Cash Advances for Merchants
It opens the doors to the financial world for many retailers. The merchant cash advance industry is growing at an amazing rate. This growth is because traditional banks are not meeting the needs of small businesses.
This product is very unique. It’s a purchase of an asset, not a loan, so we have to use specific language consistent with purchasing an asset, such as recovery rate and discount rate rather than interest rate. It sounds a lot like factoring, but it involves a sale that has not yet been made.
A cash advance provider gives merchants a lump sum cash advance up front. In exchange, the merchants agree to repay the principal and fee, giving the company an agreed percentage of your credit card sales until your balance is zero. This percentage is between 12%-24%. The repayment term is only 5-12 months.
Merchants generally must use the vendors credit card processor because the down payment is automatically returned as a percentage of revenue for each lot. A small number of merchant cash advance companies do not require the merchant to change credit card processors. So if this is a problem, be sure to ask the merchant cash advance company you’re thinking of working with.
Cash advances are very different from traditional financing programs. In essence, merchant cash advance providers buy a small percentage of future MasterCard and Visa earnings, and the merchant pays this out as a daily percentage of that earnings.
Obtaining cash from traditional financial institutions can be difficult for some businesses, particularly retail, restaurant, franchise, or seasonal businesses. These merchants primarily use credit card processing, so merchant cash advance programs offer a number of benefits.
Why do merchants like it?
Cash is often available more quickly than with traditional loans. These programs especially appeal to retailers and restaurants, not only because these types of businesses can rarely get traditional financing, but also because of the immediate liquidity.
Most cash advance providers advertise that cash can be available in approximately 10 days. Unlike a loan with a fixed interest rate, amount due, and a set due date each month, with merchant cash advances, money is paid back as credit card receivables come in.
Merchant Cash Advance programs are cash flow friendly, especially during slow seasonal periods. Traditional loans and leases require a fixed payment every month, whether or not the business has made a sale. Because payments are calculated as a percentage of sales, if sales are up, payback may be faster, but if the owner experiences a business interruption or downturn, payments will be lower.
In most cases, business owners do not offer a personal guarantee or personal guarantee.
How vendors make money
Finance charges can vary widely, not only from one provider to another, but also from one down payment to another. As an example, the financing range for a $10,000 down payment could be as low as $1,500 or as high as $4,000. That’s a 60% difference.
There is no fixed interest rate; the effective interest rate varies depending on the business. If the merchant’s business is good and sales increase, the cash advance provider collects the money sooner and the interest rate is quite high. Since there is no time limit to repay the loan, the effective annual rate decreases as the payments are spread out over time, although the cash provider usually forecasts a fairly short period for repayment, typically less than a year.
There is no question that the merchant’s cost for this type of financing will be higher than a conventional loan, but it is virtually a foregone conclusion that a conventional bank will turn down this merchant for his much-needed loan.
Merchants interested in a program like this may have sketchy or distressed credit histories. They will have things like past tax issues, a delinquency list, collection issues, liens or judgments that would be an automatic red flag to a conventional bank. The merchant cash advance industry caters to businesses that cannot obtain traditional financing.
A risk worth taking
There is risk to cash advance providers, and quite high risk (hence the higher merchant cost for money), but they use sophisticated models to determine likely future credit card purchases. They also offer cash with relatively short payback periods to help mitigate risk.
Although approval is not as difficult as it is for most bank loans, few cash advance providers will approve new merchants without a history of credit card transactions. Even fewer will approve sums greater than what merchants can reasonably expect to earn from credit card transactions in a year.
The merchant cash advance provider assumes all risk, the risk is high, but since it is paid out of projected future sales, it is generally a risk worth taking. Seasonal businesses that need cash to get through lean seasons or merchants experiencing an unexpected downturn in business (for example, due to road construction, building repairs, or prolonged illness) may find the need for a cash advance. of cash until the business recovers.
However, cash advance merchants say struggling businesses aren’t the only merchants interested in this type of program. Many types of businesses are often underserved by traditional financing institutions. Let’s take a restaurant as an example, it could be a very successful business, but a traditional bank wants to see tangible assets. Perishable foods or used restaurant equipment just won’t cut it, even if that restaurant is packed every night.
There are many examples of times when healthy small business owners could use cash to help build their businesses, but are unable to obtain the necessary traditional financing. These include franchisees who have exhausted their savings to purchase their first franchise and want to open a second; merchants whose competitors have gone out of business and have an opportunity to purchase their competitor’s old inventory or move to a new location; expansions; acquisitions; or simply the desire to move quickly into a new perceived opportunity.