Given the number of small businesses in operation today, it’s no surprise that there are millions of them that accept credit and debit cards as a form of payment, and every single one of those businesses need some way to get their money from the customer’s bank to their own. These payments are facilitated by companies called merchant processors, payment processors, or sometimes merchant acquiring banks. These organizations move funds between the customer’s bank and the bank of the acceptor for a fee – also known as interchange.
The processing companies may offer additional financial services in the form of advances or loans, which can be attractive to a business because they allow a lump sum payment before all of the credit card charge income is received. Like anything money-related, though, merchant advances aren’t always the best or even a good option given a business owner’s circumstances. In this post, we’ll take a look at how merchant cash advances work and when they might be a good option for a business or a bad one.
What are Merchant Cash Advances?
The basic concept of a merchant cash advance isn’t all that different from that of a consumer cash advance: the advance companies provide funds based on estimated future income and receive a fee or interest in return. Instead of a consumer cash advance which may draw the repayment from a paycheck or some other form of income, the merchant cash advance company simply takes their “cut” from the daily card income that the company generates. Also, unlike consumer advances, merchant cash advance companies do not call or consider themselves lenders. Their services are described more as a sale of future credit or debit card sales.
Merchant cash advances are attractive because repayment amounts correspond directly with the amount of card revenue the business generates. If sales slow and income dips, so do the payments to the merchant cash advance company. Advances are also easier and faster to obtain than loans are, because there may not be the typical credit approval and processing requirements – they generally look at business performance and revenue generation more than personal credit scores. This means that business owners who might not qualify for a traditional loan may have a much better obtaining a merchant cash advance.
Benefits of Merchant Cash Advances
There are many reasons that a merchant cash advance may be an attractive option for a business in need of funding:
- Speed – Merchant cash advances do not have to follow the loan credit and application process, which means that advances are typically much faster than more traditional loans.
- Flexibility – Since the merchant cash advance is not a loan and is considered a sale of future revenues, the advanced funds can be used for any purpose. Loans are usually tied to a specific purpose and can only be used as agreed, but merchant cash advances are free and clear of those restrictions. This makes them a useful option for a business owner in need of emergency or fast funds.
- Repayment – As mentioned earlier, the repayment of a merchant cash advance is completely dependent on the amount of revenue being generated. Unlike a loan, the advance does not have a set payment every month, instead relying on a percentage of credit/debit card sales. The payments are taken automatically from daily or monthly card sales and will decrease with any dips in those sales numbers.
Downsides to Advances
Of course, nothing comes without a price, and merchant cash advances are not immune to their share of downsides:
- Cost – With ease comes costs, and merchant cash advances are very easy. The companies issuing these advances know this, and charge for their services accordingly. The fees charge for an advance can easily surpass those of a typical loan or line of credit and may cost the business owner a great deal more over even a short period of time. Payday loans take a deserved bad rap, because they cost consumers dearly – sometimes in the triple-digit percentage point range in interest rates. Merchant cash advances can be very similar in their fee structure on an annual basis, so it’s important to weigh those costs carefully.
- Repayment – Since merchant cash advances can be obtained by business owners that have less than stellar credit histories, they are more susceptible to repayment problems. Even though the advance companies are taking their payment automatically, the initial advance may have been taken at a less than responsible time by the business owner or under less than ideal circumstances. A business having trouble managing other parts of their finances will have issues managing their card revenues as well.
Right Time for an Advance
When is the right time for a merchant cash advance? The answer depends on quite a few factors, but the one time that is wrong in every case is when a business is struggling to manage their finances in other areas.
As we’ve seen, merchant cash advances can have considerable costs attached to them, so the business owner must weigh their options carefully before proceeding. In many cases, the opportunities will outweigh the costs and the advance will be an attractive option to expand. Merchant cash advances are also a reliable way to bridge seasonal income changes or hire additional staff in preparation for a busier time of year.
When the economy is great and business is booming, it’s easy to assume that good times will continue, but keeping an eye on the future is important when dealing with a financial product that will impact your ability to generate revenue for the foreseeable future.
With any financial product, the costs and risks need to be considered carefully before moving forward. Merchant cash advances are particularly enticing because they offer quick funds, easy approval, and automatic repayment, but that convenience comes at a cost that many business owners don’t understand. A business that is able to support themselves without relying completely or mostly on their card revenues may be in a great position to take advantage of a merchant cash advance, but one that is struggling and truly needs the income from card sales will find that the costs and repayment terms of an advance may be a crippling liability for months to come.