A merchant cash advance isn't for every business, but it's a great option for some. Learn if it's right for you and how to choose a provider.
When it comes to financing your business operations, you have a number of different choices. There are traditional bank loans, SBA loans, equipment loans, crowdfunding, hard money lenders … the list goes on. But one of the best, and arguably most underutilized, types of financing is a business cash advance, also known as a merchant cash advance.
But with so many different providers and terms, how do you choose the right one? This article will help you better understand the process.
What is a merchant cash advance?
According to OnDeck, a merchant cash advance allows a business owner who accepts credit card payments or has other payment or receivables streams to obtain an advance of the funds regularly flowing through the business's merchant account. A merchant cash advance (MCA) is not a loan, but rather an advance based upon the future revenues or credit card sales of a business.
In a merchant cash advance situation, an agreement is formed between the provider and the small business on specific terms – such as the advance amount, holdback percentage and payback amount. Once these are agreed upon, money is transferred directly into the business's account, and in return, the business promises to pay a percentage on future receivables.
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Repayment is based on a percentage of the daily balance in the merchant's account. So, the more transactions a business completes in a day, the faster the repayment happens. If transactions are slow for a period, the repayment is also slower.
Merchant cash advance providers generally evaluate risk rather quickly by using some different rules of thumb. Whereas a bank has to go through multiple evaluation stages, all a merchant cash advance provider cares about is the history of daily receivables and/or credit card receipts and whether the business can pay back the advance in a timely manner.
Benefits of a merchant cash advance
Now that you understand what a merchant cash advance is and how it works, let's quickly analyze some of the biggest benefits associated with them.
1. High approval rate
Merchant cash advances are often sought out for their high approval rate. If you have bad credit, it's not going to prevent you from getting an advance. Your score could be below 500 and, as long as your receivables align, you could still get an advance.
2. No collateral
Another beautiful thing about merchant cash advances is that there's no collateral attached to the advance. It's a sales transaction, and nothing is noted on your credit report. The provider is the one taking all of the risk.
3. Flexible use of capital
Whereas some lenders tell you exactly how you can use the money they lend you, you can use a merchant cash advance any way you want. You could use it for marketing and advertising, buying equipment, paying employees, purchasing real estate, paying rent, or anything in between. It's yours to spend how you please.
4. Simple payback
Finally, you'll appreciate the easy payback process. Because your merchant cash advance is revenue-based, you only have to pay back the advance in proportion to the volume of sales you complete. In other words, it's nearly impossible to get yourself in a position where you can't repay.
5 tips for choosing the best cash advance provider
Once you decide that a merchant cash advance is right for you, you'll begin to realize just how many providers there are. Here are some guidelines for selecting the best one:
1. Compare interest rates.
Because merchant cash advance providers are essentially giving you money in return for something you don't have yet, they charge really high rates. They don't ask for collateral, but they want the effort to be worth it. As a result, they charge high rates and fees. The rate from one provider to another can vary rather dramatically, so do your research.
2. Consider industry experience.
Most businesses don't realize that industry experience plays a big factor in being successful with a merchant cash advance. You want to make sure the provider you're considering has worked with other businesses in your niche – or at least businesses with similar revenue models.
For example, if your business accepts retainer payments, will you be restricted in how you can use that cash? Get clear on little nuances like this before reaching an agreement.
3. Research reviews and reputation.
A merchant cash advance provider may win you over with a well-designed website and enticing promises, but does it live up to its claims? You'll be communicating a lot with your provider during the repayment process, and it's a much easier experience if you feel comfortable with them.
Do some research online and read reviews. You can also ask around if you know business owners who have taken out advances for their own companies. An easy customer service experience is worth its weight in gold.
4. Read the fine print.
It's imperative that you read the fine print and carefully consider all terms before signing any document with a provider.
"Since MCA providers are technically not lenders, merchants have little recourse to government regulatory support should the relationship go awry," VendorSeek notes. "Without protection from the Truth in Lending Act, Electronic Funds Transfer Act, and Fair Debt Collection Act, merchants have to rely fully on the contract for legal protection."
5. Trust your gut.
At the end of the day, think about whether a certain provider feels right. Is it asking the right questions and showing a genuine interest in your business, or does it feel like it's treating you like just another customer? If it isn't pulling out all of the stops now, then chances are you won't get treated well after you sign the dotted line.
Merchant cash advance to the rescue
A merchant cash advance isn't for every business. It typically works best for businesses that complete a large volume of credit card transactions on a monthly basis – and your margins have to be big enough that you can absorb the factor rate and holdback percentage. But, assuming that all the numbers line up appropriately, it's a fantastic option.