If you’re a startup, you might be considering getting a merchant cash advance. For startups, getting capital is hard, especially in COVID times. Banks are stringent, and won’t lend to most business owners. The criteria for qualifying for a small business loan is tough and difficult to breach. Most established businesses having a difficult time getting funding, but startups have it even more difficult.
The fact is, sometimes – as a startup, it might make sense to get a merchant cash advance.
Business owners in need of quick funding may wish to consider a merchant cash advance or MCA. Not a loan, a merchant cash advance allows business owners to borrow against their daily credit card sales. The advance is repaid through a percentage of the credit card sales the business receives in its business merchant account. Business owners will find that the application process for this type of advance is typically quite simple and fast. In fact, when approved for an MCA, business owners can usually receive their funding within 24 hours following approval.
To determine whether a business owner is eligible for a merchant cash advance, the lender will usually evaluate the business’s daily credit card receipts to determine whether it is feasible for the advance to be repaid in a timely manner. The criteria used to determine approval for a merchant cash advance are typically different from those used by lenders and banks. It should be understood that due to this, the rates for a merchant cash advance will often be higher than traditional business loans.
Why are merchant cash advances so expensive
Let’s chat about the elephant in the room. Merchant cash advances are expensive. That’s because unlike traditional bank loans, merchant cash advances are not secured by anything besides your future revenue. It means if you default, the lender can’t go after your physical assets. In addition, defaulting on a merchant cash advance will not impact your personal, or business, credit score.
The term “holdback” is one that business owners may find unfamiliar. This term is used to refer to a percentage of the business’s daily credit card sales. The provider takes this percentage, the holdback, as repayment for the advance. Depending on the provider, the holdback could range anywhere from 10% to 20% of the daily credit card sales. This holdback will apply until the advance has been repaid.
Due to the fact that the holdback is based upon the daily deposits in the merchant account, advances can be repaid faster when the business receives more credit card transactions. Should transactions dip lower than the amount expected, the withdrawal from the merchant account would also naturally be lower. This also means it would take longer to repay the advance unless credit card transactions increase.
Comparing Interest Rates and Holdback Amounts
It should also be understood that there is a difference between interest rates and holdback amounts. Factor rates are usually charged by MCA providers. Since merchant cash advances are not usually amortized as like with a traditional loan, the factor rate associated with a merchant cash advance could potentially range between double digits and triple digits.
Should You Choose a Merchant Cash Advance for Your Business?
Although a merchant cash advance can offer numerous benefits when a business owner needs cash without waiting, it is important to understand the costs associated with this type of advance. Since the requirements for a merchant cash advance are less stringent than those of a traditional business loan, you should expect to pay a higher cost for the advance. Even so, if you are a business owner who needs fast short-term funding, a merchant cash advance could be the right option to receive the capital you need.
You should also understand that since a merchant cash advance is not actually a loan, this means that providers are not obligated to report your timely payments to credit bureaus. As a result, even if you make your advance payments on time, doing so will not assist you in building your credit profile.
Possible Alternatives to Merchant Cash Advances
There are possible alternatives to merchant cash advances. Among those options is a short-term business loan. Business owners who have a strong credit profile may find they are able to take advance of a business line of credit to solve their short-term funding needs.
With this type of loan, business owners can obtain the funding they need and repay the loan within just a few short months. Additionally, depending on the terms of the loan, payments could be made on a daily or weekly basis. This makes it possible to spread the debt burden out over the month instead of making a single large payment. The payments made on a short-term business loan can also be reported to credit bureaus, which could help you to improve your credit profile.