38% of startups fail due to a lack of cash alone. Traditional loans and lines of credit are certainly helpful, and sometimes necessary, for small businesses and startups to keep their doors open. That said, the process of applying for and being approved for small business loans can be extremely rigorous and time-consuming.
Generally, small business loans only have a 57% approval rate. Even for businesses that are approved for loans, by the time they go through the lengthy application process, it might already be too late. Businesses that need funds now don’t have the luxury of waiting weeks or months for an answer from lenders.
If only there were another option for businesses in this situation. Oh wait, there is!
Merchant cash advance (MCA) is an alternative option to traditional business loans that allows businesses to get cash, fast. Sounds too good to be true? Well, you should already know that everything has its pros and cons. Before you search for an MCA today, there are definitely a few more things you should know.
In this article, we will cover everything you need to know about merchant cash advances, so you can make an informed decision about whether or not you want to use one for your business.
Let’s dive in!
What is a Merchant Cash Advance?
A merchant cash advance is similar to a regular business loan in some ways but there are key differences. Traditional business loans come from a lender. Unlike a traditional business loan in which money is borrowed from the lender and then repaid over time, MCAs come from funders that are essentially purchasing future receivables from a business.
The financing institution will evaluate your business’s credit card receipts and spending history to see how much money your business needs. The financing institution will also look at how much money your business makes to determine what sum of money you will be able to pay back. Based on this information the financing institution will come up with an amount of money for the merchant cash advance.
The financing institution will then draft a contract including the amount of the cash advance, and the factor rate and term associated with your advance. Rates vary greatly depending on the industry of your business, and who it’s from.
How do Merchant Cash Advances Work?
Merchant cash advances also differ from traditional business loans in other ways. For one, because MCAs are not loans your business doesn’t have to put up any collateral, like property or other assets in order to be eligible.
Merchant cash advances act as an alternative source of short-term financing for businesses that need cash fast for any number of business needs, like filling in revenue gaps. The way it works is that funders give you an advance on your business’s future revenue. The funders do this in exchange for rights to a percentage of your business’s future revenue.
In other words, your business receives a lump sum that is then paid for with a portion of future credit and debit sales. The factor rate terms, or how much the cash advance will cost, varies but usually ranges from 1.1 to 1.5. The factor rate multiplied by the amount of the advance will be the fee your business will pay for the funds.
The payment schedule is dependent on the number of sales your business has made. Meaning if you have a slow month you pay more slowly, while a month with many sales will mean you pay for the cash advance more quickly.
What Can Merchant Cash Advances be Used for?
Merchant cash advances can be used to take care of pretty much any of your business needs, there are no specific rules about what you can use the money for. Some of the most common uses of merchant cash advances are the following:
- Purchasing inventory
- Repairs or renovations
- Equipment purchases
- Marketing or website development
- Working capital
- Emergency expenses
How to Get a Merchant Cash Advance
One of the best things about merchant cash advances is that it is relatively easy to get one. That said, the merchant cash advance application process will vary at each financing institution. Some may be more rigorous than others.
You will generally need to provide general information about your business. This will include details about how long you have been in operation, what your average monthly revenue is, and how much money you are looking to receive with the merchant cash advance. Funding Institutions will also sometimes do due diligence of their own by checking your credit score and background.
Some businesses that are not eligible for traditional business loans because of bad credit or a lack of credit might want to pursue an MCA as an alternative option. Getting a merchant cash advance with bad credit or no credit can be tough, but is still possible. Certain underwriters might not provide merchant cash advances with no credit check, but there are some funders that will. There are underwriters who perform credit card revenue checks instead of credit history checks to determine the eligibility of businesses for an MCA.
Merchant Cash Advance Terminology
Before filling out your MCA application, there are a few important terms you should be aware of. Take the time to familiarize yourself with some of the common features of merchant cash advances and what they are called.
The factor rate is the amount of money you will have to repay in addition to the principal amount. The factor rate is like a fee for taking out a merchant cash advance. For example, if your principal is $10,000 and your factor rate is 1.2, you will end up paying back a total of $12,000.
The term is the amount of time your business has to pay for the merchant cash advance. This will usually be a relatively short period of time ranging between three months and two years.
The frequency is how often you will make your payments to the lender. This can be daily, weekly, or monthly depending on the terms of the contract.
Merchant cash advances for small businesses can be a great short-term funding solution, especially when traditional small business loans are not an option. Whether your business needs money for emergency repairs or to fill inventory on an unexpectedly busy month, MCAs could be just what your business needs. That said, before signing off on an MCA, you should make sure you have done all calculations related to fees and understood whether or not it is a good idea for your business.
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