What is a Merchant Cash Advance

A merchant cash advance is a type of funding where a lender provides a lump sum of cash to a business in exchange for a percentage of its future credit card sales. The lender typically receives repayment by deducting a portion of the business’s daily credit card transactions until the advance, plus fees, is fully paid back. Merchant cash advances are often used by small businesses that need quick access to working capital and may have difficulty qualifying for traditional business loans due to factors like credit score or time in business.

Why Small Business Owners May Need a Merchant Cash Advance

1. Cash flow needs: Small businesses may experience fluctuations in revenue and cash flow, making it difficult to pay for operational expenses, such as inventory or payroll. A merchant cash advance can provide quick access to capital, allowing the business to cover expenses during slow periods.

2. Expansion or growth opportunities: Small businesses may need to expand or take advantage of growth opportunities, such as opening a new location or launching a new product. A merchant cash advance can provide the necessary capital to make these investments, which can lead to increased revenue and profitability.

3. Seasonal business: Businesses that experience seasonal fluctuations in sales may require additional capital to cover expenses during slow periods. A merchant cash advance can provide the necessary funds to cover these expenses until sales pick up again.

4. Emergency expenses: Unexpected expenses, such as equipment breakdowns or a natural disaster, can disrupt a small business’s cash flow. A merchant cash advance can provide the necessary funds to cover these expenses, ensuring that the business can continue to operate.

5. Limited access to traditional financing: Small businesses that have a limited credit history or poor credit score may have difficulty qualifying for traditional business loans. A merchant cash advance can provide an alternative financing option for these businesses.

How Merchant Cash Advances Work

1. Lump sum funding: A merchant cash advance provides a lump sum of cash upfront to a business in exchange for a percentage of its future credit card sales.

2. Repayment structure: Instead of a fixed repayment schedule, the lender receives repayment by deducting a percentage of the business’s daily credit card transactions until the advance, plus fees, is fully paid back.

3. Factor rate: Merchant cash advances charge a factor rate instead of an interest rate. This rate is a multiplier of the original amount borrowed and is typically expressed as a decimal, such as 1.2 or 1.5. For example, if a business borrows $10,000 at a factor rate of 1.3, the total amount due would be $13,000 ($10,000 x 1.3).

4. Holdback percentage: The holdback percentage is the portion of daily credit card sales that the lender deducts from the business’s account until the advance is fully repaid. This percentage is typically between 10% and 20% of daily credit card sales.

5. Term length: Merchant cash advances typically have shorter repayment terms than traditional loans, with repayment periods ranging from 3 to 18 months.

6. Use of funds: There are typically no restrictions on how the business can use the funds from a merchant cash advance. The business can use the funds for any operational expenses, such as payroll, inventory, or marketing.

7. Fees: In addition to the factor rate, there may be other fees associated with a merchant cash advance, such as an origination fee or processing fee. These fees can add to the total cost of the advance, so it’s important to understand all the costs associated with the funding before agreeing to the terms.

It’s important to note that merchant cash advances are not considered loans but rather purchases of future credit card sales, which means that they are not subject to the same regulations as traditional loans. As a result, the fees and rates associated with merchant cash advances can be higher than those of traditional loans.

How is the Amount of a Merchant Cash Advance Funding Determined?

1. Credit card sales volume: The amount of funding a business can receive through a merchant cash advance is typically based on its monthly credit card sales volume. Lenders will typically look at a business’s past credit card processing statements to determine the amount of funding it qualifies for.

2. Time in business: Most lenders require businesses to have been in operation for a minimum of 6 to 12 months to qualify for a merchant cash advance. The longer a business has been operating, the more likely it is to qualify for a larger advance.

3. Business type and industry: Some industries, such as restaurants and retail, tend to have higher credit card sales volume than others. Lenders may offer larger advances to businesses in these industries.

4. Repayment history: If a business has a history of making timely payments on previous merchant cash advances, it may be able to qualify for a larger advance in the future.

5. Financial stability: Lenders may also look at a business’s financial stability, including its revenue, profitability, and credit score, to determine the amount of funding it qualifies for.

