How Merchant Cash Advance Can Help You With Small Business Finance
In most cases, the capital required to start up a business or to expand one is not always readily available. When this is the case businesses often seek ways to fund their franchises. And sometimes getting small business finance especially through the usual channel of commercial banks can prove to be rigorous, if not impossible. This is usually the case if the business has a poor credit score, or if the required collateral cannot be provided—or both. In scenarios like this businesses have to seek alternative modes of funding.
One such alternative method of obtaining the working capital for a business is through merchant cash advance. But, of course, most business owners usually get apprehensive when having to consider this option; this is due simply to the several misconceptions people have about the service. It is, therefore, pertinent to provide a detailed explanation of what merchant cash advance stands for and how it might prove to be the best option when considering small business finance.
What is merchant cash advance really?
From a technical perspective, merchant cash advance is not a loan per se since it is a commercial transaction that requires the business to sell a portion of the future credit card sales to the lending company. This portion is usually a percentage that is agreed to by both parties and could be more or less than 10%. To really understand how this whole thing works, let us assume that the business in question is a restaurant that requires a small business finance of $100000 to acquire some modern equipment. Let us also assume that this restaurant has monthly revenue of $50000. With these assumptions, we can proceed to examine what takes place when merchant cash advance is to be obtained by a firm seeking a small business finance.
For the above scenario, the company providing the merchant cash advance usually determines the factor rate which in most cases does not exceed 1.5, and this determines how much is to be repaid by the franchise in total. So for our own case, using a factor of 1.5, the total amount to be paid by the restaurant is 1.5*$100000; this gives $150000.
The lending company, having estimated the monthly revenue to be $50000, and having agreed to buy 10% (this is for our case study) of the restaurant’s future credit card sales, which is $5000, agrees to collect this $5000 until it accrues to the $150000 earlier obtained.
As can be seen from the foregoing discussion this payment would naturally take a period of 30 months to be completed. But in most real-world scenarios payments would normally take much less than that to be completed. It should also be noted that in the event that the actual monthly revenue exceeds the original estimate, nothing serious happens except that the advance is repaid much quicker. And, of course, when the actual revenue is lower than that estimated, the advance takes longer to repay.
What are the modes of repaying a merchant cash advance?
After small business finance has been obtained from a merchant cash advance firm, the question arises as to whether the mode of repayment is flexible or rather rigid. In this regard suffice it to say that there are two main options that a firm can choose from in repaying such cash advances. Although it may appear that both are the same, a closer look, however, will show that there is a significant difference, so much so that the method adopted might prove the difference between being able or unable to repay the advance—at least within the expected time frame.
Percentage of credit card sales
In this payment option, the amount either per month, week, or even per day is dependent on the credit card sales for the period agreed upon by both the business and the lending company. In this method, the restaurant will only pay the agreed 10% of credit card sales no matter what they are. In short, it is this method that the period of repaying the advance gets to fluctuate—either it is paid earlier than expected if the credit card sales are good, or later if sales take a turn for the worse. Of course, this mode seems to be more profitable to the business because in nearly all cases, it always takes longer than expected to pay up the cash advance. This method might not strain the business too much if credit card sales plummet as the payment timeline can be extended.
Fixed weekly or monthly withdrawals
Still using our hypothetical restaurant, there could be a scenario where the $5000 which stems from the 10% of the estimated $50000 monthly revenue of the business is paid either on a monthly basis, or is divided into weeks or days depending on what is agreed, and this amount is remitted regardless of whether credit card sales exceed the estimate or not; or even if it goes way beyond the estimate.
It can also be seen that in this method, the time frame for offsetting the advance is fixed. While this method might be more favorable to the lending firm, it can turn to be disastrous for a business depending on what circumstance might arise. Moreover, even if this means the firm gets to pay up this small business finance much quickly in this mode, there really is no benefit for early payment with merchant cash advance as opposed to traditional small business finance from banks in which early payment usually means a lesser interest.
Benefits of using merchant cash advance for small business finance
So far, we have taken time to discuss what this method of obtaining a small business finance is all about, but we cannot be left out on why it always seems an attractive option to businesses. Indeed, if we are to consider these benefits it would appear a better option as compared to the traditional financing that is obtained from commercial banks.
One of the foremost things businesses consider in trying to get a small business finance is how quickly it can be obtained. And the conventional bank loan, in most cases takes several weeks or months to process. But on the contrary getting merchant, advance cash takes a little over a week or even less since all the lending company has to do is look at the daily credit receipts of the business, and quickly determines whether or not the firm would be able to pay. So if speed is what matters most, this should be the first choice in getting working capital for a business.
It is a fairly regular occurrence that some businesses, especially startups, are not able to provide the collateral required by commercial banks in order to acquire the much needed small business finance. And it is also the case that when the collateral is provided it can sometimes happen that the business is unable to redeem the advance. When this happens, the firm usually loses the said collateral to the bank.
With merchant cash advance, however, there is no need for any form of collateral as it is technically not a loan and the situation will not arise where the business would have to sell personal assets in order to offset the loan. That being the case, the risk is almost entirely on the lending company so that when the firm is unable to meet up or if the firm even goes into bankruptcy, it usually means that the lending firm has lost her investment. It is no surprise that one of the leading slogans for MCA`s is “we only get paid when you get paid.
Apart from the fact that it is very easy to obtain this sort of small business finance, the method of payment could be such that the duration is adjusted to in manner that synchronizes with the fortune of the business; that is, if, for instance, the percentage of credit card sales is chosen, the payment is quicker when business is good. The opposite is also true: when sales are down, the payment period is extended.
Credit is not affected
One major obstacle to obtaining a financial assistance is low credit score. So some businesses spend time trying to improve their credit scores before seeking financial assistance. This is not so for merchant cash advance as it is simply not alone. Of course, the lending firms will often examine the credit score of the business, but a good score is required in order to get the cash advance. It is even possible that the cash obtained through this medium can serve to improve the credit score of the borrowing firm.
Although it might sometimes happen that merchant cash advance will attract a higher interest rate as compared to small business finance from commercial banks, when the immense advantages of this method of raising capital is examined, it proves to be much more beneficial than small business finance from banks.
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