Small businesses often do not have the most unrestricted access to credit. Banks often do not have the certainty necessary to take the risk to lend money to these businesses. However, this does not mean that small businesses are cut off from obtaining necessary cash infusions should they need it. There are other ways for these companies to leverage their business revenues to obtain immediate money to help their business or smooth their cash flows. Businesses can obtain a merchant cash advance to help them meet their needs.
A merchant cash advance involves a business obtaining a certain sum of money up front. This is not a gift nor is it a loan. Instead, the advancing party is paid back over time. Generally, they obtain a certain percentage of the business’ sales on a daily basis until the advance is recouped. Specifically, this comes from credit card receipts that a business receives.
There are two different forms of merchant cash advances. The first is the more traditional form where the credit card company is instructed to remit a certain amount to the provider daily. The second is where the merchant must make a fixed daily or weekly payment through a payment that comes from the merchant’s bank account. The latter form is becoming the preferred means of merchant cash advances. This broadens the number of businesses that can receive merchant loans because not every business receives their revenues primarily through credit cards.
When a business applies for a merchant cash advance, the provider will look at the daily credit card receipt to ensure that the business will be able to pay back the advance. They may also run a credit check and request bank account stubs to ensure that the merchant can pay back the advance. The provider will then assign a factor rate to the advance. This is another way of describing the fee that the provider receives for the advance. Fees can vary, but in some instances, they may be high.
The factor rate determines the total amount of repayment that the merchant must make. It is multiplied by the amount of the advance and become the number for repayment. Businesses that are less of a risk will receive a lower factor rate since they are a more attractive recipient of these funds. Conversely, businesses with a checkered credit history or without substantial revenues will receive a higher factor rate since there is a greater chance that they may not be able to repay the advance. The quicker that the advance is paid back, the lower the amount of total payments that will have to be made to the provider.
Although they usually have higher rates than traditional loans, there are a number of reasons why businesses would choose a merchant cash advance. First, they may not be able to qualify for a loan, especially in light of tightened credit standards after the Great Recession. Second, merchant cash advances do not have the same paperwork requirements as a traditional loan. This means that businesses can receive a cash infusion in shot order without an excessive wait. Third, since they are not a loan, no collateral needs to be pledged. Thus, if a business cannot pay back the advance, it will not cost the business owner their home. Finally, those merchant cash advances that are tied to sales may take a lower amount in repayment each day if sales are lower than usual.
As with any financial products, users should make sure that they understand the exact terms of what they are committing to before they take the advance. They should weigh their needs for financing versus the cost obtaining the advance. In some instances, the business’ financial needs may make a merchant cash advance the best option to obtain quick financing. Before signing, a business should shop around among providers because terms of the merchant cash advances may vary between providers. In addition, the business should check to see if a short-term loan makes more sense.