What is a Merchant Cash Advance?
A Merchant cash advance is a funding option for businesses that need access to money for operations, expansion or unexpected expenses. A merchant cash advance is not a loan; it is a purchase and sale agreement where the business receives a lump-sum payment in return for a portion of the business' future credit/debit card sales. When a provider purchases future sales, they do so at a discount. For example a provider may pay $20,000 up front for the right to collect $25,000 in future sales.
The merchant cash advance industry was developed in 1998 in response to declines in small business lending by traditional banks. According to FDIC data, the share of business loans going to small businesses has fallen from 51 percent in 1998 to just 26 percent today. Similarly, conventional bank loans to small businesses have declined by 21.8 percent since 2008. Cash advances for small businesses are one of the alternative financing options that have filled the void.
Unlike most bank loans, approval is based on the business' monthly cash flow, their ability to repay, as well as the volume of transaction revenue the business typically/historically runs through their business per month, not the business owner's personal credit history. Also, most typical small business loans must be backed by collateral, but collateral is not required for a merchant cash advance. These characteristics make funding more accessible to most small businesses.
How a merchant cash advance works.
In contrast to conventional bank loans and many other types of small business financing, a merchant cash advance is relatively simple: As a business owner, you receive an up-front payment in exchange for a fixed percentage of future credit and/or debit card sales.
An advance is not "free money." The up-front funding you receive will be less than the amount you repay because the provider receives a discount on your future sales. For example, if you receive $20,000 in funding, the discount might be $5,000, which would make your total repayment amount $25,000. Discounts vary according to the specific terms of each agreement, but typically range from $0.17 to $0.40 for each dollar funded.
Repayment is automated, with no need to write checks or transfer funds manually. Instead, your funding partner will receive a fixed percentage of your daily credit card sales directly from your payment processing system. Though the percentage is fixed, the repayment timeframe can vary due to the fluxuation in a business' daily sales. Many agreements schedule full repayment within six to 12 months.
It is important to note that the repayment term is flexible, since repayment is based on a fixed percentage of your credit card sales. If your sales decline one day, the amount repaid on that day will be reduced. Similarly, if your sales increase the next day, the amount repaid will increase, too. This is one of the key advantages of a merchant cash advance; you are not stuck with a fixed payment amount, as you would be with a typical bank loan.
9 Advantages of a Merchant Cash Advance
Conventional bank loans, in addition to being difficult for most small businesses to obtain, often require a great deal of paperwork that creates headaches for small business owners. In contrast, the merchant cash advance marketplace features streamlined processing and other benefits for small business owners.
- Easy to apply. Most applications can be completed online in just a few minutes. Reducing paperwork saves time and eliminates frustration.
- No personal collateral is required. According to Entrepreneur.com, collateral is what most traditional banks like to see when they loan money to a business. A merchant cash advance does not require collateral, so the funding does not have to be secured by the borrower's home or other personal property.
- Available even if credit history is not perfect. As reported at Inc.com, conventional bank loans usually require a stellar credit report. Merchant cash advance funding, however, is based on the strength of your business, so you may be eligible for funding even if there are blemishes on your credit report.
- Less time in business. A small business cash advance may be available after as little as four months in business; most traditional bank loans require two or three years of consistent profits before they'll lend to your business.
- Leverages cash flow, not assets. Businesses that do not have tangible assets to borrow against may still be eligible for a business cash advance if they have to cash flow to support a repayment plan.
- Fast funding. With a merchant cash advance, you will most likely receive funding within a matter of days. This can be a huge advantage when money is needed immediately.
- Flexible repayment. Since repayment is based on your daily credit/debit card sales, you aren't locked into a fixed payment amount. You repay the advance faster if sales go up, or take longer to repay if sales decline.
- Automatic repayment. Payments are automatically made from your bankcard processing system, so there's no need to write checks or transfer funds manually.
- Renewable. Many business cash advance agreements are renewable after a certain portion of the funded amount has been repaid; this can give your business additional flexibility in the future.
What's driving growth in the merchant cash advance industry?
The New York Times recently reported that big banks approve fewer than one out of five small business loan applications. According to the Small Business Administration (SBA), large banks shy away from loans to small business because they are less profitable. Community banks are more likely to lend, but Inc.com reports that even the smaller banks still reject nearly half of all small business loan applications.