Once these factors are taken into account, the lender will determine the amount of funding the business is eligible for and offer a lump sum of cash upfront. Keep in mind that the amount of funding a business can receive through a merchant cash advance is typically less than what it could receive through a traditional business loan, due to the higher fees and rates associated with merchant cash advances.

How is Repayment Structured for a Merchant Cash Advanced?

Repayment for a merchant cash advance is structured differently than traditional loans. Here’s how it works:

1. Percentage of daily credit card sales: Instead of a fixed repayment schedule, the lender receives repayment by deducting a percentage of the business’s daily credit card transactions until the advance, plus fees, is fully paid back.

2. Holdback percentage: The holdback percentage is the portion of daily credit card sales that the lender deducts from the business’s account until the advance is fully repaid. This percentage is typically between 10% and 20% of daily credit card sales.

3. Repayment term: The repayment term for a merchant cash advance is typically shorter than a traditional loan, ranging from 3 to 18 months. However, the actual term depends on the amount borrowed and the holdback percentage agreed upon.

4. Repayment frequency: Repayment frequency varies, but it is often daily or weekly, with payments being automatically deducted from the business’s credit card sales.

5. Fixed fees: In addition to the percentage of daily credit card sales, some merchant cash advance lenders charge fixed fees, such as an origination fee or processing fee, which are deducted from the lump sum upfront. These fees can increase the overall cost of the advance.

It’s important for businesses to understand the repayment structure and associated fees before agreeing to a merchant cash advance. While this repayment structure can provide flexibility for businesses with fluctuating revenue, it can also result in higher costs than traditional loans, especially for businesses with high credit card sales volume.

What are the Advantages and Disadvantages of Merchant Cash Advances?

Advantages:

1. Quick access to funding: Merchant cash advances are typically approved faster than traditional loans, with some lenders offering funding within a few days.

2. No collateral required: Unlike traditional loans, merchant cash advances are unsecured, meaning they don’t require collateral, such as property or equipment.

3. Easy qualification: Qualifying for a merchant cash advance is relatively easy, as lenders typically look at a business’s credit card sales volume and time in business rather than credit scores or financial statements.

4. Flexible repayment structure: The percentage-of-sales repayment structure can provide flexibility for businesses with fluctuating revenue, as the repayment amount adjusts based on the business’s credit card sales.

Disadvantages:

1. High fees and interest rates: Merchant cash advances often come with higher fees and interest rates than traditional loans, resulting in a higher overall cost of borrowing.

2. Short repayment terms: The repayment terms for merchant cash advances are typically shorter than traditional loans, resulting in higher daily or weekly repayment amounts.

3. Limited borrowing amount: The amount businesses can borrow through a merchant cash advance is typically lower than traditional loans, due to the higher risk associated with the unsecured nature of the advance.

4. Impact on cash flow: The percentage-of-sales repayment structure can impact a business’s cash flow, especially if sales decrease or if the business has other fixed expenses.

It’s important for businesses to carefully consider the advantages and disadvantages of merchant cash advances and to evaluate all available funding options before deciding on the best course of action.

Qualifying for a Merchant Cash Advance

1. Time in business: Most lenders require businesses to be in operation for a minimum period, usually at least 6 months to a year.

2. Monthly revenue: Lenders typically require a minimum monthly revenue, which can vary from lender to lender but is generally in the range of $5,000 to $10,000.

3. Credit card sales volume: Merchant cash advances are based on a percentage of future credit card sales, so lenders will evaluate a business’s historical credit card sales volume to determine the maximum amount that can be borrowed.

4. Credit score: While some merchant cash advance lenders don’t require a minimum credit score, others may look at credit scores to determine the interest rate and fees.

5. Business type: Some industries are considered higher risk than others, such as bars, restaurants, and retail stores, and may have different eligibility requirements.

6. Other factors: Lenders may consider other factors, such as the business’s cash flow, outstanding debt, and profitability.

It’s important to note that qualifications can vary by lender, and each lender may have its own specific requirements. Therefore, it’s essential to shop around and compare offers from different lenders to find the best fit for your business.