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Merchant financing is used by small business owners to cover operating expenses or make necessary purchases when cash flow is not sufficient to cover business needs. This type of financing is popular with business owners that have revenue cycles dependent on seasons, are in process of implementing growth strategies, or any other business where income is collected via credit card or debit card sales. In this article, we explore financing options through merchant financing as well as provide tips on choosing the best merchant loan company for your business needs.

What is a Merchant Loan Company?

Merchant financing programs, like merchant cash advances (MCAs), are a type of business financing where the business owner receives a lump sum of money upfront and the merchant loan company is repaid by collecting a predetermined percentage of daily credit card payments from the business. These types of commercial agreements do not have fixed repayment terms since the payments are based on future sales.

How a merchant cash advance works

The funding that occurs between a merchant loan company and an entrepreneur is not actually a loan, but a financing agreement. Merchant cash advances are often offered through alternative lenders, or online lenders, as well as companies dedicated to providing merchant cash advances. The process works similarly to other types of small business loan options and begins with an application.

  • Application process – Any small business owner can apply for a merchant cash advance. The amount of money the company will provide upfront depends on the business’s sales history, industry, and business plan. Typically, business credit history or personal credit scores are not taken into account during the approval process for a merchant cash advance.
  • Funding – Once the application is completed, approved entrepreneurs can expect to receive funds in their business bank account from the merchant account within 24 to 72 hours.
  • Repayment agreement – Merchant loan providers that approve financing will then set up a process for collecting their percentage of the business’s credit card transactions. The arrangement usually includes daily or weekly withdrawals. The amount of time it requires to pay off an MCA in full depends on the advance amount, the frequency of installments, and the provider’s fees.

How to qualify for a merchant cash advance

While credit score is not a primary factor considered for approval, some merchant financing companies will take a good credit rating into account for new business owners or other borrowers that have a limited sales history. However, since these financing arrangements are not like traditional bank loans, the eligibility requirements are simple. An interested business owner will typically be asked to provide the following documents to the lender:

  • Credit card processing statements
  • Identification- driver’s license, or passport
  • Voided business check
  • Bank statements
  • Federal income tax returns

Applicants that have been in business for at least 18 months and generate a minimum of $150,000 in annual revenues are typically approved quickly by financing companies.

How much does an MCA cost?

Merchant cash advances are a more expensive financing option than some small business loans or other sources of business funding. The financing costs of an MCA are calculated using factor rates. The factor rate provides a decimal value that is multiplied by the amount of funding provided to the business to determine the total cost of the agreement. For example, if a business owner borrows $5,000 from a merchant loan company with a factor rate of 1.12, the business will need to repay a total of 5,600 to the provider.

How to find the best merchant loan company

If a merchant cash advance sounds like it may be the right decision for your business needs, you may be wondering how to get started.

Tips for comparing loan companies

When selecting a merchant loan company to work with, do your research ahead of time to be sure the company has a reputation for providing a fair service to its customers. A provider that has a history of being transparent about the repayment period and cost of the agreement is going to be your best bet.

  • Do an online search – Doing a simple internet search is a great way to get an overview of different companies. Ultimately you want to do business with a company that has a significant online presence and whose website has been registered for at least 6 months. There are also several websites that provide regular reviews on financial services. For instance, when searching “best merchant loan companies,” you may come across this article by Funding Hero that names Biz2Credit as the 2022 Editor’s Choice for merchant cash advances.
  • Check with the Better Business Bureau – Once you’ve narrowed down your search, additional reassurance can be gained by checking the Better Business Bureau’s (BBB) website. The site ranks businesses by assigning a grade to each company. The grading scale ranges from A+ to F, with ratings of A-C being considered good businesses to work with. In addition to the grade, the website lists reasons for the rating and provides customer reviews for most businesses.
  • Trust your instincts – Don’t be afraid to reach out to merchant cash advance companies. Speaking with a representative from the lender can indicate whether they provide transparency and good customer service. Did the lender return your email or call in a timely manner? Was the lender upfront about their factor rates and origination fees? Was the representative able to get all your questions answered?

Advantages and disadvantages of using a merchant loan

Not unlike other business financing decisions, deciding to take out a merchant cash advance is a big decision. Before you decide to sign any financing agreements, be sure you have considered the pros and cons of MCAs.

