Why Do Merchants Like It
The cash is usually available more quickly than it is with traditional loans. These programs appeal especially to retail and restaurant merchants not only because these types of businesses can rarely get traditional funding, but also because of the immediate liquidity.
Most cash advance providers advertise that the cash can be available in about 10 days. Unlike a loan with a fixed rate of interest, amount due and set due date each month, with merchant cash advances the money is paid back as credit card receivables come in. A merchant cash advance (MCA) isn’t technically a loan, but rather acash advance based upon the credit card sales of abusiness.
Merchant Cash Advance programs are cash flow friendly, especially during seasonally slow periods. Traditional loans and leases require a set payment every month, whether the business has made a sale or not. Because payments are calculated as a percentage of sales, if sales are growing, the amortization could be quicker, but if the proprietor experiences some interruption or downturn in business, the payments will be lower.
In most cases, business owners put up no personal collateral and make no personal guarantee.
How Providers Make Money
Finance charges can vary widely, not just from one provider to another, but from one advance to another. As an example, the range of financing on a $10,000 advance could be as low as $1500 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 doing well and sales are up, the advance provider collects the money sooner and the interest rate is rather high. Since there is no time limit on paying back the loan, the effective annual rate decreases as the payments are extended over time, although the cash provider typically forecasts a fairly short period for payback, usually less than a year.
There’s no question that the merchant’s cost for this kind of financing is going to come in more than a conventional loan, but it’s pretty much a foregone conclusion that a conventional bank will reject this merchant for their much needed loan.
The merchants interested in a program like this may have a sketchy or distressed credit history. They’ll have things like past tax issues, a list of delinquencies, collection matters, liens or judgments that would be an automatic red flag for a conventional bank. The merchant cash advance industry caters to businesses that can’t get traditional funding.
A Risk Worth Taking
There is a risk to cash advance providers and a fairly high risk (hence the higher cost to the merchant for the money), but they use sophisticated models to determine the future likely credit card purchases. They also offer the cash with relatively short payback periods to help mitigate risk.
Although approval isn’t 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 larger than what merchants can reasonably expect to earn from credit card transactions in a year.
The provider of the merchant cash advance takes all of the risk, the risk is high, but since it is paid out of projected future sales, it is typically a risk worth taking. Seasonal businesses that need cash to carry them through lean seasons or merchants who have an unexpected downturn in business (say because of road construction, building repairs or extended illness) might find a need for a cash advance until business picks up again.
However, merchant cash advance companies say that ailing businesses are not the only merchants interested in this kind of program. Many types of businesses are often underserved by traditional funding institutions. Take for example a restaurant, 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 make the cut, even if that restaurant is packed every night.