Opens Doors to the Financial World for Many Retailers. The
merchant cash advance industry is growing at an astonishing clip. This
growth is because traditional banks are not meeting the needs of small
businesses.
This product is very unique. It's a purchase of an
asset, not a loan, so we have to use specific language consistent with a
purchase of an asset, like retrieval rate and discount rate instead of
interest rate. A lot like factoring but it's of a sale that hasn't yet
happened.
A cash advance provider gives merchants a lump sum cash
advance up front. In exchange, merchants agree to pay back the principal
and fee, by giving the company an agreed percentage of their credit
card sales until their balance is zero. This percentage is between
12%-24%. The payback time-frame is only 5-12 months.
Merchants
generally must use the providers' credit card processor because the
advance is paid back automatically as a percentage of each batch's
proceeds. A small number of merchant cash advance companies do not
require the merchant to change credit card processors. So if this would
be a problem, make sure to ask the merchant cash advance company you are
thinking about working with.
Cash advances are very different
from traditional funding programs. In essence merchant cash advance
providers purchase a small percentage of future MasterCard and Visa
revenues, and the merchant repays this as a daily percentage of those
revenues.
Getting cash from traditional financing institutions can
be difficult for some businesses, particularly retail, restaurant,
franchisees or seasonal businesses. These merchants most heavily use
credit card processing, so merchant cash advance programs offer a number
of benefits.
Why Do Merchants Like It
The cash is usually
available more quickly than it is with traditional loans. These programs
appeal especially to retail and restaurant merchants not only because
these types of businesses can rarely get traditional funding, but also
because of the immediate liquidity.
Most cash advance providers
advertise that the cash can be available in about 10 days. Unlike a loan
with a fixed rate of interest, amount due and set due date each month,
with merchant cash advances the money is paid back as credit card
receivables come in.
Merchant Cash Advance programs are cash flow
friendly, especially during seasonally slow periods. Traditional loans
and leases require a set payment every month, whether the business has
made a sale or not. Because payments are calculated as a percentage of
sales, if sales are growing, the amortization could be quicker, but if
the proprietor experiences some interruption or downturn in business,
the payments will be lower.
In most cases, business owners put up no personal collateral and make no personal guarantee.
How Providers Make Money
Finance
charges can vary widely, not just from one provider to another, but
from one advance to another. As an example, the range of financing on a
$10,000 advance could be as low as $1500 or as high as $4,000. That's a
60% difference.
There is no fixed interest rate; the effective
interest rate varies depending on the business. If the merchant's
business is doing well and sales are up, the advance provider collects
the money sooner and the interest rate is rather high. Since there is no
time limit on paying back the loan, the effective annual rate decreases
as the payments are extended over time, although the cash provider
typically forecasts a fairly short period for payback, usually less than
a year.
There's no question that the merchant's cost for this
kind of financing is going to come in more than a conventional loan, but
it's pretty much a foregone conclusion that a conventional bank will
reject this merchant for their much needed loan.
The merchants
interested in a program like this may have a sketchy or distressed
credit history. They'll have things like past tax issues, a list of
delinquencies, collection matters, liens or judgments that would be an
automatic red flag for a conventional bank. The merchant cash advance
industry caters to businesses that can't get traditional funding.
A Risk Worth Taking
There
is a risk to cash advance providers and a fairly high risk (hence the
higher cost to the merchant for the money), but they use sophisticated
models to determine the future likely credit card purchases. They also
offer the cash with relatively short payback periods to help mitigate
risk.
Although approval isn't 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 sums larger
than what merchants can reasonably expect to earn from credit card
transactions in a year.
The provider of the merchant cash advance
takes all of the risk, the risk is high, but since it is paid out of
projected future sales, it is typically a risk worth taking. Seasonal
businesses that need cash to carry them through lean seasons or
merchants who have an unexpected downturn in business (say because of
road construction, building repairs or extended illness) might find a
need for a cash advance until business picks up again.
However,
merchant cash advance companies say that ailing businesses are not the
only merchants interested in this kind of program. Many types of
businesses are often underserved by traditional funding institutions.
Take for example a restaurant, it could be a very successful business,
but a traditional bank wants to see tangible assets. Perishable foods or
used restaurant equipment just won't make the cut, even if that
restaurant is packed every night.
There are many examples of times
when owners of healthy small businesses could use cash to help build
their businesses but can't get the traditional funding necessary. These
include franchisees who have exhausted their savings to purchase their
first franchise and want to open a second one; merchants whose
competitors have closed and have the chance to buy their competitor's
old inventory or move into a new location; expansions; buyouts; or
simply the desire to move quickly on a perceived new opportunity.