What You Know About Traditional Business Funding Does Not Apply to Merchant Cash Advance
You may be in a position where your business is booming but you need cash to expand your business. Or maybe you had a few bad months and need some additional capital to give you some breathing room. In either situation you may decide that now’s the time to find new funding.
When you start researching your options on the internet, you will most likely be exposed to various types of funding sources to help meet your business needs — traditional loans, lines of credit, and alternative funding.
A traditional business loan and a merchant cash advance are two of the most common sources of capital being offered on the internet, but what, if any, is the distinction? When is one better for your business than the other?
In this article, we want to explain what the differences are between these funding sources. Hopefully, we can help you decide which is the best option for you.
Traditional Business Loans
Short-term business loans are a common financing option for working capital. A business loan works similarly to a mortgage or automobile loan. A lender will offer your business a specific dollar amount of funding at a fixed rate with regular payments due to be paid on a set schedule.
Lenders will amortize payments over the term of the loan and will offer interest rates ranging on average from 9% to 18%. The repayment schedule on a traditional business loan is going to require monthly payments although, sometimes, weekly payments may also be an option.
With a traditional business loan, there will be a fixed maturity date and the borrower must repay the loan in full by that maturity date. Loan amounts for business loans can range from as little as $5,000 and up to $1,000.000.00 or more, depending on factors like your business assets, financial statements, accounts receivables, proof of collateral and many times a business plan.
The process is very time consuming and the time frame to receive funding can take upwards of 1 to 2 (sometimes longer) months. In most instances, you will also need good credit to get approved for a traditional business loan.
Lines of Credit
Lines of Credit or Revolving Lines of Credit should be noted here because they are a type of short-term business loan. However, lines of credit act more like credit cards rather than typical, long term, amortized fixed loans.
Lines of credit are similar to credit cards in that once the lender approves you for a certain amount of credit, that credit remains at your disposal to use or not use and you see fit to meet your business needs.
A line of credit is primarily used for working capital needs. Examples would be a revolving line of credit used for the purchase or replenishment of inventory, or they can be used to make payroll or for other general cash flow purposes.
Consider a law firm that does personal injury work. Maybe that law firm settles or wins 12 good cases a year but it must have the capital to fund those cases and it also must make payroll every week, pay its rent and so on.
Often, these law firms will use lines of credit they secure through their banks, to fund their cases and pay their employees and eventually, when one or two of those cases is settled or won, the law firm then refills its credit line buy paying down a chunk of the credit it has used to continue to operate steadily.
Merchant Cash Advance
Until now, this article has discussed traditional business funding sources. There are alternative financing sources for small businesses besides business loans and lines of credit.
Merchant Cash Advances (MCA) have been around since the 1990s and lenders in the merchant cash advance industry have been the pioneers of alternative financing in America. While these may seem like loans on the surface, they most certainly are something altogether different.
So, if it is not a loan, then what is an MCA?
An MCA provides your business with a lump sum deposit direct into your bank account that you have given them authority to access as part of your MCA agreement. Thereafter, rather than requiring monthly installment payments over time on a fixed monthly or weekly payment schedule, a merchant cash advance is repaid using a percentage of future credit card and debit card sales deducted directly from your recurring credit card revenue.
This means theoretically, that a merchant or business owner does not owe any repayment to the lender until they generate sales. This flexibility can provide relief from the financial stress that may come with the other types of small business funding.
Simply stated, an MCA does not qualify as a loan because it is considered the sale of your company’s future revenue. Due to this technicality, an MCA is not subject to the scrutiny and regulations that are imposed on standard small business loans or revolving lines of credit.
That means cash advances are a quick and easy way for businesses to acquire the cash infusion they need, rather than waiting for a bank’s complicated and slow approval process.
Moreover, an MCA does not require a traditional payment schedule and, most importantly for many borrowers, one’s credit score plays little to no role in whether you will qualify for the MCA.
Generally, business loans are as straightforward as other traditional loans you may be familiar with such as mortgages. You are lent a certain sum of money and you pay back that money over time at a clearly identified interest rate. Payments are usually paid once a month and a borrower can most often repay a traditional loan early with no pre-payment penalty.
A merchant cash advance is extremely different. With this type of alternative financing, you are lent a sum of money that is paid back from your company’s future credit card receivables. The agreed upon percentage to be taken from your credit card merchant processing is usually swept from your account daily or weekly. Please remember that to obtain a merchant cash advance, you must give direct access in and out of your business bank account to your MCA lender.
We know what you must be thinking, how can some so-called “alternative finance company” buy a percentage of your future revenue from credit card sales and intercept that money automatically before you ever see it?
Credit card processing companies, or more accurately Merchant Processors, have partnered with merchant cash advance companies to make transferring funds much easier and faster for you, the merchant. Because payment processors already had access to a merchant’s funding account for credit card sales, it only made sense to use them to streamline the cash advance process.
Merchant Cash Advance Qualifications
Merchant cash advance lenders focus primarily on a company’s credit card sales. This is because lenders base the size of the advance on a company’s annual credit card sales and repayment comes from a percentage of the company’s daily credit card receipts.
To receive a merchant cash advance, borrowers must have an account with an approved credit card processor. Depending on the MCA provider and its agreements, a business owner may need to change credit card processing providers. The minimum requirements for time in business and creditworthiness for a merchant cash advance are lower than almost any business loan.
Merchant cash advances require three (3) months of bank statements and many times that is all that a business owner may need to show to be approved. No financial statements are needed, no collateral is needed, and you can be approved with bad credit. If you can show that you generate at least a certain revenue figure every month for the last three months, you can get approved for money.
The Pitfalls of Alternative Financing
Yes, merchant cash advances are much quicker and easier to obtain than a traditional business loan, but this quick funding comes at a high price.
While traditional business loans have fair rates (approximately 7% on average), when you calculate the true APR of a merchant cash advance, the rates can soar upwards of 200% or even more.
If this were a traditional loan, that excessive Annual Percentage Rate would be considered illegal usury. Because merchant cash advances remain unregulated and presently classified as advances and not loans, there are no regulations as to what the MCA broker may charge you for the advance.
If you have an opportunity to obtain a traditional business loan, we strongly urge you to make that choice. Merchant cash advances may be OK for a very short period of time and a small amount borrowed, but you must be aware of the extremely high rates you will be charged and understand that daily funds will be deducted from your business bank account.
It is easy to get in over your head very quickly with a merchant cash advance.
Defaulting on a Merchant Cash Advance?
If you find yourself possibly defaulting on a merchant cash advance, please realize that the MCA companies are much more aggressive than traditional lenders.
Many will attempt to sweep your bank accounts clean before they ever take any proper legal action or obtain a court order to do so.
How do they do this? The fact is that you gave them lawful access to your bank account when you accepted the advance and signed the MCA agreement.
If you feel that you may be nearing a default point with a merchant cash advance or you are currently in default but a catastrophic event has not yet happened, you should contact a qualified law firm for a thorough consultation before it is too late.
The lawyers at Business Debt Law Group offer complimentary consultation to anyone seeking further information. If retained, our lawyers will provide comprehensive legal support including the defense of MCA lawsuits and good faith but hard-nosed negotiations with your MCA lenders to bring about a favorable resolution that won’t cost you the business you worked so hard to build.
Contact Business Debt Law Group today for a free consultation. We are here to help.