How Does a Merchant Cash Advance Work?

What is a Merchant Cash Advance – You own a successful bistro – and the chance has come up for you to open a second location at a major real estate discount in an up-and-coming part of town. Or you’ve had a rush on your products and now you don’t have enough in the warehouse to keep the orders coming. Or a fire just devastated your warehouse, and you don’t have time to wait for the insurance check to keep things going. You’re not the first business owner who has seen a need for quick cash. However, if you don’t have collateral or if your credit is iffy, a small-business loan may not work for you – and even if your credit is solid, the banks like to take their time issuing financing. This is when you should consider a merchant cash advance.

Why? Approval rates for merchant cash advances are much higher than for small business loans, and you have the money a lot sooner. The cost of the money can be a lot higher – a rate factor of 1.40 of the advance (so if you took out a $50,000 advance, you’d end up paying back $70,000 in that case) – but rate factor can be as low as 1.15% if your risk profile is lower. And if the money ends up giving you that shot in the arm that you needed, it’s a lot better than having to close the doors.

How does cash advance work on credit card

So here’s how it works in the merchant cash advance industry. When you take out a merchant cash advance, you have to pay it back out of your daily debit or credit card sales. A traditional loan requires payments on a set schedule (weekly, bi-weekly or monthly), but you make a merchant cash advance payment every day on which you conduct business. A percentage of those card sales goes to the lender each day.

So you want to get a merchant cash advance to help you with the cost of opening that second location of your bistro. You have some of the money on hand, but you get approved for a merchant cash advance of $75,000 to help out. You have a factor rate of 1.3 (meaning that payback is 30%), so your total loan cost will be $22,500. This means that you’ll be paying back a total of $97,500. Generally, merchant cash advance lenders use a schedule of nine or ten months for the repayment, so they set your approval amount (and your daily percentage withdrawn) on how much you can afford to pay them back each day until you have the loan settled. Obviously, the more you sell through debit or credit cards, the faster you’ll pay the advance back.

Now, let’s say that the withdrawal rate is 10%. If you make $1,000 in credit and debit card sales on a particular day, then you get $900, and the lender gets $100. If you make $100 in credit and debit card sales, you get $90, and the lender gets $10. So when you have big days, you make a bigger payment, but when things aren’t so flush, you don’t have a fixed payment that will eat into your cash flow.

One thing to watch out for when you sign your contract is automatic re-advances. Obviously, there are some companies who start out on their payment plans and realize that they need more money than they thought. So they go back to the lender and ask to advance more money, back up to their original amount. So if you took out that $75,000 for that second location, and you’ve paid back $40,000 of the $97,500, you still owe $57,500 – but then you realize you need to upgrade the oven in that second location, so you go back and get more money to go back up to a $75,000 balance to help with the purchase. There’s nothing wrong with that – but you need to watch out for automatic re-advances. Some lenders put provisions in that if you pay off a certain amount, you get more money to go back to your original balance. If you need the money, that’s one thing – but it is an expensive form of lending, so if you don’t need it, you shouldn’t have to pay for that financing.

Need the skinny on Merchant Cash Advances? Look no further.

Needing some short term cash in a hurry is an experience that many small business owners go through, so if this describes you, you’re far from alone. For many small entrepreneurs, a merchant cash advance (MCA) has made the difference to help get them through a rough patch or to fund an expansion. It’s important to find a provider who you can trust and understand how the advance works before you sign the paperwork. Let’s take a look at some of the basics of this innovative form of business credit.

How do merchant cash advances work?

Once your business gets approval, your business gets a check for a lump sum. In most cases, you can expect funding in a week, if not sooner, because there’s a lot less red tape to work through with the approval process. This is a major plus for companies that are in a bind financially.

You pay the advance back through your future sales. If you don’t have much in the way of collateral, or if your business has poor credit, but if you do a lot of sales through credit and/or debit cards, this can be the right deal for you.

An MCA is different from a loan. You’re exchanging future sales for cash now. So you won’t make a payment every month or every quarter; instead, the provider takes an agreed amount right out of your daily credit and debit card sales. This happens every business until you have paid back the total agreed amount.

You can expect your provider to put together terms that will bring their money back between 6 and 12 months, depending on the situation. You also want to pay attention to retrieval rate (the amount of money that comes out of your credit/debit card sales each business day) and to factor rate (the multiplier that determines how much the advance costs you).

Let’s check out the benefits and drawbacks of this type of credit, so that you know what you’re going into when you take out this advance.

Advantages of an MCA

  • Your personal assets don’t go in as collateral. This is an unsecured loan, and if your business goes down the tubes, you won’t be personally liable for the balance due.

  • You don’t have a set weekly, monthly or quarterly payment. So if you have a down cycle in your business, you pay less back, and you don’t have to pay any fees as a result either.

  • You get the money quickly. Approval takes a business day or two in most cases, and your advance gets funded within a week. You don’t have to send in a ton of documentation, and you don’t have a stack of papers to sign. The provider will check your incoming credit card receipts to ensure that you’ve been getting what you say you have, and you’ll have to give them some bank statements as well to show the financial health of your company.

Disadvantages of an MCA

  • The costs are high. You can expect an effective APR of 50 to 60 percent, and it could go even higher if you end up paying the loan back faster, because there’s no benefit to paying it back early, except you don’t have a provider taking out some of your sales over a longer period of time.

Basic Concepts of an MCA

The factor rate is set by the provider and indicates how much you have to repay. If you take out $60,000 with a factor rate of 1.2, you pay back $72,000 ($60,000 x 1.2).

The retrieval rate tells you how much of your debit and credit card sales the provider takes out each day. If the retrieval rate is 10%, then you can expect 10% of your receipts each business day to go to the provider until you’ve paid back the agreed amount in full.

Tips for Getting the Best Deal

Get the retrieval rate lower even if it means a higher factor rate, because it allows you to get more of your revenue while you’re paying the loan back.

Is an Advance Right for You?

If you’re having a hard time finding financing for your short-term needs as a small business owner, you’re not alone. Banks have become a lot more conservative about their lending practices since the 2007-2008 global recession, and they haven’t really loosened up the purse strings since then. That means that a lot of small business owners aren’t getting the loans they deserve, even though they have companies that do well and bring in consistent revenue.

However, sometimes big things happen, whether it’s a quick change in your inventory, or a chance to expand that has a short time window. That’s when MCAs can make the difference for your company.

Want to learn more? Contact Amansad Financial. We’ll be happy to talk you through your current situation and recommend your next course of business.