A merchant cash advance is a common form of a business agreement that allows businesses to receive a credit line of cash in exchange for a portion of product sales in the future. This percentage usually includes interest, taxes, and other additional fees.
Some financial lenders may consider this a business related loan, while others consider it as a form of an investment, but the real important factor is that both sides get what they want.
The concept of merchant cash advances will be explored in the following sections of the post in order to try and provide a better understanding of what it is and how it could potentially work in your favor.
What is a Merchant Cash Advance?
As briefly mentioned above, a merchant cash advance is usually a transaction of a large portion of money from a financial lender in exchange for a percentage of product sales in the future. The specific terms of each agreement is different, and the terms can usually be changed depending on the intentions of each party involved.
Why is a Merchant Cash Advance good for the Lender?
The lender in this scenario is banking on the business to have a significant amount of sales that will pay back the initial lump sum transaction that was made in order to provide the business with a large portion of cash. Many financial lenders and brokers will construct the agreement so that projected sales will pay them back their initial loan amount plus some interest within one year.
This is usually a really safe investment for lenders to take because of the guaranteed return from each individual product sale. If the business sells 5000 of their own products through credit card transactions, the business is required to pay a royalty to the lender for each individual sale, this amount of money adds up quickly and can pay the lender back in a matter of weeks or months.
Why is a Merchant Cash Advance good for the Business?
In almost all cases, a merchant cash advance could be considered a ‘win – win’ scenario for both the business and the lender. There are multiple reasons that a cash advance can help the business side of the transaction. First off, in many cases, small businesses simply don’t have enough liquidity when it comes to having enough financial control of their business. For businesses that don’t have enough up-front cash, they are forced to consider taking out business loans or merchant cash advances.
The biggest reason that a small business would want a merchant cash advance is to expand their operation internally in some way, which usually requires a large amount of cash. The problem is that if the business waits to sell enough product to make this expansion, years of potential revenues could pass by. Therefore, businesses have the option to establish a merchant cash advance agreement with a lender that takes a portion of credit card product sales in exchange for a lump sum of cash upfront.
When a reasonable agreement is reached, the cash is handed over to the business so that they can spend it on whatever they need, while the lender is confident that they will be paid back entirely in a reasonable time frame, plus fees.
There is often confusion between business loans and merchant cash advances, and the main difference is the interest rate and the repayment requirements. A business loan usually requires relatively large interest rates and payment deadlines, where a merchant cash advance requires payments to be split and established at the moment that the credit card finalizes the purchase.
One of the really nice things about a merchant cash advance is that in most cases this form of an agreement benefits both parties for their individual needs. Lenders obviously want to make smart agreements that allow them to be paid back within a reasonable time frame, usually with a little extra so that it was all worth the while. Businesses often times need cash up front before launching a product so that they can improve their internal workflow and expand their entire company operation.