Merchant Cash Advances – Why and When a Small Business May Need One

The pitfalls of running a business are numerous, and can be very expensive. A key piece of equipment can break down when it’s needed most. A supplier can go belly-up, leaving you scrambling for a replacement. A sudden spike in demand can leave you flat-footed. If you need emergency business financing, are merchant cash advances a viable option? Alliant Business Systems takes a closer look.

What is a Merchant Cash Advance?

If you’ve been in business for any length of time, you may already be familiar with many types of traditional business loans. They’re a good option, given that you can get small business financing for capital projects, improvements, and expansion, normally with lower interest rates and good repayment terms.

However, bank loans take time to get, and involve a difficult qualification process that can take more time than some business emergencies will allow. A merchant cash advance is not a loan, it has a lower barrier of entry, the cash is delivered quickly, and the repayment terms are typically shorter. This has some upsides as well as some significant disadvantages, so it’s best for you as a business owner to go in with your eyes open.

How Merchant Cash Advances Work

A merchant cash advance requires a business to be open for a set period of time. Some companies will consider a business only open six months, while others require a year’s worth of receipts, or the same two-year period required by lenders. Merchant cash advances are similar to accounts receivable loans (which are secured against your future receipts), but are different in that they’re specifically issued against your future credit card receipts. Some will also require a personal guarantee or collateral.

A business cash advance can range from as little as $10,000 to as much as $1,000,000. The amount for which you qualify, and your repayment terms, will be determined by your daily receipts. This is a twofold process, using factoring (a multiplier that represents the interest charged, usually between 1.1 to 1.4) and a holdback percentage from your daily receipts that typically ranges between ten and thirty percent. Repayment terms are usually between 12 and 24 months.

Here’s how that works in practice. Your business borrows $100,000 with a 1.4 factor and a 30% holdback percentage. You’re paying 40% interest over the life of the loan (so the amount repaid will be $140,000). Now, let’s say you have $3,000 in credit card receipts daily. The 30% holdback percentage means that the cash advance issuer will be taking $900 off the top of your daily receipts until the loan is repaid. Other repayment plans may allow for fixed daily or weekly withdrawals via direct debit/ACH, which can come in handy for businesses with good cash flow but fewer credit card receipts.

Qualifying for a Merchant Cash Advance

What are the qualifications for a business cash advance? These can vary quite a bit between lenders, but let’s look at a fairly typical scenario illustrated by FitSmallBusiness:

  • $50,000+ in Annual Credit Sales
  • 2+ Years Accepting Credit Card Payments
  • 600+ Personal FICO Score
  • Credit Card Processor Account

Should You Consider a Business Cash Advance?

So what are the pros and cons of business cash advances? On the one hand, you can qualify quickly, with lower qualifications than you’d encounter with a bank, credit union, or SBA. You’re also likely to get that money in hand much faster, since the application process and disbursement alike are designed for speed.

On the other hand, a bit of back-of-the-envelope math quickly exposes a major flaw of merchant cash advances: they can be staggeringly expensive. If your business has uneven cash flow, or isn’t on solid footing, those expenses can be crippling. Furthermore, since many options require collateral or a personal guarantee, missed payments or default can be as personally ruinous as they are damaging to your business. As such, many sources tend to suggest them only as a finance option of last resort. It’s often better to do the harder work of business credit repair, followed up by careful business credit monitoring, so that you have access to cheaper funding that preserves more of your cash flow. For assistance doing just that, reach out to Alliant Business Systems for a free business credit consultation today.