 18, depending on your business and on the provider’s terms and conditions.
Also, the repayment period depends on the fixed percentage of your credit card sales you’re using to pay the lender. The higher it is, the shorter your repayment time. However, your cash flow, in this case, will be tighter.
How to decide if a merchant cash advance is a good choice?
Paying off a loan with your business’ daily credit card sales can be more expensive than you might expect.
However, you actually have to repay less during slower weeks and months. This makes it different from a term loan as in if you don’t make your payments on time, you’ll have to pay for the late fees.
How much will a merchant cash advance cost you?
There is a way to calculate the actual cost of a merchant cash advance. If you have taken an advance of $20,000 with a factor rate of 1.18, you should multiply the amount by the rate. So, $23,600 is the total that you’ll need to repay with your business’ daily credit card transactions. That may seem like you’re paying an 18% interest rate. But this is not the case. Factor rate has to be transformed into APR in order to determine the true cost of the merchant cash advance.
If your lender will receive 15% of your future credit card sales and you’re estimating $25,000 a month in credit card transactions, you’d be able to repay that advance in 189 days divided by daily payments of $125. This means that the APR comes up to 65.96% which is higher than the original estimate.
In other words, merchant cash advances are fast and convenient, they’re only worth their price if the borrower is confident that he can repay them quickly without harming his cash flow.
Before borrowing, you should shop around and see if you qualify for other types of loans.
Who can qualify for a merchant cash advance?
Is your business eligible for a merchant cash advance? To find out, you should check whether you have little or no collateral, limited business history or bad credit history. If so, merchant cash advances could be the proper solution for your financing problems. The providers usually have easy-to-qualify standards, so most small businesses shouldn’t have a problem with them.
Also, for businesses that make a large part of their revenue through credit card payments, a merchant cash advance is quite appropriate as a short-term financing tool. It can help maintain the working capital, inventory purchases, debt payments or unexpected payments.
Usual minimum requirements include an annual revenue of $100,000 and credit score of 600 points. Also, the borrower should be in the business for at least 5 months but there’s no requirement regarding profitability.
What documents are needed for applying?
If you want to apply for a merchant cash advance, you’ll usually need a driver’s license, a voided business check and recent bank statements. Also, you’ll have to prove your credit score and business tax returns. Finally, you’ll have to show some credit card processing statements.
Why work with us?
We offer transparent pricing and our terms are clear upfront. With us, you can check several offers simultaneously to find the lowest rates for yourself. Most importantly, we provide a long-term relationship for every client, even those with bad credit.
It is well known that bad credit has a significant impact on the small business owner’s cost of capital. Traditional lenders usually decline applications from such clients. Many of our customers have been declined other forms of financing because of their poor credit scores.
We are creative and flexible. We take into consideration the impact of bad credit but we are also ready to hear the personal story of every merchant. We support small business and understand the impact of bad credit. We won’t judge certain business just because it is going through a period of financial instability.
A merchant cash advance is the perfect business loan alternative if your business is struggling with bad credit. It comes without application fees, personal collateral or late payment fees. Therefore, if you have bad credit, a cash advance could be a better decision than a business loan.
Cash advances are based on the revenue of your business, not on your credit score. This makes it 5 times more likely to get approved for a cash advance than a government-sponsored finance program or a traditional bank loan. The merchant cash advance could be transferred in just days as opposed to weeks or even months when dealing with a bank loan. A cash advance can even help with catching up on bills, so the borrower can use the money to help improve his credit score.