May 19, 2021
The Pros and Cons of a Merchant Cash Advance
However, many small business owners don’t understand how merchant cash advances work, and are unsure of whether it's the right business funding option for them. In this blog post, we’ll explain what a merchant cash advance is and highlight the pros and cons associated with receiving this small business financing product.
Merchant Cash Advance Definition:Many people believe that merchant cash advances are a type of business loan, but this isn't the case. Instead, it's important to note that a merchant cash advance is the purchase of your business’s future credit card receivables. Once you complete the cash advance application process, your lender will provide you with a lump sum. Then, a percentage of your business’s future credit card receivables are put towards fulfilling your obligation. This is unlike a small business loan, which has set repayment terms.
The Pros of a Merchant Cash AdvanceWhile merchant cash advances are not for everyone, they can be useful to some business owners. Here are the top benefits to consider:
1. Remittance based on your business’s daily or weekly credit card salesOne of the top advantages of receiving a merchant cash advance is the remittance structure. With a traditional term loan, a business is required to make their set payment, whether their customers have paid their invoices or not. This can put a strain on a business that may have slow paying clients, or those with fluctuating cash flow. As we mentioned, with a merchant cash advance, a percentage of your business’s credit card sales is used to meet your obligation. Therefore, if you have a slow sales month, you won’t be paying as much as you would during busy seasons.
2. Payments are automatically madeWhen remitting a merchant cash advance, payments are automatically withdrawn from your business’s received credit transactions. This means that you don’t have to take time out of your schedule to make the payments, and there is very little chance of late fees. If you often forget to pay your bills, it can be comforting to know that your cash advance remittance is handled for you.
3. Funds are received quicklyWhen applying for a business loan from a bank, it could take weeks or months to finalize the process. If your business has an immediate working capital need, you probably can't risk going through a long financing process, only to find out that you didn't qualify for a business loan. With a merchant cash advance, funds can often be available in less than a week, and many lenders can finalize their deals in less than 72 hours.
4. No additional collateral requiredEven if your business has assets, you may not be in a position or have a desire to pledge these as collateral for a business loan. With a merchant cash advance, the only collateral that lenders generally require is the percentage of your business’s future sales receipts. This keeps all other business assets available for other uses as needed.
The Cons of a Merchant Cash AdvanceAccess to fast cash without set terms sounds beneficial, but there are some downsides to receiving a merchant cash advance that you should be aware of before applying:
1. Interest rates can be highOne of the biggest reasons that businesses shy away from merchant cash advances is the cost. While lender’s charges vary, a merchant cash advance could cost you more in interest than other business financing options. Because cash advances are considered “short term” financing, merchant cash advance providers aren't subject to as many interest rate caps and regulations. Therefore, their approvals often come tied to a hefty annual percentage rate (APR).
2. There could be limitationsAnother negative aspect to receiving merchant cash advance is that there may be “fine print” that places limitations on your business while you are fulfilling your obligation. A common restriction to watch out for is wording that won't allow the business to switch credit card processing companies. Other prohibited changes may include things like moving locations or revising hours of operation.
3. Not receiving credit card sales can create challengesIn many cases, businesses receive a mix of credit card payments, cash, and maybe even checks as payment forms. While this is typically not an issue for merchant cash advance companies, they sometimes include a section in their contracts that is designed to limit businesses from offering incentives for non-credit card payments. For instance, providing discounts to customers that make cash payments, in many cases, could violate the agreement. Without daily credit card sales, you won't be able to fulfil your obligations in a timely manner. Due to this, some cash advance providers will have rules about incentivizing non-credit card payments
ConclusionThe most important thing to keep in mind when applying for a merchant cash advance is that it can be a useful tool for certain situations, but it does carry certain risks. Before making the decision to pursue this financing option, make sure that you understand all requirements and fees, and don’t hesitate to ask questions. Once you have all the information, you can determine whether your business would flourish after receiving a merchant cash advance.
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2021.