Your company or small business might have just had a piece of equipment break or need to pay an unexpected bill quickly in order to stay in operation. However, your cash flow levels may not be enough to currently support it. You know that you need to borrow, but you may not be able to get a loan in time to cover your time-sensitive expense. As a result, you might turn to a merchant cash advance.
A merchant cash advance (MCA) is a type of financing that allows your business to leverage its future credit card sales as a way to get a quick cash infusion. This is a slightly costlier but quick and convenient option to be able to take care of unexpected expenses that your working capital may otherwise be unable to handle.
However, given that you may be about to undertake a large expense that impacts your small business’s future cash flow, you might be interested to know whether a merchant cash advance is right for you. You have come to the right place! In this post, we will review all the pros and cons of merchant cash advances to help make you confident in your decision. We’ll cover the following topics in-depth in this article:
What is a Merchant Cash Advance?
Before analyzing the pros and cons of a merchant cash advance, it might be helpful to get specific about what a merchant cash advance is exactly. A merchant cash advance originates from a lender, but it is distinct from traditional loans like term loans or bank loans. A merchant cash advance allows you to get quick and convenient access to cash to do with it what you need.
Usually, you will apply to a lender for a merchant cash advance with information about your previous credit card transactions and credit card sales history. You will apply with an amount of money in mind that you believe would be useful and affordable for your business. At this point, the lender will review your application and determine the amount that they can offer you and the conditions of the advance based on your credit card transactions. The application process and approval process are relatively straightforward for you to get business funding.
The lender will give you an offer with specific terms and information about the interest you will pay on your merchant cash advance. The exact amount of interest will vary depending on factors like your credit score, your state, and other information. You should be cognizant when reading through these documents, as the terms of the advance can be different from those of a regular loan and substantially affect your business operations. You should also be aware that this type of funding does not require collateral, which may be an advantage to you and your business.
How does a Merchant Cash Advance Work?
A merchant cash advance can be a little complicated to understand in comparison to a traditional loan. This is because a merchant cash advance has a distinct structure. Rather than paying regular monthly payments of a sum of principal and interest, you pay back a portion of your credit card sales each day, for example. In addition, the terms of the advance will differ from a loan. It is important to consider these terms in light of the potential costs they will expose your business to.
Merchant Cash Advance Amount
The merchant cash advance amount is an important aspect of your merchant cash advance. It determines many factors that will end up affecting your small business or company’s overall expense of paying it back.
You will want to be sure to first only ask for the amount of cash that you think you will need for your expense. If you ask for too much, you will be paying for the advance at a much higher interest than other forms of funding that could help your small business instead. This disadvantage comes alongside some others, such as harming your future cash flow. Keep in mind that you can request a merchant cash advance amount that is at, greater than, or less than your monthly sales. However, the higher the amount you request, the greater the payback term will likely be.
Since the merchant cash advance is leveraging your future credit card sale receivables, you will want to be careful about how much money you are leaving your small business to operate with in the future. You will still likely have rent, wages, and inventory left to pay.
In any case, you should consider asking for the merchant cash advance amount to be exactly the amount you think you need quickly to help you cover the expense. Otherwise, it might be wiser to seek other forms of financing.
Since merchant cash advances are not like a loan in that there is no principal and interest payment each month. Instead of a typical interest rate which is charged by the month, a merchant cash advance works by way of what is known as a factor fee.
Your merchant cash advance will have an advance amount plus a factor fee. These are the two core financial obligations of your small business or company to the lender giving you a merchant cash advance. The sum of these amounts will be paid back in monthly amounts from a percentage of your credit card transactions daily in what is known as a holdback. Once the advance amount and factor fee are paid off, you are done paying back the merchant cash advance.
It is really important to pay attention to the factor fee, which is essentially the interest you are paying on your cash advance. Some of these can have APRs as high as 60, 200, or even 350. Some states in the United States regulate a maximum interest rate that can be charged. However, even at a maximum interest rate, the factor fee can be costly. In all, it contributes to making merchant cash advances one of the more expensive business financing options.
Another important financial obligation that your small business will be subject to under a merchant cash advance is known as a holdback amount. A holdback amount is a monthly percentage of your credit card sales which is set aside each day to pay back the lender for the merchant cash advance. You need to be cautious with this requirement as the requirement will affect the amount of money that your business receives in the future. That can make paying for ongoing expenses like labor, utilities, and inventory much more difficult. Whatever holdback amount you go with, it is best to spend time considering what your company can afford.
Qualifying for a Merchant Cash Advance
Given the unique and somewhat costlier structure of a merchant cash advance, you might not be surprised to learn that it is easy to qualify for a merchant cash advance. Indeed, qualifying for a merchant cash advance is much easier than qualifying for a conventional loan. It is also a more convenient and faster process.
If your small business is struggling to get funding or financing, you might be able to get a merchant cash advance. The availability of collateral and your credit score will be much less of an obstacle for getting a merchant cash advance, making the ability to qualify for a merchant cash advance much easier.
