Small to medium-sized businesses in every industry require capital to maintain inventory, pay suppliers, and keep their company thriving. A business that needs to look for funding will have access to different aids. However, while there numerous working capital options available, not every business owner qualifies for a loan from conventional lenders. In fact, many business owners often struggle to find lenders willing to finance their business. Unfortunately, new small businesses usually don’t have credentials to demonstrate that they’re reliable in the eyes of numerous traditional moneylenders and others have bad credit scores that block them from procuring business funding. Fortunately, there are many alternative ways to get the capital you need. Merchant financing is one of the most popular and quick ways to get a business loan without facing a strict approval process.
Also referred to as merchant cash advance, merchant financing is the ideal alternative to conventional loans for small and medium-sized businesses. It offers a business funding source that entrepreneurs can use when their collateral or credit rating is lacking. This financing product allows small businesses to obtain instant cash access that they can use to fund their daily operations. Unlike the regular business loan, merchant financing means purchasing a section of the future business credit card sales for a specific discount. Once the contract is signed, the company receives a lump amount. In exchange, the provider has the right to take out part of the credit card sales of the business each month until the contracted amount is fully recovered. A merchant cash advance is not a loan, but an advance payment on the future income of your business.
Just like any other financial product, merchant financing has certain pros and cons. Even though the merits of merchant financing to small business companies exceed the demerits, it is still important that you know about the good and the bad of the credit program so you can decide whether it’s the right solution to your small business.
The Advantages of Merchant Financing
- They Are Easy to Qualify For
In addition to being readily available to bad credit business owners, merchant financing’s other underwriting conditions are also easy to satisfy compared to those for traditional small business loans. What really matters to the provider is whether you can demonstrate that your business is averaging a specific amount in monthly bank transactions over a stipulated period of time.
Lenders will have varied requirements that can differ by the deal. For instance, a lender may want you to demonstrate an average of $6,000 in monthly credit card sales over the past 6 months. The variables of the average amount of monthly credit card sales over a certain period of time will be determined by the advance amount being sought. It’s worth noting that financial variable weighed are the average dollar amount and the frequency of transactions, depending on the nature of your industry. For instance, a business like a construction company that may have a few bank deposits in a month may still be eligible provided the dollar amount of these transactions satisfies the average amount requirements.
- Collection is Based on Revenue
One of the main problems with conventional loans is that whenever sales are not made, the company will face difficulties in making the monthly payments. This is not a problem with credit card based merchant financing because repayments are typically done only when the company makes money. If your business is still not eligible for a credit card based merchant financing, you may still be an ideal candidate for an ACH plan, where a small fraction of your deposits is debited on a recurrent basis.
- The Application Process is Simple
Apart from necessitating large amounts of paperwork, signings, and meetings, business loans take a substantial amount of time to process. However, merchant financing requires much less paperwork and takes less time, making the process quick and easy. The entire application process is basically streamlined because it’s mostly done online. Typically, a business loan application process with a commercial bank may take months. This won’t be helpful, particularly if you want cash to take care of immediate cash flow needs. With merchant financing, the most important things that the lender may want to confirm include, credit card transaction requirements. This means that you may only be required to provide your business bank statements and/or your recent credit card processing statements.
Furthermore, in some cases, the lender would want to see a copy of your lease just to ensure that your business will be there for the anticipated repayment period. The low friction experienced while applying for a merchant financing allows you to respond rapidly to changing events in your business. Also, it greatly reduces your administrative expenses to applying. Rather than requiring hours of your time or your accountant’s putting together the business loan paperwork, the statements required by the Merchant financing lender are easy to prepare. The simple process allows you to focus more time on your business instead of being swamped with hours-long applications that may not be any fruitful.
- Automatic Repayment
Another advantage of merchant financing is the repayment structure put in place. There’s no need for you worrying about missing a payment. Depending on the merchant financing your eligible for, the repayment will be credit card revenues and/or bank statements. Basically, it’s intercepted by your lender before it even reaches your account. This automatic repayment structure is basically a daily percentage of your transactions and allows you to repay at convenient pace.
- Ideal for Bad Credit Business Owners
Banks and other traditional lending institutions are stingy with lending to business owners with a less-than-stellar credit score. As such, it can be tough for bad credit business owners to secure business financing if their score rating is less than 630. Fortunately, merchant financing focuses on the future and less on your credit history. Therefore, a bad credit score, while still a determining factor, may in most cases not affect the approval decision. This is one of the reasons why merchant financing has a higher approval rate when compared to small business loans. A merchant cash advance is an ideal option for business owners with tainted or no credit information.
