HOW CAN I TELL IF A CASH ADVANCE COMPANY IS LEGIT
The cash advance industry has taken off in the last decade. It has become a very common way for, especially small businesses, to get short-term financing.
As with anything, there are advantages and disadvantages to using a financing strategy like this. Let’s break them down so you can make an informed, well thought-out decision on if and when to utilize this option.
First of all, let me explain what it is. It’s technically not a loan. It’s a cash advance where a merchant cash advance financing company, let’s call it MCA from now on for short, gives a business a big pile of cash for a larger pile of cash in the future.
To break it down, let’s say a local retail gift store on the main street of a small town is getting ready for a big festival that draws in tens of thousands of people from around the state.
In order to take advantage of the extra foot traffic and ensuing large volume of new customers, they need to stock up on inventory to meet the demand. They estimate the demand and figure out that they need to purchase $10,000 worth of goods from their various wholesalers.
Of course the problem is that they are short on cash like most small businesses. They can call up an MCA and get a lump sum payment of $10,000. In return, the MCA is going be repaid $14,000. In merchant cash advance parlance, that’s a factor of 1.4 (10,000 X 1.4).
The MCA will make $4,000 on this deal, but the retailer will make a potential of $50,000 from the selling the inventory. The retailer loses $4,000 on the MCA deal, but makes $36,000 ($50,000 sales – 14,000 repayment to MCA = 36,000) overall.
The cool part is that in order for the MCA to get repaid, they will hook up to the retailer’s credit card system and pull out a portion of each sale that is made to pay back the advance until the $14,000 is reached.
Now for the pros and cons.
There are several upsides to this deal for the retailer, as well as some downsides which we’ll go over later.
The biggest upside to MCA’s is how quickly the retailer gets the cash on hand. If he needs to buy the inventory ASAP in order for it to come in by the date of the festival, he can do that more easily with MCA’s.
Other types of financing such as bank loans, credit cards and other loans, require documentation, interviews, application forms to be filled out, credit scores to get checked and so on.
Unlike most loans, MCA’s don’t require collateral as a security for the financing company. That means you’re not risking losing your home or any other assets because MCA’s usually aren’t tied to any collateral. Here is a good resource on collateral backed loans if you’re interested in learning more.
That being said, because the MCA’s connect to your credit card system, the only way they DON’T get paid back is if you go out of business and stop making sales.
That’s also an advantage for the retailer in that the MCA’s get paid in proportion to the sales that are coming in. So if they have a light week, the MCA’s repayments won’t be as large. When there’s a good week, the MCA get’s repaid at a faster rate.
Now for the downsides to MCA’s. There are several that you must keep in mind. But if you can manage these downsides, you can make the MCA work for you.
If you looked at the earlier example of the MCA being repaid by a factor of 1.4, the retailer is paying $4,000 over time to receive $10,000 today. That’s a 40% interest rate. The cost of capital is rather high.
But again, if you have an opportunity that’s going to yield you far beyond the cost of capital and you don’t have any other alternatives, the retailer can still come out on top.
MCA’s are super quick and easy to get. That can be a good thing if you need cash quickly for a great opportunity to grow or make even more money.
It could also be detrimental if a retailer or business uses it to keep their head above water. If the cash isn’t going toward cash generating investments, it can easily be used as a never ending debt cycle system. Given the high cost of capital, this could get you into the danger zone.
At the end of the day, MCA’s can be a great source of quick cash for any business to grow and take advantage of unexpected opportunities. But there are downsides as well that need to be kept in mind if a business is going to use this as a financing strategy.
Did you ever think about how merchant cash funds came into existence, how does the process work, and who they benefit the most? This article sheds some light on the history of merchant cash advances.
Merchant cash advances have in fact been a popular lending method for a number of years and it is not a new concept. Businesses and merchant owners have been using merchant loans for years to meet their financial requirements. While the process may have changed a bit, the basic intents as well as implications remain the same. Earlier firms preferred to avail business loans from banks which quite often prove to be a lengthy as well as a complex process. With merchant cash borrowing being easy and simple, big and small firms started turning towards cash advances.
Credit History of Merchant Owners
Businesses are often offered merchant loans based on their past as well future sales record. Rather than emphasizing on collaterals or cash-in-hand the lender analyzes the sales volume of a business merchant. It is always a plus for the businesses if they have a good credit payment history. This enhances their chances to receive funding for their business expansion.
Lenders disburse the loan amount in exchange for future credit and debit card sales. Merchant owners aren’t required to pay any fixed amount. The repayment amount (generally a certain fixed percent of total credit/debit card sales) is directly collected by the lender from various credit card processors. Generally accepted credit/debit cards include MasterCard and Visa Card.
There are many occasions which sound business organizations which can use cash to propel their business growth; however, they aren’t able to qualify for traditional bank loans. Such business funding factoring agreements don’t’ require any rules of providing any collateral or security. They offer a lump sum amount to the merchant owners in exchange of their future receivables. For example, if a firm has sold $20,000 of its future sales, the lender will collect all its money from customer’s debit or credit transactions sales until it has collected the full amount of $20,000.