When a business is starting up, there will be initial investments through bank loans or venture capitalists —depending on the nature of the business. It is quite common for a start up to go over budget, which may mean a cash advance for the business owners is required. If the business owners decide to go through a bank, they may be waiting for weeks to see their money. At this point in the life of a business, time is critical, so the business owner needs to consider all their options before making a decision on how to come up with the capital.
A merchant advance loan is one of the options that should be considered. These often carry a higher interest rate than conventional bank loans, but the cash can often be delivered within a few days which may make it more beneficial overall. There are a few things which need to be remembered. It is not a something to apply for without carefully calculating and comparing the projected extra repayment over a bank loan with the business lost by waiting the extra time for the bank loan to come through.
How do Merchant Cash Advance Work?
Merchant advance are not loans, they are actually a sale of the portion of the credit card sales of the business which haven’t happened yet. They work by funders giving cash to a business, and as that business makes credit card sales, a portion goes directly back to the funder. This is a low percentage—usually between 5-12%. This continues until the funds have been paid back, including around 20% interest.
Merchant cash advance essentially has a higher interest rate because the money can be accessed in a much smaller timeframe than a regular bank loan. Another reason they have higher interest rates is that they are often available to businesses that the banks won’t lend to due to bad credit scores. The rate will correlate with the credit score of the business, so it may not necessarily be much higher than that of a bank or credit union . The repayment length can be anywhere up to two years, depending on the amount of future credit card sales sold and the amount of money the business makes in credit card sales.
What are the Drawbacks of a Merchant Cash Advance?
The most obvious drawback of a cash advance for business owners is the higher fees. The business owner must be sure that it is worth paying the extra interest to keep their business fully operational in the short term. The other drawback is that the repayment happens automatically every day. This may make it seem like it is easier to manage, but it is essentially reducing profits by around 10% every day. This means the profit margin on the credit card sales of the business need to be able to withstand this reduction; otherwise other areas of revenue will need to be used. There is no option of a business not matching the repayment schedule, because the money comes out automatically.
More Good than Bad
If your business is starting up and needs money fast in order to stay afloat in the short term, then a merchant cash advance could be the right option for you. If you calculate what you stand to lose by waiting for a bank loan and compare it with the extra interest, as well as determine if you can deal with the repayments — it is one of the best sources of fast money.