Comparing Merchant Cash Advances to Traditional Business Lending
Merchant cash advances (MCA) are becoming more mainstream as many small to medium businesses that are unable to secure a bank loan turn to alternative funding sources. A merchant cash advance can be accessed by a business quickly with minimal paperwork, making it an extremely appealing option to business owners since banks continue to be very tight with their loans.
Basically, an MCA provider purchases a specific amount of a business’s future credit card receivables in one lump sum in exchange for the receivables which are paid to the provider over time, usually in the form of a daily percentage of the customer’s daily credit/debit card totals. This is one of the benefits that separates this program from a conventional loan. An MCA is not loaning a company any money. It is simply buying a portion of future revenue.
The Current Lending Environment
Despite the recent uptick in the economy, most banks have maintained extremely high requirements for a small business loan, putting capital out of reach for many companies. In many instances businesses need to have sufficient collateral, near-perfect credit scores, and an established cash flow to get a loan from the larger banks.
Smaller banks often relax some of those standards in order to do business with local companies, but only if they have qualified for the Small Business Administration guarantees. In other words, yes, it’s possible to get a loan from them, but you may have to prove you have a large government organization willing to back your endeavor.
When/Why Would You Go This Route?
According to an article in USA Today (published October 2012), large banks were approving around 14.8% of small-business loan requests, way down from the 46% approval rate that was the average before the economic downturn. Now, around 65% of loans going to small businesses (those with one to 10 employees) are unconventional. If the traditional lending institutions aren’t going to provide the finances, then companies have to look to other sources, which could include factoring, merchant cash advances, and cash-flow lending. At the time the USA Today article was written, they claim the number of companies seeking this kind of funding is up about 25% from two years ago.
There is, however, more to it than just the limited amount of available funds that is driving companies to seek this kind of funding. Some of the common reasons to seek alternative financing include:
- Purchasing new equipment and restocking inventory to grow the business
- Paying off existing debt and improving credit
- Enhance a marketing campaign to take advantage of current trends
- Renovate or expand on an existing location
- Purchase and move into new locations
- Building a cushion against seasonal or slower periods
Advantages Over Bank Loans
Merchant cash advances generally require no liens, or collateral, although this is subject to certain conditions. Beyond that, though, there are a range of benefits that come from choosing this kind of funding.
- No fixed monthly payments.
- No points or upfront fees.
- No UCC-1 at the time of funding.
- No collateral, subject to certain conditions.
- No business use restrictions – there are no limits on how you spend your funds.
- Approval times are much lower.
One of the biggest advantages, though, is simply that the amount the business pays is based on the amount of credit card transactions received each day. In other words, there are no set fees that must be met every month, so businesses still have access to a greater portion of their own revenue. If your sales begin to drop off one month, your payments will also be lowered to reflect that change.
Points to Consider
Funding your business endeavors is a big step, and it’s important to understand all the ins and outs of the system before making your final decision. While you may have a better chance of receiving a merchant cash advance than traditional bank financing, they may have a higher cost.
This does not, however, mean that small businesses should forget about alternate sources of funding. You simply need to be aware of the requirements of an MCA and understand that they are most ideal for those activities that have a sufficiently high rate of return.
Comparing MCAs to Conventional Loans
How does an MCA really stack up against a conventional loan? There are many differences, and each one could have an impact on your final decision.
How do MCAs Get Paid?
A merchant cash advance is not a loan, which means that the repayment method is very different. Since the provider is technically just buying a percentage of future credit card sales, the payments are simply collected by splitting the debit/credit card totals, based on the agreed upon percentage and forwarding that amount to the provider every day.
This allows the merchant to manage expenses based on their daily income. If there are slow days, or if the off season starts to affect the number of transactions, their payments will also change to reflect their current credit card sales. In other words, they won’t have to come up with the same fixed amount each month like they would for a traditional bank loan. This leaves them with more funds to handle the other aspects and demands of the business.
MCA Best Practices
There are some accepted best practices within the MCA marketplace that, when followed, create a solid foundation that businesses can rely on. These companies should provide:
Terms Based on Client Profiles – A responsible MCA company will be careful to “work within the margins.” They should have a history of making accurate projections to ensure that the amount of money retrieved never interferes with your ability to survive as a business. Providers should also be able to adjust their retrieval rate based on your company’s margins.
Full Disclosure of Fees – You need to know exactly what is required before the signing of any contract. You definitely don’t need any surprises or unexpected costs making things more difficult. Your provider should be clear and transparent about every facet of the process.
Successfully Securing Your Funding
Always remember that you are the one in control of your business. No matter how transparent the MCA provider is, in the end it comes down to you and whether or not this financing is right for your business. You need to be proactive and learn about all your options.
- Ask to see all the fees upfront.
- Make sure you understand the structure, because you will be paying a certain amount every day.
- Look around and see what is available. Compare programs from different companies.
- Ask the company for references. Have they worked with other in industries like yours?
- Find out if the provider has a history of acting responsibly and following best practices.
When an opportunity to expand or improve your business appears, you can’t afford to wait for traditional funding to come through – especially when both large and small banks continue to be conservative with their lending practices. This may be the perfect time to consider another option and get the financing you need, when you need them.