As you got to apply to a merchant cash advance lender, you will notice that they require far fewer documents and application information than traditional banks. For some of these lenders, the only thing that they need to see is your credit card sales. If you are interested in a minimum benchmark of credit card sales to qualify for a merchant cash advance, some estimate that you will need to have an approximately $2,500 minimum average in credit card sales monthly over the last six months.
It is likely that if your company has employees, you are probably already making enough in credit card sales and debit card sales to support your qualifying for a merchant cash advance.
Some additional things that a lender for a merchant cash advance might ask to see include the credit history of you and your business and what you intend to do with the advance. This helps the lender assess the riskiness of the advance that they will grant you. They will likely not ask for your bank statements.
Again, one of the beautiful parts of applying for a merchant cash advance is that the advances do not usually require you to put up collateral for the advance. This also means that you do not have to subject your personal assets to the advance in the event of a default.
Payment Mechanisms for a Merchant Cash Advance
Chances are if you are applying for a merchant cash advance, you are likely concerned about the speed of the merchant cash advance being granted and the funds being deposited into your bank account. The good news is that merchant cash advances are designed to be a quick way to get a lump sum of money to help your business immediately.
The typical period of time to wait for a merchant cash advance from application to funds deposited can range from two days to a week. This means that your company can get the funding it needs much quicker than with a bank, which can take up to several weeks before a decision is reached.
The payment mechanisms for the MCA provider, however, also work quickly. As mentioned, an amount of your card payments will be held every day to pay back to the lender. This allows for the lender to get their money back quickly, but it does add a time constraint to your money and diminishes the financial flexibility of your company.
A Merchant Cash Advance is not a Loan
One of the important things to keep in mind about a merchant cash advance is that it is not a loan. This is fundamental to understanding the likely financial obligations of your small business to your merchant cash advance provider and making good financial calculations and projections under the advance. However, it is also important to understand contextually. This is because your business may benefit more from a traditional loan in certain circumstances and a merchant cash advance in others.
One of the largest ways a merchant cash advance is different from a loan is how the amount of interest is calculated. At the beginning, you will know the amount of the merchant cash advance that obligates your company to pay back. This is the amount of the merchant cash advance and the factor fee. In a loan, while there are some fixed-amount loans where you pay a certain amount of interest for the entire period of the loan, they are not as common.
There are additional differences in the way you make payments back on the loan or advance. For instance, some loans allow you to pay back a loan early and avoid some of the interest. The interest for these loans can be calculated on the remaining principal you have left to pay. In the case of merchant cash advances, the payments are taken daily and the loan is only paid off when both the advance and factor fee are.
Moreover, whereas a loan has you to pay your obligation at the end of each month, with the source of funds being flexible as long as they come from your business, a merchant cash advance is structurally different. In a merchant cash advance, you are obligated to pay this form of financing with a portion of your daily credit card sales each day. As you can see, a merchant cash advance provider takes payment every day from a specific source of your business earnings.
While these differences are nuanced, they may be important to the best way of managing your cash flow for your small business. You should consider both the repayment period and the repayment terms you will be subject to. It is worth considering the best payment mechanisms and advantages of each option before choosing the type of loan or funding option which is best for you.
Use Cases of a Merchant Cash Advance
As you prepare to dive into the pros and cons of a merchant cash advance for your business, it might be worth it to consider the best use cases of a merchant cash advance.
In summary, the most efficient use of a merchant cash advance assumes a few things about the state of your small business. First, your small business is likely experiencing a large and unexpected cost or an opportunity that it cannot pass up. You need funding as fast as possible.
One such case is that you have a pizza restaurant and one of your only ovens breaks. The only way to get an oven back up and working again is to buy a new pizza oven. However, this pizza oven is extremely expensive for your small business. But, if you do not buy the pizza oven, your small business will miss out on a lot of revenue. Or, you might have a large purchase order for your small manufacturing plant. You will not be able to meet the order if you do not purchase an additional machine to add to your production line. If you cannot get the machine in a week, then you cannot accept a profitable purchase order. This is made worse by the equipment being expensive.
As you can see, in these cases, quick funding is needed for these businesses to be able to either continue operating or not miss out on very profitable opportunities. That brings us to the next assumption, which is that neither of these businesses have enough cash on hand to handle buying the equipment that they need. Correctly so, if they do not have enough cash on hand, these businesses will need to seek quick financing.
In these cases, it might make sense to leverage their credit card sales to get a merchant cash advance. This might be especially true if they do not have collateral available for the loan or have a bad previous credit history. This option might be more affordable if they are offered a lower factor fee or favorable terms. If the businesses are sure of their ability to pay off the merchant cash advance, these would be great examples of use cases for merchant cash advances.
In all, you need to consider your company’s unique financial and funding needs. If your situation is similar to the ones we reviewed, a merchant cash advance might be for you.
