It opens doors to the financial world for many retailers. The merchant cash advance industry is growing at a staggering rate. This growth is due to traditional banks not meeting the needs of small businesses.
This product is very unique. It is a purchase of an asset, not a loan, so we have to use specific language consistent with the purchase of an asset, such as the recovery rate and the discount rate rather than the interest rate. It looks a lot like factoring, but it is a sale that has yet to be made.
A cash advance provider gives merchants a lump sum cash advance up front. In return, merchants agree to repay the principal and fee, giving the company an agreed percentage of their credit card sales until their balance is zero. This percentage is between 12% and 24%. The repayment term is only 5 to 12 months.
Merchants should generally use the vendors’ credit card processor because the advance is automatically refunded as a percentage of the proceeds of each batch. A small number of commercial cash advance companies do not require the merchant to change credit card processors. So if this is a problem, be sure to ask the commercial cash advance company you are thinking of working with.
Cash advances are very different from traditional financing programs. In essence, merchant cash advance providers purchase a small percentage of future MasterCard and Visa income, and the merchant repays it as a daily percentage of that income.
Obtaining cash from traditional financial institutions can be difficult for some businesses, particularly retailers, restaurants, franchises, or seasonal businesses. Credit card processing is most often used by these merchants, so merchant cash advance programs offer a number of benefits.
Why do merchants like it?
Cash is usually available more quickly than with traditional loans. These programs especially appeal to restaurant and retail traders, not only because these types of businesses are rarely able to obtain traditional financing, but also because of the immediate liquidity.
Most cash advance providers advertise that cash can be available in about 10 days. Unlike a loan with a fixed interest rate, the amount owed and the due date set each month, with merchant cash advances, the money is returned as the credit card accounts receivable comes in. .
Merchant Cash Advance programs are conducive to cash flow, especially during slow seasonal periods. Traditional loans and leases require a fixed payment each month, whether the business made a sale or not. Because payments are calculated as a percentage of sales, if sales are growing, payback could be faster, but if the owner experiences any business interruption or slowdown, the payments will be lower.
In most cases, business owners do not offer personal guarantees or offer personal guarantees.
How Suppliers Make Money
Finance charges can vary widely, not just from one provider to another, but from one advance to another. For example, the funding range for a $ 10,000 advance could be as low as $ 1,500 or as high as $ 4,000. That is a 60% difference.
There is no fixed interest rate; the effective interest rate varies by business. If the merchant’s business is doing well and sales increase, the prospective supplier collects the money earlier and the interest rate is quite high. Since there is no time limit for repaying the loan, the effective annual rate decreases as payments are spread over time, although the cash provider generally forecasts a fairly short payback period, usually less than a year.
There is no doubt that the merchant cost for this type of financing will be more than a conventional loan, but it is almost a foregone conclusion that a conventional bank will turn down this merchant for his much needed loan.
Merchants interested in a program like this may have bad or bad credit. They will have things like past tax problems, a delinquency list, collection issues, bonds, or judgments that would be an automatic red flag for a conventional bank. The merchant cash advance industry caters to businesses that cannot obtain traditional financing.
A risk worth taking
There is risk for cash advance providers and quite high risk (hence the higher cost to the merchant for the money), but they use sophisticated models to determine likely future credit card purchases. They also offer the cash with relatively short payback periods to help mitigate risk.
Although approval is not as difficult as it is for most bank loans, few cash advance providers will approve new merchants without a history of credit card transactions. Even fewer will approve larger sums than merchants can reasonably expect to earn from credit card transactions in a year.
The merchant cash advance provider bears all the risk, the risk is high, but since you pay out of projected future sales, it is generally a risk worth taking. Seasonal businesses that need cash to get through lean seasons or merchants who have an unexpected downturn in business (for example, due to road construction, building repairs, or prolonged illness) may find a need for a cash advance until business recovers again.
However, commercial cash advance companies claim that troubled businesses are not the only merchants interested in this type of program. Many types of businesses are often neglected by traditional financial institutions. Take, for example, a restaurant, it could be a very successful business, but a traditional bank wants to see tangible assets. Perishable food or used restaurant equipment just won’t make the cut, even if that restaurant is full every night.
There are many examples of times when healthy small business owners could use cash to help build their businesses, but are unable to obtain the necessary traditional financing. These include franchisees who have exhausted their savings to buy their first franchise and want to open a second one; merchants whose competitors have closed and have the opportunity to purchase their competitor’s old inventory or move to a new location; expansions; acquisitions; or simply the desire to move quickly in the face of a new perceived opportunity.