A Crash Course On Merchant Cash Advance
When you have a business that accepts credit card payments from customers, you will have to get yourself a merchant account. A merchant account is a bank account where all the money from your business transactions are held before they are paid to you.These Merchant accounts can come in handy especially if you have a small scale capital requirement.
What is a merchant cash advance?
It is a type of loan which small businesses can use to take a cash advance using their merchant accounts. It is also called as Credit card factoring. If you look at it, as a business you are essentially selling a portion of your future sales in order to get an instant capital. Your transaction history is used to decide on the amount that you will be eligible for.
Who provides a merchant cash advance?
Merchant cash advance is obtained from merchant cash advance providers. They basically look at your daily sales through credit card transactions and assess the amount to be granted as an advance.
Why would a business need a merchant cash advance?
A business may need a short term financing for various reasons as shown below.
Purchasing of new equipment to replace outdated or worn out equipment
Routine repair and replacement work
Businesses need extra capital when they expand by introducing new products or services
How does it actually work?
First,a Merchant cash advance (MCA) provider and a business owner get into a financial agreement. This agreement will include all details such as the total advance amount, how much amount will be held back, the amount to be paid back and other terms and conditions.
An agreed percentage of the total sales on a daily basis is withheld as a repayment amount to the MCA. This amount is called ‘Holdback’. The good thing about it is that, if you work hard to increase your daily sales, then you can pay back the cash advance much faster. The converse is also true. On days that you do not make enough transactions, you get to pay lesser repayment amount.
Though a merchant cash advance does not have an interest rate of traditional bank loans, the fee to be paid is calculated based on a ‘factor rate’. The lending amount is multiplied by this factor rate and the total amount so derived is added to the lending amount. So this new amount is what you owe the MCA and does not change like interest rate as you repay the cash advance.
What if I need more money?
At times the money that you receive as cash advance is not sufficient to cover the intended use. The existing merchant cash advance may cause financial strain too. In such cases, there is a facility you can use which is called additional position cash advance funding.
So if you already have a cash advance and want to obtain additional advance before the first one is repaid, it would be called a second position advance. You can also obtain more advance and accordingly, they are named as thethird position, fourth position advance and so on. This is also called ‘Stacking’ and allows businesses to pay one lender by consolidating all loans.
What type of loan is a merchant cash advance?
Merchant cash advance is considered as an unsecured loan because unlike traditional bank loans you don’t need a collateral to be eligible for one. The cash advance is only based on your business’ credit worthiness.
What are the advantages and disadvantages of merchant cash advance?
As with any financing option, there are bound to be both pros and cons. Before you jump into getting yourself one, it is good to know the disadvantages too so that you can make an informed decision.
The processing time and paper work is minimal
Loans are typically paid in 3 business days
You can spend the money for any purpose that you wish
Repayment period is short, typically between 6 and 12months
Repayment is automatic, so you don’t have to worry about remembering to make payments
You repay only based on your credit card transactions, hence there is no late fee to worry about
There are no monthly payments or interest rates or a stipulated period of time within which the money has to be paid off
You don’t need a collateral to apply for a merchant cash advance
In case of a business loss where you are unable to pay back the amount, you won’t be legally liable
If you don’t qualify for a traditional bank loan, then a merchant cash advance will be the perfect way to get some quick capital
You can avail merchant cash advance even if your business has bad credit or a number of NSFs (No insufficient funds)
They are more expensive than traditional bank loans, with typical cash advance fee between 60% and 200%
You can’t change your credit card processor until you repay the full advance amount
You cannot make cash transactions as they are considered a breach of the contract
As there is no restriction on how you spend the money, companies may use them for unnecessary expenses too