HOW DOES MERCHANT CASH ADVANCE WORK?

A merchant cash advance is a form of financing that is based on future credit card sales. The company providing the financing will purchase a portion of these credit card transactions from your business at a discount. The rate of the advance is typically based on the historical performance and general health of the business. The applicant receives an instant lump sum of capital, while the financing company collects a fixed daily percentage of the business’s credit card sales, until the amount is paid off.

As a brief example, a financing company may advance a retailer $20,000 today for the right to collect $28,000 on their future credit card sales at a fixed daily collection rate of 10 percent. The financing company will partner with a credit card processor and collect the percentage from the retailer each day when credit card transactions are processed and batched.

WHAT ARE THE PROS?

Unlike bank loans, there are no closing costs or upfront fees. In addition, there is usually no fixed timeframe for repayment of the cash advance. Daily deductions will continue until the total balance has been repaid, which typically takes 6-8 months. As a fixed deduction percentage, there is no need to worry about making scheduled payments during periods of slow sales. Additionally, a cash advance comes with no restrictions on how or where it can be spent.

Cash advances generally have a quick and easy approval process. Applicants will be asked to fill out a short online application that will be reviewed within 24 hours. Upon approval, most companies will send the money to the applicant within a week. Since the financing is based on future sales, credit history is generally not a factor for approval. Companies typically give more weight to the underlying performance of a business rather than an applicant's personal credit score.

Cash advances are also easily renewable. Merchants can renew their funds when they’ve repaid at least 60% of their current advance. Renewing requires no need to complete additional paperwork, and providers can wire these funds into a merchant's account in as little as 48 hours. Merchants can also renew their advances as many times as they wish. 

WHAT ARE THE CONS? 

The money provided in a merchant cash advance is very expensive, often costing up to 30% or more of the original advance. This is due to the high degree of risk because the loan is unsecure and there is no collateral. The cash advance industry is known for being unregulated, leaving the door open to predatory acts. Business owners must scrutinize their contracts to understand the expense involved and ensure that the payback percentage remains fixed before signing the paperwork.

Before becoming eligible for a cash advance, merchants must build up at least a 6-month track record, because providers use monthly credit card sales to determine how much they qualify to receive. Startup businesses do not have a track record or merchant statements and therefore are ineligible for merchant cash advances. Providers also typically require a minimum amount ($2500-$3000) of credit card sales per month and no unresolved bankruptcies.

Merchants can easily find themselves addicted to or dependent on cash advances if the money is mismanaged or used to pay other compiling debt such as utility bills. These loans do not solve long-term budgeting problems and typically only offer a short-term solution. Advances that go unpaid are subject to compounding interest and hefty fees that can burden merchants with debt quickly.

SHOULD YOU GET A CASH ADVANCE?

The answer to this question undeniably depends on your unique circumstances. If your business is generating steady credit card sales and you have the ability to repay a loan, you should make the effort to apply for a bank loan. However, if you are unable to obtain financing through a traditional source and you really need the extra cash flow, merchant cash advance is an option. It’s important that you understand exactly how much the cash advance will cost you. If you have any doubts or lingering questions, you should consult your payment processor and your business accountant. They may be in a better position to analyze the health of your business and review realistic financing options, which will help you make an educated decision.