What Is a Merchant Cash Advance?
A merchant cash advance (also known as business cash advance) is a form of financing by which small-business owners get a lump-sum upfront payment, in exchange for a pre-agreed percentage of future credit and debit card sales. Essentially, this equates to a business selling its future credit card sales to the merchant cash advance company at a discount.
Merchant cash advances can be an easy way for small businesses to get financing when other alternatives like traditional bank loans may not be available for a variety of reasons. Although a merchant cash advance can be much more expensive than other sources of financing like bank loans, there are several advantages like ease of availability, speed of funding, etc. that make merchant cash advances popular among small businesses.
Since a merchant cash advance is not a traditional loan – it is really a sale agreement – it is not regulated like a loan and does not have the same restrictions that come with a traditional loan. While this is beneficial to a business getting a cash advance, it can be very risky for the cash advance provider and therefore results in high premiums, that translate into a high effective interest rate compared to loans. See comparison with other financing alternatives.
Advantages and Disadvantages of Merchant Cash Advances
|Limited restrictions on use of funds||High rates, especially compared to loans|
|Quick approval and funding process||Short term financing|
|Potential tax benefits||Need significant credit card sales to qualify|
|Repayment amount based on actual sales|
|No impact on credit report|
|No other recourse for cash advance provider, i.e., no collateral or personal guarantee|
What do Merchant Cash Advance Companies Look For?
Cash advance companies are generally very similar in terms of what they look for in businesses. Good candidates for a merchant cash advance have generally been in operation for at least a year, which makes getting cash advances for start-ups rather difficult. In addition, cash advance companies generally ask to see credit card processing statements for at least six months. Other criteria like no prior bankruptcies, judgments or property liens are fairly standard for most cash advance companies. A strong credit rating is not required for a cash advance, but can help in getting better rates.
How Do Merchant Cash Advance Companies Get Paid Back?
There are generally three different repayment methods for the business:
Split Withholding: This is the most common (and preferred) method, through which finance companies collect funds from the small business. In this method, the business’s credit card processing company automatically splits the credit card sales between the business and the finance company according to the agreement (typically 10% to 22%) and pays the financing company directly. Since the credit card processor is responsible for splitting and paying the merchant cash advance company, the business getting a merchant cash advance is required to change its credit card processor to an approved processor.
ACH Withholding: Under this method, the merchant cash advance company receives the credit card processing information or statements and deducts its agreed upon portion directly from the business’s checking account via ACH.
Lock Box or Trust Bank Account Withholding: Under this method, all of the business’s credit card sales are deposited into a trust bank account controlled by the merchant cash advance provider and then the agreed upon portion is sent to the business via ACH, EFT or wire transfer. This method is generally not preferred by businesses, as there can be a one-day delay between credit card sales and the receipt of funds by the business.
Before You Get a Merchant Cash Advance, Ask Yourself These Questions
Before getting a merchant cash advance, ask yourself a few questions and determine if it is right for you. You may also want to see illustrative calculations for a merchant cash advance to understand it better.
- Can you qualify for cheaper financing, such as traditional bank or SBA loans?
- How quickly do you need the funds?
- Does the benefits of quick approval and access to funds outweigh the potentially higher costs associated with merchant cash advances?
- Do you have sufficient sales on credit cards to qualify you for a cash advance?
- Does the cash flow remaining after making daily payments to the cash advance provider leave you with enough to run your business?
- How flexible is the cash advance provider with respect to adjusting the daily retrieval rates, should your actual sales differ from expectations?
- Could you get financing from factoring, i.e., do you have accounts receivables?
Common Terms Used in Merchant Cash Advance
Business or Merchant Cash Advance Provider: A business that purchases the future credit card sales of another business in exchange for an upfront cash payment.
Advance Amount: The amount of cash given to a business upfront in exchange for a percentage of future credit card sales. Depending on the length of history and stability of sales, businesses can expect to get advances from 80% to 120% of the monthly average
Factor Rate (also called Provider Fee): The factor rate is the percentage of the advance amount that the merchant cash advance provider charges in exchange for the cash advance. The factor rate varies depending on the merchant cash advance provider and the riskiness of the business getting the cash advance, but is generally between 30-35% of the total cash advance. Rates as high as 75% may be charged by some cash advance providers, depending on the risk of the business the cash is being advanced to. Variables such as credit history, age of business, predictability of sales, etc. influence the factor rate.
Daily Retrieval Rate: The amount a merchant cash advance provider collects from daily credit card sales. This is typically expressed as a percentage and determines how fast the business will be able to pay off the cash advance.
Safe Retrieval Rate: Refers to the daily retrieval rate as a percentage, which is the portion of daily sales that are “safe” to use for daily repayment while leaving the business with sufficient cash flow to run itself. This percentage varies from business to business depending on the volume of credit card sales, the advance amount and the cash flow needs of the business.