Getting a great idea for a new business and starting your new venture can be incredibly exciting. This is especially true if it’s a dream business that’s finally getting it’s chance at a launch.
Once a entrepreneurial venture gets off the ground, the harsh reality of keeping the business going and growing can hit like a ton of bricks.
Why Businesses Fail
According to Forbes, roughly half of business started will fail within the first five years. A third will survive the 10 year mark.
The question is, what brings down these businesses? The first place most people would go to in their thinking would be that these businesses didn’t have a good product or service. At the very least, most people think these ventures failed to acquire customers or to generate sales.
In many cases, that is a reason for business failure. But most businesses that make it past the year mark usually have customers and sales. Otherwise, they wouldn’t have lasted past just a few months.
Most of these ventures don’t fail due to lack of sales or customers. In fact, many of these businesses are actually profitable. That means they are making a profit each month. To break it down even more, their sales revenue is exceeding their expenses. And yet, they still fail. Why?
Most businesses fail because of a lack of working capital. What that means for a small business, in essence, is that they ran out of cash and couldn’t get more cash. You may have heard the saying, “cash is king”. There’s a reason that saying exists.
So how does this happen? How does a small business that’s making a profit run out of cash to run their business? It’s simple. It all has to do with cash flow.
Let’s say a business generates $10,000 in sales that month. They have $8,000 in expenses that month. They end the month with $2,000 profit. Looking good so far right?
Well, that is until you realize half of the revenue came from customers who are going to pay in 30 days. In financial language, we’d have $5,000 in 30-day accounts receivables (AR). The other $5,000 is cash now.
So you see the problem? They made $10,000 in revenue, but they have $8,000 in expenses that they have to pay now. They only have $5,000 in cash on hand to pay those expenses. They are $3,000 short this month and have to wait 30 days to get that other $5,000.
Merchant Cash Advance
Above is just one overly simplified example of the cash flow problems that businesses face. This is why many businesses use credit cards, lines of credit or bank loans to keep their cash flowing, pay their current expenses, keep the business going while they collect on future cash.
There are many businesses, however, that have run out of runway and the bank won’t give them anymore loans. They don’t qualify for a variety of reasons and now their in a cash crunch.
Some business may be fine in their current cash flow situation, but they have see a great opportunity to expand and grow their business, but don’t have the cash to invest in that opportunity. This is where merchant cash advances come in.
Merchant cash advances are not loans. They are simply buying a portion of future sales.
Companies that offer merchant cash advances like Delancey Street are not giving loans. They are giving you an upfront lump sum payment to receive a portion of your future sales transaction.
Let’s say Acme Coffee Shop’s espresso machine is completely broker and they need $10,000 to invest in a new espresso machine custom-built from Italy. A merchant cash advance company may come in and give them the $10,000 to buy that machine and keep the business going. In return, they will ask for $14,000 in future sales.
But they will take say 10-15% of future sales via the coffee shop’s credit card and debit card transactions until they reach the $14,000 amount. There will usually be a small percentage transaction fee in there as well.
Now, the coffee shop can keep their business going by being able to buy that new machine. In exchange, the merchant cash advance makes money in the future. If there were no other sources of funding for the coffee shop, it would have to go out of business.
One of the upsides to this is that it’s an automatic payment from the credit card machine. That means you pay off the advance as sales comes in, and because it’s automatic, there’s no temptation to use that cash for other needs.
That is essentially how merchant cash advance works and why businesses need financing mechanisms like this to stay in business. It’s an innovative and relatively simple way to manage a business’ cash flow.