What is a Merchant Cash Advance?
Merchant Cash Advance
A merchant cash advance is not a loan, but is the buying of a businesses future expected receivables. For the purpose of this post, future receivables are the expected future sales projected for a company, based on the past sales performance and therefor expected future performance. A lender will buy a certain percentage of a company’s future receivables for a lump sum payment. This ‘loan’ or advance will be paid back by the business in fixed installments or a pre-determined percentage of credit card sales. For the purpose of this post, we will explain the fixed payment model, as the credit card split is not as popular today.
How a Merchant Cash Advance is Paid Back: Daily Payment
The advance is paid back through a daily ACH from the businesses bank account. Basically the term of the payback period is pre-determined and a fixed payment schedule is agreed upon, where the lender will retrieve funds daily (Monday through Friday) directly from the merchant’s business bank account.
Cost of A Merchant Cash Advance
The cost of a merchant cash advance will vary however, it is important to note that the cost of the capital is fixed and is not going to become more expensive during the length of the term.
The cost is known as a factor rate, or rate that your advance amount is multiplied by in order to get the cost of the money.
For example, $10,000 funding amount multiplied by the factor rate 1.30 gives you a cost of $13,000 or the amount that you will have to pay back for the advance.
- High Tier- the factor will typically be no lower than 1.18 but can go as high as 1.30. This means that the payback for $10,000 will go from 11,800-13,000. As a rule of thumb if your factor is between 1.18-1.30 for a 9-18 month term, you are considered a great candidate and, depending on your time table, this may or may not be the best option for you.
- Middle Tier- The factor for this advance will go from 1.30-1.42. This means that $10,000 will cost you $13,000-$14,200. in this situation the cost is pumped up however, if you are included in this tier your options are starting to grow thin and there may not be another option for you to obtain financing that is unsecured. If you were to seek another option at this point, almost 90% of the time you will have to secure the financing via substantial collateral.
- Low Tier- The factor rate for this advance will go from 1.42 but no higher than a 1.50. This means that $10,000 will cost you $14,200-$15,000. In this scenario you will have no other real choice in the matter. Your credit is not good and your business is usually showing signs that it is on its last legs. The cash advance can either make the business or break it. Though the cost of the capital is extremely expensive, this infusion of capital into the business can save you if you use it wisely. i.e. I personally had a client that i had serviced with an advance of this type and the client returned 3 times already asking for more capital each time. The clients business showed huge growth every single time she came back. Looking at her business today from where we started you would have no idea that it was going under. She made a decision and stuck to her guns and got out of the hole that she was in. she is now considered a HIGH tier candidate and progressing more and more each time.
What a Merchant Cash Advance Isnâ€™t
Now that i went over what a merchant cash advance is, I want to be clear on what a merchant cash advance isn’t. You have many companies out there who will secretly go around and give you false ideas to what a merchant cash advance is. They will tell you things like it’s a line of credit, it will improve your businesses overall credit. Those are just two deceptive practices. Below are more.
- A Merchant Cash Advance is NOT a RLOC (Revolving line of credit). A merchant cash advance is simply an advance on your future sales.
- A Merchant Cash advance is NOT a LOC (line of credit). A line of credit implies that you have a credit limit that you can always pull from when your business needs capital. A merchant cash advance doesn’t function in this manner once you actually receive the capital. so if a company says we got you approved for a LOC of 100,000 where you can only pull 30,000 the first time, they are really saying your max approval is $30,000 and once you are eligible for refinancing (50% through term) we can provide you with an additional amount of capital. In NO WAY are you approved for $100,000. STAY AWAY FROM THESE COMPANIES.
- A Merchant Cash Advance is NOT A LOAN it’s simply as it states, an ADVANCE on future sales. i.e. Let’s say you’re a pizza shop that does 30,000 in business a month. I’m a customer that comes up and says, I love your pizza so much I’m going to give you 30,000 in business over the next 9 months. You would be extremely happy over this idea because here I am a new customer saying I’m going to give you 30,000 over the next 9 months. Now lets play the same scenario back where you need 20,000 to grow the business and you want it now. As an understanding customer i say, Okay merchant I understand you need the money now so what if you offer me a discount today. If i give you 20,000 today can you provide me 30,000 worth of your pizza in 9 months?â€ If you agree to these terms I’m advancing you 20,000 today for 30,000 over 9 months.
- In most cases there is NO PREPAYMENT DISCOUNT. There are some lenders out there who will offer you a prepayment discount however, if you fall into middle tier or low tier this simply doesn’t exist. So if you have a 12 month term and you want to pay off early you can do that without a penalty however, there will be no discount awarded to you. Don’t be fooled by this erroneous statement if a lender states this, many people are fooled and many people become upset.