Understanding Merchant Cash Advances

What is it? What are the Pros and Cons?

When it is time to buy that new piece of equipment your business needs, a critical part of the purchasing process is the payment method you ultimately select.  Whether it’s an upgraded telephone system, a new lift for your garage or an oven for your restaurant, finding the right equipment is just one part of the procurement strategy.  This article discussing the merits of utilizing a merchant cash advance to acquire the equipment you are purchasing.  Like everything, there are upsides and downside to utilizing this option.    A merchant cash advance is not technically considered a ‘loan’. It is basically a lump sum of money paid to a business in exchange for a share of future sales.

How a Merchant Cash Advance Actually WorksMerchant Cash Advance

Let’s say that there is a business that needs an infusion of cash for one reason or another. Maybe they need to catch up on some bills, buy some equipment, renovate their workspace, expand to a new location, etc. (merchant cash advances can be used for virtually anything that has to do with your business).

Let’s say that this company tries to get a bank loan but is denied. Once they realize that their options are a bit limited, they might consider a merchant cash advance. In order to qualify for this type of cash payment, the business will need to be processing a certain number of credit card/debit card sales (generally at least $3,500 per month), will be required to have been in business for a specific amount of time (generally about a year), and will need to have no bankruptcies present on their credit record. Of course, there are a few additional terms—though in general they will have a good chance of getting approved if they can meet these.

Once approved, they will typically get their cash infusion within 7 days and will immediately begin making payments on it, though this is where merchant cash advances differ from more traditional types of loans. With merchant cash advances, businesses are not required to make monthly (or regular) payments at all. Instead, a small amount is deducted from each credit/debit card transaction and goes toward paying off the sum of the advance, plus interest. The amount of this deduction varies with the type of the loan and with the business, but it could range from 1% to as high as 18%. The exact amount depends upon the circumstances, the size of the advance, and on the business that is applying.

The major downside to merchant cash advances is how much they cost. They are available with little or no collateral and/or credit, but the equivalent interest rates range anywhere from 60% to 200% APR. This definitely makes them more costly.

Who Might Find this Type of Cash Advance Useful?Money Maze

According to an article published by Businessweek.com, there are over 50 different merchant cash advance providers, though not all of them are created equal. Some are definitely more ‘responsible’, and self-regulate to avoid scrutiny. One of the main problems that these types of businesses have faced is the ‘predatory loan’ stigma. Many people take one look at their high interest rates and see them as little more than glorified payday loans, though it is also fair to say that those with a stake in the industry would not classify what they do as a ‘loan service’.

The big difference between a loan and a cash advance is that a cash advance company will suffer a loss if the business goes under. Since they give out cash advances against future profits, they can’t collect if future profits are zero.

With that being said, there are many different types of businesses that could potentially benefit from them. Retail stores, restaurants, and service companies are examples of businesses within just a few of the different types of industries that are more likely to qualify for a merchant cash advance. Businesses that do larger volumes of credit/debit card sales are more likely to qualify for larger cash advances, as they are more likely to be able to pay the sum back (with interest) within 12 months.

Of course, one of the major benefits to a merchant cash advance is that they are based on your existing credit card sales. There are no monthly bills and no fixed payments. If you have a slow month, you pay less. If you have a busy month, you pay more. And once you pay it off, it’s gone.

Cash Advance Pros & ConsPros and Cons

Here are the basic pros and cons of merchant cash advances.

Pros

  • They require little to no established credit history
  • No monthly payments
  • No due date
  • Payments are based on your current cash flow… not an estimate that will require you to pay more per month than you might be able to afford
  • They can be obtained quickly

Cons

  • They are very ‘expensive’ when compared to options like cash flow loans or bank loans
  • You must already do a moderate number of credit/debit card sales every month just to qualify
  • New businesses, unless they have already really established themselves with a steady stream of revenue, might not be able to get approved
  • Fine print on the agreement can be extensive and restricting
  • Merchant cash advance companies are not bound by laws that regulate lenders (and in turn, interest rates), which can make some people uneasy

Conclusion

Merchant cash advances are definitely an option that businesses might consider, though you should always make sure to examine your current situation closely to find out what will work the best for you. The truth is that this option does have some negatives. These cash advances come with big price tags, though they can be a good option for people with no other way to get an infusion of cash quickly. Most agree that cash flow loans accomplish pretty much the same thing in a very similar way with a much lower cost—though again, it really all depends upon your situation.

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