Liquidity is the superpower of every small business. With enough funding, your small business can pay suppliers on time, hire and compensate your staff, and have money to set up and run marketing campaigns that will take you closer to your goals.
Good cash flow offers a buffer against daily challenges that come with running small businesses. When your small business experiences cash flow challenges, you may need a quick fix to continue operating. Infact, 82 percent of American small businesses fail due to poor cash flow.
If your small business sales are shaky and highly variable, and you have fluctuating operation costs, you may have difficulties accessing traditional loans.
Many small businesses rely on merchant cash advances. The quick, less stringent eligibility requirements and collateral-free funding may be a viable option, but is it suitable for your small business? Let’s explore more.
What Is A Merchant Cash Advance?
A merchant cash advance as a funding option that allows your small business to temporarily deal with cash flow issues based on your future sales. It gives you an upfront sum in exchange for a certain percentage of your future sales.
A merchant cash advance is an ideal option for small businesses that have high credit card sales volume and are in need of quick funding but don’t qualify for traditional loans.
Merchant Cash Advance Companies
Many companies offer merchant cash advances, but they don’t operate equally.
Some cater to businesses with bad credit, others deal with businesses that use credit cards, and some offer higher limits.
Regardless of their categories, it’s advisable to choose a merchant cash advance company with good ratings, one that caters for your needs and has outstanding reviews within your locality.
How Do Merchant Cash Advances Work?
Traditionally, merchant cash advances have primarily worked for businesses with revenue from debit and credit card sales like retail shops or restaurants.
However, many merchant cash advance companies have extended their services to companies that do not rely heavily on debit or credit card sales.
Repayment Structure
Fixed withdrawals
With fixed withdrawals, a certain amount is repaid daily or weekly, based on your monthly revenue estimates. The payment amount doesn’t change regardless of the sales fluctuation.
Percentage of your daily sales
Here, the borrower agrees to pay the lender a certain percentage of the daily credit/debit card sales. This payment plan fluctuates daily based on your sales.
Contract terms
Although merchant cash advances don’t have stringent requirements, you will sign a contract. The contract will include:
Advance amount
This is the amount that the lender has agreed to advance to you. The advance amount may be equal to, or less than or even significantly more than your monthly business sales. However, the advanced amount depends on the actual financing the borrower needs.
Payback amount
The payback amount is higher than the advanced amount since it includes the lender’s fee known as a factor rate, plus the principal amount.
A factor rate determines the lender’s cost, and it ranges from 1.2 to 1.5 calculated based on the risk assessment of your business — the higher your risk, the higher your factor rate, and consequently, the higher your repayment fee.
For example, if your advance has a factor rate of 1.5 and your advance is $40,000, your total MCA repayment will be $60,000.00.
Holdback
Holdback technically keeps a certain percentage of your sales (credit card transactions) aside daily. The holdback percentage ranges from 10% to 20% and remains fixed until you fully repay your advance.
For example, if your business generates around $3,000 per day and your holdback percentage is 10%, you hold back $300 until you clear $60,000.00.
However, this may change depending on the fluctuation rate of your revenue. For example, if your sales increase, you may repay faster, if they fall, you may take a longer time.
How Can I Use A Merchant Cash Advance?
You can use a merchant cash advance to cover the following operation costs:.
- Paying pressing debts
- Working capital issue
- Unplanned expenses
- Purchase of inventory
- Payroll
- Temporary cash flow issues
Why Should You Consider A Merchant Cash Advance For Your Small Business?
As a financing option for small businesses, merchant cash advances have a some pluses like:
● They are quick
You can get a merchant cash advance in a week or less without the need for heavy documentation. It usually takes 24-48 hrs, on average.
● Little Or No Physical Collateral Required
Most merchant cash advances are unsecured; thus, you don’t need any physical collateral to get one. As such, you don’t risk losing your personal or business assets when you default.
However, most lenders require the borrower to provide a personal guarantee like a written agreement. Such an agreement makes the borrower personally responsible for repaying the advanced amount, and in case of default, gives the lender the right to recoup any incurred losses from you personally.
● Flexibility
When the sales are down, your payment amount reduces/adjusts but only when your repayment plan falls under the fixed percentage of your daily/monthly transactions.
● Easy approval process
Merchant cash advances are among the most accessible funding options to qualify for any business, regardless of the credit score. Lenders work with companies with bad credit, startups, and small businesses.
However, your qualification may affect your rates. For example, your factor rates and holdback percentage become higher if you have a bad credit score.
What Are The Disadvantages Of Merchant Cash Advances?
● Higher fees
While they are easy to access, merchant cash advances are an expensive form of funding. The rates, compared to traditional loans, are pretty high.
When you calculate the annual borrowing plus interest and all other fees, the percentage lies around 45% to 350%. A conventional bank loan is approximately 10% or less, 8%-99% for online loans and 12%-29.9% for credit cards.
● No Benefits If You Repay Early
Unlike traditional loans where you get interest savings for repaying early, the amount remains fixed for a merchant cash advance regardless of your repaying speed.
For conventional loans, your interest gets amortized when you repay early, thus paying less interest. Additionally, with a merchant cash advance, if you decide to refinance, you restart the whole process again, including repayment of applicable fees and early repayment penalty.
● No Federal Oversight
The merchant cash advances industry doesn’t follow the oversight of federal regulations. It does not fall under the loan category but as commercial transactions.
However, the Uniform Commercial Code regulates the operations, and each state has different regulations as opposed to the uniform banking laws.
● Danger Of Debt-Cycle
The ease and speed of receiving merchant cash advances can put your business into a debt cycle, especially if you do not have access to other financing options.
By borrowing soon after repaying, you may find yourself in need of another advance, thus making you a frequent borrower. This eventually leads to more cash-flow problems. And on and on it goes. For example, a daily repayment of $200 may be difficult for a small business, especially during slow sales periods.
● Confusing Contracts
The repayment structure and applicable fees can be quite difficult for an average small business owner to understand. Many merchant cash advance contracts have unfamiliar terms like specified percentage (your credit card sales repayment percentage), purchase price (given amount), and receipt purchase amount (the total of payback amount).
Additionally, with MCA, you may be required to sign a confession of judgment, thus forfeiting your right to defense once taken to court.
So Do You Think Merchant Cash Advance Is Suitable For Your Small Business?
Yes and No. Proceed with caution, but the choice of applying for a merchant cash advance depends on your urgency, purpose and ability to access other financing options. The flexible and fast funding may be a practical short-term financing option.
However, every borrower should be cautious and plan on increasing their credit card sales revenue to exceed the borrowing cost, read and fully understand the contract terms and work to avoid getting into a debt spiral. Merchant cash advances should be strictly a short-term solution.
