Working capital and consistent cash flow are necessary for a successful business to operate. Every business goes through times when revenue is low and finances are tight. You might then consider looking for outside funding sources when this occurs. One of the many kinds of funding options available to small businesses is a merchant cash advance.
What is a loan for a cash advance?
With a cash advance, the lender “advances” you the money before you get paid, allowing you to borrow an instantaneous amount against your future income. A cash advance differs from a standard loan because, technically, you are selling your future income in return for money now.
Lenders deduct the loan amount plus additional fees from your checking account when you take out a personal cash advance loan against your next payday. Sometimes, after the borrower receives the money, lenders require borrowers to write a check for the loan amount plus fees, which they then cash.
These loans often have very expensive fees, which can leave you deeply in debt. Loans for cash advances are occasionally regarded as predatory. However, if you don’t have a credit card, they can offer essential cash flow. If your business requires quick funding, there is a particular kind of cash advance available called a merchant cash advance loan.
A merchant cash advance: what is it?
If you are unable to get financing from a bank or another source, you may be able to get short-term funding through merchant cash advance loans. The majority of these advances, along with any associated fees, are returned within six to twelve months. These advances are secured against future credit card sales.
Your company needs to have daily credit card transactions from customers and documentation of at least four months’ worth of credit sales to be eligible for a merchant cash advance. Depending on the amount of the advance, many merchant cash advance providers demand that your monthly credit card sales be in the range of $2,500 to $5,000. This enables the lender to verify your ability to pay back the advance.
What’s the process for a merchant cash advance?
If your company’s main sources of revenue are debit and credit card sales, merchant cash advance companies will probably cooperate with you. This covers the retail, service, and dining industries. If your company doesn’t have a lot of debit or credit sales, it can still obtain an advance thanks to these two structures:
Conventional merchant cash advance:
With a traditional merchant cash advance, your company would receive payment upfront. A predetermined portion of the company’s daily or weekly sales is deducted to repay the loan, along with any associated fees. Another term for this is a “holdback.” The advance is returned more quickly the higher your company’s sales are. To avoid having a portion of their sales go toward repayment, do not, however, advise clients to pay in cash as this is against the terms of the contract and may lead to legal action.
A cash advance for ACH merchants:
You would get paid in advance for an ACH merchant cash advance, which you would subsequently repay using the checking account of your business. Until the advance, plus fees is paid back, a set amount is taken out of your business checking account on a daily or weekly basis via an Automated Clearing House (ACH) withdrawal. In contrast to a conventional merchant cash advance, the amount that is debited is fixed, independent of your business’s sales volume.
This type of advance can be repaid faster than one that is deducted from sales, unless your company runs out of cash, in which case you might not be able to make your weekly or daily payment.
The amount of risk that the merchant cash advance company is accepting will determine how much you will pay in fees. The factor rate is typically between 1.2 and 1.5 percent. Your entire payment, including fees, will be $60,000 (your $40,000 advance plus $20,000 in fees) if you take out a $40,000 advance with a 1.5 percent factor rate.
The cost of a merchant cash advance is significantly higher than that of traditional financing. Additionally, it may start a debt cycle that requires you to take out another advance to pay back the first, incurring further costs.
Benefits and drawbacks of merchant cash advances
When comparing merchant cash advances to other small business loans, the following benefits and risks are associated with doing so:
Pros in merchant cash advances
- Quick access to money
- Simple payback
- Acceptable low credit score
- No limitations when using a loan
- No requirement to provide collateral
Cons of merchant cash advances
- Extremely high APR—possibly as high as 200 percent
- The frequency of payments is too high which could impede cash flow
- No effect on the report or score of business credit
- Unavailable to small businesses that do not accept credit card payments; binds in ways that other loans do not
Options for not using a merchant cash advance
If you need additional funds but are hesitant to take advantage of a merchant cash advance, think about other financing options that can give your small business working capital. There are numerous options for small business loans. Term loans, payment processor financing, and credit lines are a few of the available choices.
Credit line for businesses
A credit card and a line of credit (LOC) are comparable. For the duration of the LOC, you may borrow against a predetermined amount that you apply for and are approved for. Your credit limit will never be exceeded, but you are free to borrow money again as often as necessary and repay what you have already borrowed. For your business, you can open a line of credit for any amount, typically between $2,000 and $500,000. Usually approved in less than a week, funding has three to twelve months for repayment.
One lender offering business credit lines is Fundbox. Offering up to $150,000 over three to six months, Fundbox’s quick and transparent application, pricing, and approval processes are highly appealing. Fundbox is renowned for providing clear and concise information about the weekly fees associated with its services. These fees are automatically deducted from your bank account. See our detailed Fundbox review to find out more.
Temporary loan
An unsecured business loan provided by a private lender as opposed to a bank is known as a short-term loan. Although lenders will check your credit history, these loans offer more transparency and lower interest rates than merchant cash advances. Short-term loans typically have repayment terms of three months to three years, are approved in less than a week, and provide up to $500,000 in one-time financing. A leading provider of short-term small business loans is Fora Financial. With Fora, you can get a loan of up to $500,000 with a maximum 15-month repayment period.
There is no collateral required, and you are free to customize your payment plan to suit your needs. Furthermore, the loan can be funded in as little as 72 hours after the approval process, which only takes a day. Our in-depth analysis of Fora Financial contains more information.
Financing for payment processors
You might be qualified for financing offered by Square and PayPal if you use their credit card processing services. Using your online account, you can apply for loans, which are typically under $100,000. They typically have a factor rate between 1.1 and 1.16 percent, which is less than that of a merchant cash advance.