Most small businesses will require additional financing at some stage and bank loans are still the most common way to access the necessary funds. However, with the lending criteria for many banks still highly restrictive, it can often be a struggle for businesses – especially those without a suitable credit profile, collateral guarantees or a proven business track record – to secure the cash they need from traditional banks. Luckily, there are various alternatives to the high street lenders, such as merchant cash advances. Let’s examine what they are and whether they’re a good idea for your business.
What Is a Merchant Cash Advance?
Merchant cash advances are primarily designed for businesses that process the bulk of their sales through credit cards. After a merchant cash advance provider advances an agreed cash sum to your business, you repay that amount – plus a fixed fee – by allowing the provider to keep a small portion of your business’ monthly credit card sales. To calculate the exact amount you’ll need to repay, your business will be assigned your own rate together with the advance you receive.
As well as the factor rate, another variable with merchant cash advances is the ‘withholding amount’. This is the percentage of your business credit card sales that goes to the provider until the full amount is repaid. Merchant cash advances are typically used as short-term loans and generally repaid within six to nine months. However, it is worth noting that the withholding amount can vary greatly among providers, as well as depending on your volume of business sales and the amount you borrow. At the low end, merchant cash advance providers may only seek to withhold 5% of your monthly credit card sales. However, this figure can rise to 40% in some cases.
Repay Less When Business Is Slow
Because merchant cash advances work by recouping a fixed percentage of credit card sales rather than a fixed amount every month, they are ideal for businesses that experience fluctuations in sales. Let’s say your business has several slow months at the beginning of the year. If you take out a traditional bank loan, you may struggle to make the required payments during this lean period. However, with a merchant cash advance you simply repay less because you’ve earned less. Conversely, when you have a month of bumper sales, you will repay the same percentage but the amount will be much higher, helping you pay off the advance faster.
Fast Access to Your Cash
Traditional bank loans often come with a lot of paperwork, including business and personal credit checks as well as collateral guarantees. In contrast, the paperwork for merchant cash advances is typically light, as providers are primarily interested in your volume of business sales (as well as how long you have been in business – typically 12 months is required as a minimum). As a result, providing collateral on the advance is usually not required and even businesses with poor credit profiles should be able to obtain a merchant cash advance. All this means the turnaround between application and approval is extremely fast for merchant cash advances – usually a working week or less. This is extremely valuable for businesses that need fast access to cash, particularly if they are struggling to get approval for a bank loan.
Making the Right Choice for Your Business
If this all sounds too good to be true, it must be remembered that merchant cash advances carry their own associated risks. For example, before signing an agreement you must work out whether your business can afford to lose the agreed percentage of sales while still making your other payments, such as salaries, rent and supplier invoices. In addition, merchant cash advance ‘factor rate’ fees are usually much higher than the APRs associated with traditional bank loans. However, this is because merchant cash advances are designed as short-term loans and ordinarily repaid within a year.
As with any kind of borrowing, businesses need to consider the pros and cons of merchant cash advances and determine whether it is the best way to finance their business or not. While merchant cash advances are best considered a valuable way to access vital funds quickly and provide for quick growth, they’re probably not suitable as long-term credit vehicles. For this, business owners should seek to move from the ‘bridge loan’ of a merchant cash advance towards a longer-term bank loan with lower associated fees.
While most small businesses still look to banks for additional financing, there are a number of good alternative lenders offering niche services, with merchant cash advances increasingly popular among them. As such, if your business has a high volume of credit card sales and you want to use that to leverage some extra cash, a merchant cash advance may well be the best option for your business