Merchant Cash Advances: What Are They? Who Needs Them?
Richard Hassman, The Business Resource Guy, here to discuss an interesting product in the merchant services world, the merchant cash advance, or MCA.
In the last 5 years or so this product has become much more popular with cash-strapped businesses that have nowhere else to turn for the working capital they so desperately need.
So what exactly is a merchant cash advance? Is it a business loan?
Let’s take a look at one of the key terms, advance. An MCA is not a loan it is an advanced purchase of future receipts purchased by the funding organization for a fee. It will not be an inexpensive fee but for those who truly need it, not having the funds will be more costly.
A loan is a formal banking term that refers to a product that has all kinds of legal and official ramifications.
So let’s go back to that fee arrangement. Here is how it works…
You take credit cards in your business. You need working capital for an equipment upgrade, a marketing campaign, or whatever reason you deem important enough to need cash for. You have been turned down by your business bank, your personal credit is just fair or worse, and you have exhausted your credit lines and cards (or don’t have any).
Funding companies make an advance purchase of your future credit card processing revenue and give you the money now. Now as in you have money wired into your bank within 7 days. They charge you an agreed upon fee – that fee can range from $1.15-1.50 per $1.00 you are advanced, depending on a factors like length of time in business, gross receipts, bank statements, and credit reports. You repay the advance back by having a percentage of your credit card daily batches being routed to the funding company until such time that you have paid back the advanced amount plus the fee.
Positive #1 unlike servicing a loan, if your business experiences a very slow period immediately following the advance you are still paying back the same total fee agreed upon when you accepted the funds. If the funding company expects that you will take 4 months to pay them back based on their calculations but instead it takes you twice as long because business got slow, you still pay back that same amount. Period. No tricks.
Positive #2 You do not have to personally guarantee the advance. I have actually had a customer go out of business while they still had a balance on their MCA and once their business was liquidated and there were nothing left the funding company was not able to go after the owners.
Positive #3 Low credit scores, personal credit issues? As long as your business has good numbers you are very likely to approved, usually within 24 hours.
You can get as little as $4k and as much as $150k per location and the anount is based not only on the amount of credit cards you run every month in your business but your gross monthly receipts.
Merchant cash advance has a new cousin, the Total Deposit Advance that is essentially the same concept but for businesses whose income is not paid as heavily by credit cards. A good example might be a contractor or plumber or medical practice. The same general idea – but the funds are repaid out of the business’ daily bank deposits, or an agreed upon ach from their account.
Example #1 from my customers:
An auto repair shop needed $55k to cover issues related to their franchise arrangement with their franchisor. They were averaging $60k/mo in sales, $40k/mo of that was credit card sales. The fee they were charged for the advance was $16k. So they paid $1.29 for every dollar they were advanced. (they actually would have been charged less if they had accepted a shorter payback schedule). They had 15% of their daily credit card batches automatically deducted and paid to the funding company, averaging $6k/mo. It took them almost exactly the 12 months the funding company estimated at that rate it would take to repay the advance plus the fee. Their business had remained predictable and steady and they were able to get out of the jam they were in before.
Example #2 from my customers:
A salon owner was being forced to change his name and brand identity because apparently he had inadvertently copied someone else’s stuff. He was grossing approximately $15k/mo with half of that usually on credit cards. He was advanced $7000 and the fee charged was $2765. So he paid $1.39 for every dollar he was advanced. His repayment schedule was 20% deducted from his daily credit card batches. It should have taken him 6 months to repay but he actually broke his foot and it took him over 9 months. No harm, no foul – no additional fees. Most importantly, he made the necessary changes to his business and was able to avoid being sued which most definitely would have cost him more than $2765.
There is a lot of discussion among financial professionals and business advisors about the merchant cash advance and the fees that are charged versus the fees that are typically charged by a business bank. There are also lots of discussions among business owners about how to get capital when they need it and are struggling and the bank, their family, everyone else says no and yet they know that whatever plans they need the money for will be worth it in the long run, even at a higher than typical price.
Truth is the industry is a multi-billion dollar industry and that is because business owners are using the advances and keeping their businesses running and even growing.
As for those fees being in some cases really, really high you need to consider this fact I mentioned above. The funding companies are not asking the business owner to personally guarantee the advance and therefore can not be harassed, chased, or threatened if their business ends up closing and not being able to repay the funding company. If you were the funder wouldn’t you ask for enough of a fee to cover the potential losses?
Personally, I have not sold a lot of advances to my customers over the years but the ones I have were very happy I did. And lately, I am being asked by business owners if I can help them get set up with an advance as they tried their bank and got a big fat no.
And my answer is Yes.
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