Merchant cash advance providers offer fast access to funds for small business owners, often at a 30 percent premium, in return for a portion of future sales until the advance plus premium are paid off. The industry carefully distinguishes this financial product from loans; thus, loan regulations do not apply. However, financial advisors generally suggest treating a cash advance as a loan and understanding exactly what the cost is when receiving a cash advance.
What is a merchant cash advance?
Unlike a loan, a merchant cash advance does not require collateral or good credit history, is easier to apply for and receive, and minimizes the risk of default. In addition, there is no set date by which the money must be repaid, and there are no regular fixed payments. Instead, credit card invoices or accounts receivables are used as guarantee for the debt. A cash advance provides quick funds for a project or to cover unexpected expenses.
How does it work?
A merchant cash advance is a lump sum payment made to a small business owner, who pays back the money over time from credit card sales. Thus, this form of business financing is also known as credit card factoring. In a nutshell, you’re selling a percentage of your future sales for immediate cash. For every $1 you borrow today, you’ll have to repay roughly $1.35 over the next 6 months. Repayment is made by deducting a portion of your VISA and MasterCard transactions each month. If the monthly processing turns out to be less than the monthly
repayment amount, then money will be ACH’d from your business checking account to make up the difference. Generally, lenders offer a cash advance value of up to 80 percent of your monthly credit card invoices, although some lenders will go up to one and a half times sales.
For example, let’s say you have an average of $10,000 each month in credit card sales. You need to make capital improvements and decide to borrow $12,500. To determine the monthly cash advance payback, multiply the Advance Amount by 1.30 to account for the premium, then divide by 6 months:
$12,500 x 1.30 = $16,250 Payback Amount
$16,250 / 6 months = $2,708.33 monthly payback
So each month for 6 months, you’ll have to pay $2,708.33. However, you do not write a check each month; instead, the money is deducted from your credit card sales. To calculate the Cash Advance Percentage Holdback Rate, divide the monthly payback amount by the average monthly credit card sales:
$2,708.33 monthly payback / $10,000 average monthly sales x 100% = 28%
So, each month for the next 6 months, 28% of your credit card sales
will go directly toward paying off the cash advance.
How do you qualify for a merchant cash advance?
Usually, a lender wants to know that your business is stable; have you been around for at least two years? And depending on the lender, you may have to meet a minimum quota of credit card sales each month.
Merchant cash advances are a great way for businesses to access needed funds when they have poor credit history, cannot submit collateral for a loan, and cannot offer a personal guarantee for business debts.
Sam is an expert in small business financing and has been CEO at Shield Funding for more than a decade. The company has funded more than 1000 small businesses and has been a significant contributor to the phenomenal growth that many of those companies have experienced.
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