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Merchant Cash Advances
It opens the doors to the financial world for many retailers. The business development industry is growing at an amazing clip. This growth is because traditional banks are not responding to the needs of small businesses.
This product is very unique. It is a purchase of an asset, not a loan, so we will use specific language consistent with a purchase of an asset, such as the recovery rate and the discount rate instead of the interest rate. Much like factoring, but it’s about a sale that hasn’t happened yet.
A cash advance provider gives merchants an advance cash advance. In return, merchants agree to repay the principal and fee, giving the company an agreed percentage of their credit card sales until their balance is zero. This percentage is between 12%-24%. The payback time is only 5-12 months.
Merchants generally must use the suppliers’ credit card processor because the advance is automatically repaid as a percentage of the proceeds of each batch. A small number of merchant cash advance companies do not require the merchant to change credit card processors. So if that would be a problem, be sure to ask the merchant advance company you plan to work with.
Cash advances are very different from traditional financing programs. In essence, merchant cash advance providers get a small percentage of future MasterCard and Visa revenue, and the merchant pays this back as a daily percentage of that revenue.
Obtaining cash from traditional financing institutions can be difficult for some businesses, especially retail, restaurant, franchisees or seasonal businesses. These merchants use the majority of credit card processing, so merchant advance programs offer a number of benefits.
Because traders like it
The money is usually available more quickly than with traditional loans. These programs especially appeal to retail and restaurant businesses not only because these types of businesses can rarely get traditional financing, but also because of the immediate liquidity.
Most cash advance providers advertise that the money can be available in about 10 days. Unlike a loan with a fixed interest rate, amount due and due date set each month, with merchant advances, the money is paid back as credit card credits come in.
Merchant Cash Advance programs are cash flow friendly, especially during slow seasonal periods. Traditional loans and leases require a set payment each month, whether the business has made a sale or not. Because the payments are calculated as a percentage of sales, if sales increase, the amortization could be faster, but if the owner had some interruption or decline in the business, the payments will be lower.
In most cases, business owners cannot provide personal guarantees and do not provide personal guarantees.
How providers make money
Finance charges can vary greatly, not only from one provider to another, but from one advance to another. For example, the financing range on a $10,000 advance could be less than $1,500 or higher than $4,000. That’s a 60% difference.
There is no fixed interest rate; the effective interest rate varies by business. If the merchant’s business is going well and the sales are increased, the supplier will collect the money sooner and the interest rate is rather high. Since there is no time limit to repay the loan, the effective annual rate decreases as the payments are extended over time, although the cash provider typically provides a fairly short period for the payment, usually less of a year.
There is no doubt that the merchant’s cost for this type of financing will be more than a conventional loan, but it is almost a foregone conclusion that a conventional bank will reject this merchant for his much-needed loan.
Merchants interested in a program like this may have a sketchy or distressed credit history. They will have things like past tax issues, a list of delinquencies, collections, liens or judgments that will be an automatic red flag for a conventional bank. The cash merchant advancement industry caters to businesses that can’t get traditional financing.
A risk worth taking
There is a risk for cash advance providers and a fairly high risk (hence the higher cost for the merchant for the money), but they use sophisticated models to determine the future probabilities of credit card purchases. They also offer money with relatively short repayment periods to help mitigate risk.
Although approval is not as difficult as 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 merchants can reasonably expect to earn from credit card transactions in a year.
The merchant advance provider takes all 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 through lean seasons or merchants that have an unexpected downturn in business (say due to road construction, building repairs or extended illness) may find themselves in need of an advance. of money until business picks up.
However, merchant advance companies say that sick businesses aren’t the only merchants interested in this type of program. Many types of businesses are often underwritten by traditional financing 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 won’t make the cut, even if the restaurant is packed every night.
There are many examples of times when healthy small business owners could use cash to help build their businesses, but can’t get the traditional financing needed. These include franchisees who have exhausted their savings to buy their first franchise and want to open a second one; merchants whose competitors have closed and have the opportunity to buy their competitors’ old inventory or move to a new location; expansions; purchases; or simply the desire to move quickly on a perceived new opportunity.
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