Pros of a Merchant Cash Advance
In any case, if you are trying to assess whether a merchant cash advance is right for your small business, you should review the pros of one.
Money is Quickly Deposited
One of the most obvious pros to merchant cash advances is that following a successful merchant cash advance application, money is quickly deposited into your account. This allows you to be able to go from a situation where you need money quickly to correct a failing piece of equipment, repair damage, or quickly cover an order to a solved issue in less than a week. This can help your business get back on track and operate profitably.
Easy Application and Qualification
As part of the advantage of a merchant cash advance being quick, merchant cash advances also come with an easy application. This can make the application quick and convenient for you, as a small business owner, to fill out. The limited documentation requirements further make this option more accessible for companies.
The qualification for a merchant cash advance is also easier. If you are struggling to get traditional forms of small business financing like SBA loans, traditional bank loans, or other types of loans, a merchant cash advance may be easier. The funding option does not require you to put up collateral or have a great credit score. Many businesses can get merchant cash advances simply off of their credit card receipts.
No Collateral Needed
As mentioned above, many merchant cash advance companies do not require you to put up any collateral. This allows you to protect your personal assets from the riskiness of the particular business adventure that you are about to embark on. Depending on the activities and assets of your business, this might make it easier to get funding as well. Some startups cannot put up collateral as easily, for example. Thus, merchant cash advances have a serious advantage in not needing collateral.
Bad Credit History is Okay
Some businesses have experienced financial difficulties in the past and have not met all of their loan obligations on time. Others may have bad personal credit. In either case, there is no need to worry. Based on the repayment mechanisms in a merchant cash advance, providers are less concerned about people making their payments. They are more concerned about whether the business continues to operate as its credit card processing records show.
Monthly Payments are Percentage-Based
One benefit of merchant cash advances is that the payments you make daily via your credit card sales are based on a percentage of your credit card sales. This means that if your sales are lower than your previous sales history shows, there is no need to worry. This can provide you with some assurance that your business will be able to meet its obligations for this part of the payments.
Your Owed Amount does not Grow
As discussed earlier, the amount that you owe on a merchant cash advance is a sum of the advance amount and the factor fee. While you will not get to pay less through early payments like with a loan, you will not pay more. This makes the estimated cost of a merchant cash advance to your business obvious from the start. This can help you make projections to determine if a merchant cash advance is right for you.
Payments are Processed Automatically
Since your credit card payments are subject to a holdback, your merchant cash advance will typically process your portion of the payment from your future credit card sales automatically. This makes the hassle of gathering your payment each month much easier. You can rest assured knowing that your payments are being made automatically. In any case, you can check with your provider about the details of your advance.
Cons of a Merchant Cash Advance
While it is important to know the pros of merchant cash advances for your small business, it is also vital to compare both the pros and cons of a merchant cash advance with one another.
In some cases, merchant cash advance providers can require you to be open for certain days or only take card payments. If this is the case, this could affect your profitability and subject you to a host of restrictions that make running your business less profitable. In all, it is important to read through the terms of any agreement you might be signing. This will also give more specific details about information that can be contextualized into pros and cons about the particular offer.
As a small business owner or the owner of a large company, you want to be sure that the terms of your funding are good. You do not want unexpected consequences. Given the absence of regulation and reputation for less flexible terms, you should be prepared to be cautious about the merchant cash advance offer you sign.
There are High Fees
As mentioned earlier in this blog post, merchant cash advances are subject to really high factor fees which leads to a high cost overall. The APR on these can range up to 60, 200, or even 350. This means that the merchant cash advance is one of the most expensive forms of funding available to your small business. While it does make sense in certain circumstances, you should be aware of the high fees that you are paying.
Inability to Change Holdback
While you do not need to worry about meeting a certain payment amount each month to pay back the merchant cash advance, you do have a holdback that you should be concerned about. Holdback can be difficult to deal with in periods with low sales. This is because you might need to stretch every dollar you take in from credit cards to be able to meet your obligations to suppliers, shippers, and employees, aside from the advance provider. As a result, this inflexibility can place a strain on your company.
One of the disadvantages of a merchant cash advance is that it is really for temporary funding solutions in your business when you need to access funding credit quickly. If you do not have a line of credit or are experiencing problems getting other funding options, you might be left with a merchant cash advance to turn to as a last resort. However, longer term, your small business will likely be unable to completely depend on merchant cash advances for funding.
Cash Flow is Damaged
Another con of a merchant cash advance is the effect that it has on your future cash flow. As a business that is generating income, you will also have expenses that you need to pay. The expenses will theoretically remain unchanged even after a merchant cash advance comes into place. However, the cash you have at the end of the day will be affected since some of your revenue from producing the same amounts of goods or services are being diverted to your merchant cash advance lender. This reduces your cash flow, and, in turn, creates additional cash flow problems for your business during the term of the merchant cash advance.
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