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.

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 time frame 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. The marketplace will get more competitive and costs will continue to fall

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 m 2e849aeee2ad5d2c10b9f7dd78a10622-merchant-cash-advance-cost

ake 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