This guest post is by Trish Lindemood, a professional business and web writer who writes extensively on alternative financial solutions for your business – and your life.
A Merchant Cash Advance is a fast growing form of working capital for today’s small business owners. With this type of funding, the business owner agrees to sell a percentage of his or her future visa/master card receipts in exchange for an upfront lump sum amount.
Rather than waiting for sales to come in incremental amounts over a period of several months, the merchant agrees to accept a lesser cash amount in the near term. Those funds can then be used however the business owner chooses. Common uses include remodeling, advertising, purchasing inventory, opening new locations, or settling outstanding tax obligations. Here is how a typical transaction works:
Let’s assume that your business takes in $20,000 in credit card receipts per month and a funding company is willing to purchase 20% of those receipts over the next 6 months. During that time period, you would be expected to take in $120,000 in credit card sales ($20,000 x 6 months). 20% of that amount would be $24,000 (this represents the amount the funding company agrees to buy from you). To determine the amount you would receive, the funding company would divide that amount by a factor rate (i.e. 1.30 for 6 months). Therefore, you would receive an upfront payment of approximately $18,461. ($24,000 divided by the factor rate of 1.30).
The difference between the amount you pay back over the next 6 months ($24,000) and the amount you receive ($18,461) represents the FIXED COST of the money. In this case, the cost to use that money is $5,539.
As you can see, it is an expensive form of business financing – and is not right for all businesses and all scenarios.
However, there are a few benefits to consider before deciding if this form of funding is right for you:
- The funds are unsecured. This means that you don’t have to pledge any personal collateral to obtain a Merchant Cash Advance. Therefore, if you go out of business through no fault of your own, the funding company is not going to come after your house, your car or other tangible assets. Note I said “no fault of your own” – in cases of fraud or deliberate non-payment, many funding companies will aggressively pursue repayment through whatever means necessary.
- A Merchant Cash Advance will not tie up your available credit – and won’t show up on your credit report. This is because this product is NOT a loan. Instead, it is classified as a ‘True Sale’ – meaning that an asset (your future credit card sales) was traded in exchange for monetary consideration. The funding company isn’t lending you anything – they bought something of value from you instead.
- Payments are automatic. They are collected each day as you batch out your credit card transactions as you normally would. Therefore, you don’t have to write out a check each month – or worry about accruing late or missed payment penalties.
- They are available to many business types that have a difficult time obtaining traditional bank financing, including restaurants and younger businesses without an established credit history.
As with any decision you make in your business, the choice to use a Merchant Cash Advance should come down to the potential Return on Investment (ROI). If there are less expensive options available to you and your business, by all means explore them first.
If not, the most important question to ask yourself when considering a Merchant Cash Advance is “Can I take this money and use it to make more money than it cost me to use it?”
If the answer is yes, this option may be worth exploring further.
For more information on Merchant Cash Advances– including more details on the good, the bad and the ugly of using this type of funding in your business – be sure to check out Trish’s 3-part series on this topic at Beyond-the-Bank.com.
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