November 29, 2022 | Last Updated on: April 7, 2023
In this article:
Merchant financing is used by small business owners to cover operating expenses or make necessary purchases when cash flow is not sufficient to cover business needs. This type of financing is popular with business owners that have revenue cycles dependent on seasons, are in process of implementing growth strategies, or any other business where income is collected via credit card or debit card sales. In this article, we explore financing options through merchant financing as well as provide tips on choosing the best merchant loan company for your business needs.
Merchant financing programs, like merchant cash advances (MCAs), are a type of business financing where the business owner receives a lump sum of money upfront and the merchant loan company is repaid by collecting a predetermined percentage of daily credit card payments from the business. These types of commercial agreements do not have fixed repayment terms since the payments are based on future sales.
The funding that occurs between a merchant loan company and an entrepreneur is not actually a loan, but a financing agreement. Merchant cash advances are often offered through alternative lenders, or online lenders, as well as companies dedicated to providing merchant cash advances. The process works similarly to other types of small business loan options and begins with an application.
While credit score is not a primary factor considered for approval, some merchant financing companies will take a good credit rating into account for new business owners or other borrowers that have a limited sales history. However, since these financing arrangements are not like traditional bank loans, the eligibility requirements are simple. An interested business owner will typically be asked to provide the following documents to the lender:
Applicants that have been in business for at least 18 months and generate a minimum of $150,000 in annual revenues are typically approved quickly by financing companies.
Merchant cash advances are a more expensive financing option than some small business loans or other sources of business funding. The financing costs of an MCA are calculated using factor rates. The factor rate provides a decimal value that is multiplied by the amount of funding provided to the business to determine the total cost of the agreement. For example, if a business owner borrows $5,000 from a merchant loan company with a factor rate of 1.12, the business will need to repay a total of 5,600 to the provider.
If a merchant cash advance sounds like it may be the right decision for your business needs, you may be wondering how to get started.
When selecting a merchant loan company to work with, do your research ahead of time to be sure the company has a reputation for providing a fair service to its customers. A provider that has a history of being transparent about the repayment period and cost of the agreement is going to be your best bet.
Not unlike other business financing decisions, deciding to take out a merchant cash advance is a big decision. Before you decide to sign any financing agreements, be sure you have considered the pros and cons of MCAs.
If you are concerned about the financing costs associated with a merchant cash advance, you may be interested in learning about other financing options for small businesses. Each of the following types of loans can be secured through a traditional bank or online lender, like Biz2Credit.
A business line of credit is a type of revolving credit that works like a business credit card, where the borrower is approved for a maximum credit line. The business owner can then withdraw funds at any time there is available credit. When the credit line is paid down, the funds become available again. Lines of credit can be secured in cases of low credit scores, where the borrower is required to pledge an asset, like commercial real estate as collateral or provide a personal guarantee. Although, borrowers with lower credit scores tend to pay higher interest rates.
SBA loan programs are financing options for small business owners where a portion of the borrowed amount is backed by the U.S. Small Business Administration. SBA loans offer lower interest rates and require smaller down payments than MCA providers and traditional bank loans, and eligibility is based on several factors including loan amount, credit score, and time in business. The SBA offers several different loan programs including the SBA 7(a) loan, SBA Microloans, and SBA Express loans. SBA loans are available through both alternative lenders, like Biz2Credit, and traditional financial institutions, like national banks.
Term loans are a traditional type of loan where an approved borrower receives a lump sum payment upfront and repays the debt with monthly payments of principal and interest. Term loans that have repayment terms of less than 36 months are considered short-term and are approved based on the borrower’s creditworthiness. Short-term loans are best for entrepreneurs wishing to purchase inventory or cover working capital shortages. Long-term loans are an option for small business owners looking to make a large purchase, like equipment or real estate, who would benefit from an extended amount of time to repay the loan.
Merchant cash advances can be a great financing tool for small business owners, like this digital solution developer, who was able to get a cash advance of $40,000 working with the right financing company. They are different from a traditional loan because there are no fixed repayment terms and financing costs are calculated using a factor rate instead of interest rates. Merchant cash advances work well for borrowers with bad credit scores that need funding fast, but the financing costs for MCAs can be higher than other loan options. Even if a cash advance is not for you, check out other loan options from Biz2Credit like a term loan or business line of credit.
