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Merchant Cash Advances
Opens the doors to the financial world for many retailers. The merchant cash advance industry is growing at an amazing clip. This growth is due to the fact that traditional banks are not meeting the needs of small businesses.
This product is very unique. This is an asset purchase, not a loan, so we need to use specific language consistent with asset purchases, such as recovery rates and discount rates rather than interest rates. Much like factoring but it’s a sale that hasn’t happened yet.
A cash advance provider provides a lump sum cash advance to merchants. In return, merchants agree to pay back principal and fees, paying the company an agreed percentage of their credit card sales until their balance is zero. This percentage is between 12%-24%. The repayment time-frame is only 5-12 months.
Merchants typically must use the provider’s credit card processor because the advance is automatically returned as a percentage of each batch’s revenue. A small number of merchant cash advance companies do not require the merchant to change credit card processors. So if this is an issue, be sure to ask the merchant cash advance company you are considering 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 revenue and repay the merchant a daily percentage of that revenue.
Obtaining cash from traditional financing institutions can be difficult for some businesses, especially retail, restaurant, franchise or seasonal businesses. These merchants use credit card processing the most, so merchant cash advance programs offer many benefits.
Why traders love it
Cash is generally available faster than conventional loans. These programs are particularly attractive to retail and restaurant businesses because these types of businesses rarely have access to traditional funding, but also because of the immediate liquidity.
Most cash advance providers advertise that cash can be available in about 10 days. Unlike loans that have a fixed interest rate, payment amount, and set due date each month, credit card receivables with merchant cash advances are paid back.
Merchant cash advance programs are cash flow friendly, especially during seasonally slow periods. Conventional loans and leases require a set payment each month, whether the business makes sales or not. Because payments are calculated as a percentage of sales, amortization can be faster if sales are increasing, but if the owner experiences a business interruption or downturn, payments will decrease.
In most cases, business owners do not put up any personal collateral and do not provide any personal guarantees.
How providers make money
Finance charges can vary widely, not just from one provider to another, but from one advance to another. For example, the financing range can be as low as $1500 or as high as $4,000 on a $10,000 advance. This is 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 increasing, the advance provider collects the money quickly and the interest rate is high. Since there is no time limit for repaying the loan, the effective annual rate decreases as the payments are extended over time, even though the cash lender typically anticipates a very short period for repayment, usually less than a year.
There is no doubt that this type of financing will cost the merchant more than a traditional loan, but it is a foregone conclusion that a traditional bank will turn the merchant down for the loan they need.
Merchants interested in a program like this may have a sketchy or troubled credit history. They may have things like past tax issues, a list of delinquencies, collection cases, liens or judgments that are automatic red flags for a traditional bank. The merchant cash advance industry caters to businesses that cannot access traditional funding.
A risk worth taking
Cash advance providers carry risk and a fair amount of risk (hence higher value for money to the merchant), but they use sophisticated models to determine potential future credit card purchases. They also offer cash with a relatively short payback period to help reduce risk.
While getting approved for most bank loans is not that difficult, some cash advance providers will approve new merchants without a history of credit card transactions. Merchants will approve less than the amount they can earn from credit card transactions in a year.
The merchant cash advance provider takes all the risk, the risk is high, but since the money is paid from projected future sales, the risk is usually worth taking. Seasonal businesses that need cash to carry cash during the low season or merchants that have an unexpected downturn in business (ie due to road construction, building repairs, or extended illness) may need a cash advance until business resumes.
However, merchant cash advance companies say that ailing businesses aren’t the only ones interested in this type of program. Many types of business are usually undervalued by traditional funding agencies. Take a restaurant for example, it can be a very successful business, but a traditional bank wants to look at tangible assets. Perishable food or used restaurant equipment just won’t cut it, even if that restaurant is packed every night.
There are many instances when healthy small business owners can use cash to help build their businesses but are unable to obtain the necessary traditional funding. This includes franchisees who have exhausted their savings to purchase their first franchise and wish to open a second franchise; Merchants whose competitors have closed and have the opportunity to purchase their competitor’s old inventory or move to a new location; extension; shopping; Or just wanting to move quickly on a perceived new opportunity.
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