- No Upfront Collateral
Most business financing options will require you to risk your financial health. To get approved, you could need a history of good business behavior, a high credit score, or significant collateral. If you fail to repay, you’ll face financial repercussions, which may include losing your assets. With a merchant cash advance, you don’t need to prove your worth with a binder full of balance sheets or put your assets on the line. While conventional lenders and other small business loan options take a lien against all of your company assets, having high assets is not one of the requirements for merchant financing approval. A merchant cash advance is a comparatively safe way to obtain cash. Merchant Financing is a sale of future revenues, so losing collateral isn’t a risk, irrespective of what happens to the business. As long as your business is having a good sales track record as well as a potential for future sales, you won’t have to worry about the provider seizing your assets.
- Fixed Cost Means You Pay Zero Interest
Merchant Financing is not a loan, so there are really no interests. The business owner only pays a certain amount, which is not determined by an interest rate. In short, the total amount you would owe on a merchant financing remains the same. For instance, a beauty studio owner Trevor owes $50,000. If his business experiences a slow period during which his repayment is lower than normal, this does not increase the general cost of his merchant cash advance. However, if Trevor had a similar situation with a bank business loan, the repayment amount would possibly change given that he will be paying interest on the loan longer.
As a short term type of financing, merchant cash advance offers small businesses its low cost of capital. Since your payments towards paying back your merchant financing are on a daily or weekly basis, it is most likely that you’re going to clear it off in the shortest time possible. The advantage of merchant financing is that you may be making high daily payments for the purpose of paying off the amount quickly, but then you end up paying less for the financing as a result.
- Flexible Payments
Merchant financing, unlike other traditional banks, allows flexibility given that payments are designed to account for business seasonality. Merchant financing repayments are typically set up in small, daily ACH, although in some cases they’ll be set in a weekly basis; if you are eligible for a credit card based merchant financing, this repayment will be a flat percentage of your daily credit card sales. If, for instance, the terms of your merchant finance requires that you commit 15 percent of credit card receipts to repay, the actual dollar amount will differ depending on the total amount of sales for the entire month. Your payments are proportionate to what the business is earning.
The Cons of Merchant Financing
You may be excited about the possibility of accessing fast cash without strict requirements, but there are some disadvantages to receiving merchant financing. Here are the downsides that you may want to consider before applying.
- High Built-In Costs
Compared to other forms of small business financing options, a merchant cash advance is quite expensive. Generally, you’ll pay from 9 percent to 50 percent over the amount of funding, often within a short period of time. Merchant financing companies decide the amount you must pay by simply applying a factor or a multiplier to the amount of funding. This factor is usually in the range of 1.09-1.50. For instance, if you finance $200,000 and the finance company applies a 1.3, you must pay back $260,000 ($200,000 x 1.3) during the term of the loan. The high cost tends to cover the higher risk being taken on by the lender.
- Short Repayment Terms
Because the repayment plan for most merchant financing plans are set on a daily basis, this means that a percentage of your daily deposits will go towards paying off your merchant financing. All things considered, if you are worried about being capable of managing daily payments, you may want to consider a weekly or credit based business financing.
- No Benefits for paying off early
Given that the borrower has to pay off a fixed amount of fees, he/she gets no interest savings from early repayment. This is different from a traditional amortizing small business loan, which is characterized by early repayment that would result in less interest paid. Furthermore, it implies that if you choose to refinance, you’ll have to repay all of the agreed-upon fees.
- There’s Debt-Cycle Danger
The speed exhibited by merchant financing may expose you to a debt circle, particularly if you do not qualify for other forms of business financing. Most borrowers may find themselves in dire need of another cash advance shortly after taking their first on because of the extremely high costs and frequency of repayments of merchant financing, which creates cash-flow issues. A daily payment of a substantial amount of money could not only cause stress on the cash-flow of numerous small businesses but also expose them at risk of default. It is always recommended that you consult with your accountant or a financial advisor to determine if a merchant financing is the right fit for your business.
- Merchant Financing May Not Solve Your Problem
The main problem with merchant financing is that they’re often utilized inappropriately. Even though the product is not treated as a term loan, it functions much like one. Your fine receives an immediate cash infusion, and the line is repaid in regular (daily or weekly) installments. Paying off the line in this manner significantly reduces your fund's availability. This structure may be helpful, particularly if you need to buy assets or equipment that can be put to use instantaneously in the business. It is less beneficial if your business has persistent cash flow issues resulting from suppliers who demand quick payments or slow-paying customers.
The Bottom Line
The pros of a merchant cash advance greatly outweigh the cons. However, it’s important to remember that merchant financing is a financial obligation that you shouldn’t take lightly just because it appears informal when compared to other small business loans. Merchant financing may not work for every business but may be worth considering.