Thus, the biggest factor in the growth of the alternative funding marketplace is the limited access that many small businesses have to other forms of financing.
Convenience is another important factor. Virtually all of the alternative funding providers use online business models that reduce underwriting costs and streamline the funding process. Businesses benefit by spending less time on applications and paperwork, getting faster approvals, and by receiving funds quickly.
Businessweek.com reports that there are now approximately 50 providers in the merchant cash advance marketplace. According to a Forbes.com report, experts estimated the size of the market at $500 to $700 million in 2013, with the potential to reach $3 to $5 billion within just a few years.
As more business owners become familiar with the benefits that merchant cash advance options provide, the marketplace will get more competitive and costs will continue to fall, making this an even more attractive option for many businesses.
What is the cost of a merchant cash advance?
On the surface, alternative funding options may appear to be an expensive way to fund your business. After all, you are essentially discounting your future sales. That's a good way to evaluate the cost of a merchant cash advance.
You probably offer discounts to your customers for a variety of reasons: to draw new business, increase average ticket, reward loyal customers, or sell slow-moving inventory. No business owner likes the idea of cutting prices by 20 percent or more, but most realize that discounting sometimes makes sense for the long-term health of the business.
Sometimes alternative funding options make sense for the same reason: When a short-term opportunity arises, the fixed cost of the merchant cash advance may outweigh the opportunity cost of doing nothing. In that case, the long-term prospects for your business may be improved if you sell a portion of your future revenue at a discount. Basically, what you can do with cash in-hand today can outweighs the discounted revenue you'll receive in the future.
For instance, consider a restaurant owner who has a limited-time opportunity to move to a location that will boost his sales by 20 percent or more. The benefits of acting quickly may offset the discount paid for a merchant cash advance that makes it possible. If he waits until he can finance the move from cash flow he may miss the opportunity completely.
Also, don't make the mistake of comparing the cost of alternative funding options to less expensive funding options that aren't available to your business. If not for the paperwork and delays, just about every business would prefer a low-cost SBA-backed bank loan, but the reality is that many businesses simply don't qualify for that option.
Comparing merchant cash advances & traditional business loans
The most significant difference between conventional business loans and alternative funding options is availability: Approval rates for alternative funding sources are much higher than approval rates for conventional bank loans, and many businesses that do not qualify for a traditional bank loan can get a merchant cash advance. Here's a comparison of some of the other important differences:
|Merchant Cash Advance||Traditional Bank Loan|
|Approval is based on ability to repay, not personal credit history||Approval is based largely on personal credit score|
|No collateral is required||Borrower usually has to supply personal assets as collateral|
|A flat-fee premium is added to the funding amount||Interest charges are incurred over time|
|Payment amount is variable; tracks actual sales volume||Payment amount is fixed|
|Repayment term is adjust based on credit card sales volumes||Fixed repayment term|
|Efficient pre-approval process, funding received within days||Approval and funding may takes weeks or months|
Merchant cash advance eligibility
There are two primary qualifications for receiving a merchant cash advance. First, your business must have a significant number of credit/debit card sales. Second, you need to have been in business long enough for potential funding partners to evaluate your cash flow and project your ability to repay.
Most potential funding partners require at least four months of sales activity before they will consider an advance. As a result, startups are not eligible. Businesses that may be eligible for an advance include:
- Brick-and-mortar retailers
- Online stores
- Franchise operators
- Food services/restaurants
- Beauty salons
- Auto parts and repair shops
- Hotel/motel owners
- Any business that handles a significant number of credit/debit card transactions
A business that does not handle many credit/debit card transactions may be eligible for other forms of revenue-based financing with terms that are similar.
Your business may still qualify for a business cash advance even if you have experienced one or more of the following:
- You have already been turned down by a bank
- You do not have a business plan
- You do not have personal collateral
- You have a bankruptcy that has been discharged
- You have a tax lien with a payment plan
7 ways your business can use a merchant cash advance
A small business needs to be nimble when opportunity arises, but sometimes that takes money that the business doesn't have on hand. And, as every business owner knows, there's often an opportunity cost that results when you don't have the funds needed to react quickly. As the New York Times reports, a merchant cash advance can provide fast funding when your business needs money to respond to special opportunities that can benefit the long-term health of the business.