Merchant cash advances: The Pros

  • Fast funding – Merchant cash advances are one of the fastest types of business financing on the market. Typically borrowers can receive their lump sum upfront payment in 1-3 business days, which is weeks faster than other types of loans, like SBA loans.
  • Fewer documents – Borrowers often find themselves buried in document requests when working with banks or credit unions on long-term financing and other loan options. MCAs require less paperwork than traditional loans because the credit decision depends mostly on the sales records of the applying business.
  • Bad credit is okay – Merchant loan companies are repaid directly from the company’s credit card sales. Any type of business, especially retail and restaurant locations, can accept credit cards and debit cards by partnering with a credit card processing company. For these reasons, small business owners with bad credit can still qualify for an MCA if their sales histories are satisfactory.
  • Payments fluctuate with business – Since repayment is based on a percentage of card sales, the required debt payments on the advance are lower at times when business is slow. When business is going well again, and revenues have increased, the higher payments will help you pay the loan off faster. Some MCA agreements are set up to deduct periodic, fixed ACH payments from the business. In those instances, borrowers can request reduced payments when actual business receipts are less than expected.

Merchant cash advances: The Cons

  • Financing costs – MCAs can get expensive for small business owners and startup entrepreneurs. Since the arrangement is not an actual loan there is no set repayment schedule. It is challenging to compare factor rates to interest rates and annual percentage rates, but typically the factor rate results in much higher total financing costs than loan options or business credit cards.
  • Payments based on sales – While it benefits borrowers to have reduced payments when sales are low, the flip side of percentage-based payments means that the payment increases when sales are great. Since many business owners depend on busy seasons to reinvest in their businesses, the higher payments can be a disadvantage when budgeting for marketing expenses or large purchases and repairs.
  • No prepayment benefits – Since MCA borrowers agree to repay the merchant loan company with a fixed amount as a percentage of sales, there are no cost savings for borrowers that repay the debt early. While some traditional loan agreements include a prepayment penalty, they typically still offer savings by requiring less interest when repaid early.
  • Complicated contracts – The eligibility and document requirements are simpler than other funding options, but MCA contracts can still be complicated for small business owners. Since repayment is typically structured as a percentage of the business’s future receivables over a set time period and a fixed repayment amount over that period of time, it can be difficult to understand what is required of borrowers. Therefore, it’s important to work with a lender you trust when taking out an MCA.

Other small business financing options to consider

If you are concerned about the financing costs associated with a merchant cash advance, you may be interested in learning about other financing options for small businesses. Each of the following types of loans can be secured through a traditional bank or online lender, like Biz2Credit.

Line of credit

A business line of credit is a type of revolving credit that works like a business credit card, where the borrower is approved for a maximum credit line. The business owner can then withdraw funds at any time there is available credit. When the credit line is paid down, the funds become available again. Lines of credit can be secured in cases of low credit scores, where the borrower is required to pledge an asset, like commercial real estate as collateral or provide a personal guarantee. Although, borrowers with lower credit scores tend to pay higher interest rates.

SBA loan

SBA loan programs are financing options for small business owners where a portion of the borrowed amount is backed by the U.S. Small Business Administration. SBA loans offer lower interest rates and require smaller down payments than MCA providers and traditional bank loans, and eligibility is based on several factors including loan amount, credit score, and time in business. The SBA offers several different loan programs including the SBA 7(a) loan, SBA Microloans, and SBA Express loans. SBA loans are available through both alternative lenders, like Biz2Credit, and traditional financial institutions, like national banks.

Short-term loans

Term loans are a traditional type of loan where an approved borrower receives a lump sum payment upfront and repays the debt with monthly payments of principal and interest. Term loans that have repayment terms of less than 36 months are considered short-term and are approved based on the borrower’s creditworthiness. Short-term loans are best for entrepreneurs wishing to purchase inventory or cover working capital shortages. Long-term loans are an option for small business owners looking to make a large purchase, like equipment or real estate, who would benefit from an extended amount of time to repay the loan.

Bottom Line

Merchant cash advances can be a great financing tool for small business owners, like this digital solution developer, who was able to get a cash advance of $40,000 working with the right financing company. They are different from a traditional loan because there are no fixed repayment terms and financing costs are calculated using a factor rate instead of interest rates. Merchant cash advances work well for borrowers with bad credit scores that need funding fast, but the financing costs for MCAs can be higher than other loan options. Even if a cash advance is not for you, check out other loan options from Biz2Credit like a term loan or business line of credit.

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