Is a Merchant Cash Advance the Correct Alternative Finance Option Out There?

Under difficult circumstances, a business often realizes that it has to obtain funds from outside sources through borrowing. Borrowing a little money here and there might actually give the business the boost it needs to get off the ground and, perhaps, reach another milestone. Even though borrowing money is far from rocket science, firms often find it difficult evaluating which alternative finance option is right for them. Things more tricky when talking about small businesses which are almost always denied access the commonest source of business fund—commercial bank loans. For startups, the situation is even more pathetic. In most cases, startup firms have had to rely on bootstrap financing or borrowing against credit cards to finance their business ventures. But funds from personal savings and often too small while lines of credit and business loans are open majorly to established businesses. In any case, there exists quite a number of alternative finance options different from bank loans.

Some major alternatives to commercial bank loans

One of the biggest alternatives to commercial bank loans is borrowing against business credit cards.  Since commercial bank loans are not granted to businesses which are in need of less than $50000 most business owners explore this option. More than 60 percent of businesses in the United States, after all, make use of credit cards in fulfilling much their face to face business transactions. Although this seems like a good option, there is a risk, however, that a long-running bank statement coupled with the typically high-interest rate could help to undermine the firm’s profit. Moreover, defaulting on payments can serve to damage the credibility of the business and subsequently affect future alternative finance endeavors.
Crowdfunding is another popular option for small business owners. Crowdfunding websites provide funds for businesses which are pooled together from multiple sources. In order for a business to benefit from crowdfunding, the service or product itself must lend itself to a good story which the contributors would be eager to support while the business must be willing to offer free products on the platform and other rewards such as participation in product design. Crowdfunding, however, does not compare favorably with other alternative finance options because a business has to meet 100 percent of its stated goals, otherwise, the fund is voided and the business gets no money. The line of credit is also quite popular but involves such a rigorous process. Detailed financial information is often required alongside a financial review and tax returns and so forth.

What most traditional financial insititutions will require a loan can be granted

Before looking at what has proven to be the fastest and easiest alternative finance options we need to consider what almost every other traditional source of business funding will often require from small business owners in order to better appreciate the usefulness of this option. First thing first, most lending firms will often require that a business has been in operation for at least two years before funding can be granted to it. In addition, some or all of the following will be required:

  1.    A detailed business plan showing a strong budget clearly supported by financial projections such as profit and loss and cash flow statements
  2.    The purpose of the loan be it to finance debt, purchase new equipment and more
  3.    Past financial statements and the record showing your debt to equity ratio which should show that your liabilities are not more than 4 times of your equity.
  4.    Business and credit history, with emphasis on the credit score of the business
  5.    The personal equity investment of the business which is expected to account for at least 20 percent of the requested amount
  6.    Personal guarantees from all the principals—that is collateral security of the loan—and background information on all the principals

What is merchant cash advance and why do some people seem to object to it?

The above list goes to show why most small businesses are unable to get the funding which they badly need. But merchant cash advance has come to be recognized as the perfect alternative finance option for small business owners who cannot meet up with most of the demands of traditional financial institutions such as collateral and good credit score. However, it has to be admitted that there is so much controversy surrounding merchant cash advance at the moment with some persons calling for government oversight on the industry while some very few others think it should be totally stopped. The reason for this, in most cases, stems from the fact it is generally considered to be a quite expensive source of business funds as compared with bank loans and lines of credit.

Some benefits of merchant cash advance which helps understand its cost

Although there is much truth in this claim, there is a good reason why it has to be so. The first reason is that is a high-risk venture for the merchant providers as the advances are not secured. The business owners provide no personal guarantee whatsoever that the advance is to be repaid. In short, a merchant cash advance is not legally considered to be a loan. It is seen as a mere commercial transaction between a merchant and the MCA provider in which the merchant sells the future receivables of the business in exchange for an immediate lump sum of cash. So the unsecured nature of the advance, plus the speed with which it can be obtained more than offset the supposed high cost. And more and more small business owners whose businesses have been rescued by the timely intervention of merchant cash advance are beginning to admit this truth.
In addition, a good credit score is not a criterion for receiving merchant advance. Alternative finance firms often require plenty of documents which have shown in the above list. But that is just the opposite of what obtains with merchant providers. For instance, only the sales record for the past of a couple of months is required in addition to other minor documents for a decision to be made on the application. Moreover, the rate of successful application is higher in merchant cash advance than in any other funding option. It was even found that the more than 55 percent of businesses were either turned down or did not even bother to apply for commercial bank loans. Therefore, alternative sources of funding, particularly merchant cash advance have long come to the rescue of small businesses. And, in fact, more than 4 billion dollars’ worth of business financing is provided to small business from sources other than commercial banks. Business owners are beginning to appreciate the useful need of such ventures as merchant cash advance and the industry has been growing rapidly in the last decade despite the many challenges it has faced.

How does a merchant advance work and how do merchant providers make a profit?

When a firm request a certain sum of money from a merchant provider the amount is multiplied by a certain factor which usually less than 1.5. This factored amount gives the total amount payable by the merchant who opted for the alternative finance. It is the difference between the total payable amount and the actual cash advance that gives profit to merchant providers since they do not charge interest. The amount that the merchant pays to the merchant provider on a daily basis is known as the retrieval rate. This could be in the form of a fixed percentage of the daily credit card sales of the business. If for instance, the retrieval rate is 20% then at the end of each day 20% of the entire sales are remitted to the merchant provider.
If the merchant chooses to pay a fixed amount in daily he is entirely free to do so. The daily fixed amount is usually an equivalent of the agreed percentage but with the expected business situation used to arrive at the fixed amount. What this means is that if the daily credit sales were expected to be around $10000, then 20% of this would be $2000, it is this $2000 that them merchant continues to pay under this payment option even if the actual sales fall below the projected $10000. This method has a drawback of imposing a strain on the cash flow of the company during periods of poor sales. Little wonder most merchants opt for the fixed percentage mode of payment. With this method, the business pays as it generates cash: lower sales lower amount; higher sales higher amount.

Conclusion

We have looked at a number of alternative finance options with a special focus on merchant cash advance because of its numerous advantages over the alternatives as well as commercial bank loans. Nothing is more painful to a business owner than not being able to secure working capital to fund business plans. But this is exactly why merchant cash advance providers are there—to provide you with cash when you need it most.

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(800) 597-0713

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