A merchant cash advance gives you the flexibility to use it for whatever your business needs, including:
- Inventory or supplies. Use cash to stock up for a special promotion or to take advantage of special terms offered by your suppliers.
- Payroll. Staff up for the busy season or bring on new hires to support growth and expansion.
- Growth. Expand your existing store, open another location or diversify your product line.
- Remodeling. Fix-up or redecorate your business, buy new office furniture or modernize your retail store fixtures.
- Additional equipment. Purchase new computers, upgrade your point-of-sale systems, acquire additional equipment or vehicles for expansion.
- Advertising and promotions. Launch a marketing campaign, redo your web site or increase your ad budget to boost sales.
- Unexpected expenses. Make emergency equipment repairs, cover an unexpected tax bill, pay for professional services.
How to apply for a merchant cash advance
One of the benefits of a merchant cash advance is how easy it is to apply. Most providers have a convenient online application that can be completed in just a few minutes.
You'll improve your chance of being approved for funding if you work with a company that gives you access to a network of potential funding partners. Look for a company such as LendVantage, which carefully evaluates your company's needs to connect you a lending partner from the LendVantage network of leading merchant cash advance providers.
Your initial application will consist of your contact information, plus basic information about your business, including time in business, general sales information, industry, business structure (LLC, S Corp, sole proprietor, etc.) and your ownership amount.
Here are some specific application guidelines from LendVantage:
- You will need to provide the four (4) most recent months of business bank account statements
- LendVantage funding partners require you to have a personal credit score of 500 or higher to qualify
- LendVantage does not access your credit report when you apply, however, the funding partner selected for you will check your personal credit report to provide you with an accurate, viable funding offer
- There is no fee to apply, and you're under no obligation to accept any business loan/advance offer presented to you.
After submitting your initial application you'll usually receive a pre-approval notification within a few minutes. Once a funding provider has been selected, you'll work with them to determine the details of your advance. At that point, you'll be able to review the terms of the entire agreement. After the agreement is signed and accepted, you'll usually receive funding within a few days.
What to look for in a Merchant Cash Advance funding agreement
The key to selecting the right advance is to find a provider who understands the specific needs of your business. It's much easier to do this if you work with a company like LendVantage, which utilizes a network of funding partners; by considering a number of partners, you'll be more likely to connect with a provider who can help your business.
Merchant cash advance providers are usually specialists in funding small businesses. It's in their interest to carefully evaluate your business to ensure that your repayment terms do not jeopardize the health of your business.
According to Bloomberg Businessweek, a business owner's best preparation is to fully understand the terms of the agreement before signing up.
- Review the entire agreement
- If something is not clear, ask for clarification
- Be certain you understand the repayment terms, including the percentage of daily sales that will be applied to repayment and the premium you will pay
- Compare agreements from multiple providers, if possible
And, although many of the details are different, it may also be a good idea to review the Small Business Administration's advice on business loan agreements.
How Repayment Works
When you sign up for a merchant cash advance, your funds will usually be deposited in your business bank account with just a few days. At that point, the repayment process will begin.
Instead of writing a check or transferring funds once a month, you'll repay your advance out of your daily credit card receipts. Through a system known as "split processing," your credit card processor will automatically allocate the pre-set percentage of your credit/debit card sales to your merchant cash advance provider. With most agreements, payments will be made Monday through Friday, with no payments on weekends or holidays. Repayment continues until the advance and premium are repaid.
Your daily repayment is not a fixed amount; it is a percentage of your credit/debit card sales. Thus, the amount you repay will vary from day to day. If sales go up, your repayment goes up. If sales decrease, your repayment decreases, too.
For example, let's say have agreed to a repayment of 7 percent of your daily sales. On Monday, with sales of $1,000, your repayment amount will be $70. If sales fall to $800 on Tuesday, your repayment will be $56. And, when sales spike to $1,500 on Wednesday, you'll repay $105.
Remember, all of this happens automatically until you have paid off the entire merchant cash advance agreement. The flexible repayment process is a nice advantage for companies that experience fluctuations in sales volume that make it difficult to handle a fixed loan payment each month.