In response to the current recession economy, financial institutions around the U.S. are being more tight-fisted then usual when it comes to lending out their capital, and one of the hardest hit sectors has been small business financing. As a result, a significant number of small and mid-sized businesses have been forced to seek out alternative sources of capital.
Enter the merchant cash advance market. This relatively new and unregulated industry has been a life preserver for businesses looking for a quick financing to improve cash flow or to cover an extraneous expense. But it has also been causing a stir among among financial industry watchdogs who caution that this form of financing may not be suitable for all businesses and that the lack of regulation opens the door to predatory practices.
HOW DOES A MERCANT CASH ADVANCE WORK?
A merchant cash advance (also known as a business cash advance) is a form of receivables financing that is based on future credit card sales. The financing company purchases a portion of these credit card transactions from the business at a discount (the rate of which is generally based on the business' sales history). The business then receives an instant lump sum of capital, while the financing company collects a fixed daily percentage of the business' credit card sales until the full agreed upon amount is paid off.
So, for example, the cash advance company might pay a business $20,000 up front with the agreement that it can collect $28,000 in future credit card receivables at a fixed daily collection rate of 15 percent.
Cash advance companies usually partner with a major credit card processors so that the money can be automatically deducted from the sales receipts.
Since payments are based on volume of sales, this means when sales are down the amount that is deducted for repayment of the cash advance will be accordingly reduced. This can ease cash flow when business is slow. But obviously, the higher the sales volume, the quicker the obligation is repayed.
Cash advance companies generally have a quick approval process. Usually applicants will be asked to fill out a short online application that will be reviewed within 24 hours. Upon approval, most companies claim that the money will be received within a week.
Though most cash advance companies offer a similar product, there are small differences in processing fees and requirements for funding. So it pays to shop around.
WHAT ARE THE REQUIREMENTS?
Generally, cash advance companies require that a business be in operation for a significant period of time in order to receive financing. The required operating time varies from company to company, but typically ranges from 3 to 6 months. Cash advance companies will further require a minimum amount of credit card sales per month, usually around $2,500- $3,000.
WHAT ARE THE BENEFITS?
This method of financing comes with several benefits that are particularly attractive to small businesses.
Unlike banks loans, there are no closing costs or upfront fees. In addition, there is usually no fixed timeframe for repayment of the cash advance; the deductions will just continue until the total balance has been repaid.. There is also no worry about making scheduled payments during periods of slow sales.
As mentioned above, this method of financing has the benefit of a quick approval process that requires very little preparation or paperwork, and since financing is based on future sales, credit and sales history are generally not a factor for approval. A cash advance also comes with no restrictions on the use of the money.
WHAT ARE THE DRAWBACKS?
One of the biggest drawbacks to financing with a merchant cash advance is that the cost of borrowing money is always going to be higher than getting a traditional loan. One can expect to be paying about 30% on the money received. These products should also be used responsibly. Applicants should make sure that they are clear with the company's terms and conditions, that the payback rate remains fixed, and that they can afford it. (If a business is operating on a sales margin that is less then 10%, then a cash advance is probably not a good option)
Though the majority of applicants receive approval for financing, a business must already be in operation (start-ups are generally not funded) and have a history of processing a significant amount of credit card sales per month.