A merchant cash advance is a type of financing in which a business receives an upfront sum in exchange for a percentage of its future credit card sales. The advance is typically paid back through daily or weekly automatic deductions from the business's credit card sales until the advance is fully repaid. This type of financing can be a good option for businesses that have difficulty obtaining traditional loans due to bad credit or lack of collateral. However, it is generally more expensive than traditional loans, with higher interest rates and fees.
How Does Merchant Cash Advance Work?
To obtain a merchant cash advance, a business typically applies through a lender that specializes in these types of financing. The lender will assess the business's credit card sales and other financial information to determine the amount of the advance and the terms of the repayment. The advance is typically paid to the business in a lump sum, and the business agrees to pay back the advance, plus fees and interest, through automatic deductions from its credit card sales.
The lender will typically set a holdback percentage, which is the percentage of the business's credit card sales that will be withheld each day or week to repay the advance. For example, if the holdback percentage is 10% and the business has credit card sales of $1,000 per day, the lender will deduct $100 from the sales to repay the advance. The holdback percentage and repayment schedule are typically determined based on the lender's assessment of the business's creditworthiness and the amount of the advance.
It's important to carefully review the terms of a merchant cash advance before accepting one, as these types of financing can be expensive and may not be the best option for all businesses.
Pros & Cons of Merchant Cash Advance
Here are some potential pros and cons of merchant cash advances:
- Quick access to funding: A merchant cash advance can be a fast way for a business to obtain funding, as the application process is typically quicker and less involved than for a traditional loan.
- No collateral required: Merchant cash advances do not require collateral, so they can be a good option for businesses that do not have assets to use as collateral for a traditional loan.
- Flexible repayment: The repayment of a merchant cash advance is tied to the business's credit card sales, so the business can pay back the advance more quickly if it has a good month and more slowly if it has a slower month. This can be a good option for businesses that have fluctuating sales.
- High cost: Merchant cash advances are generally more expensive than traditional loans, with higher fees and interest rates. This means that a business will end up paying back significantly more than the amount of the advance.
- Automatic deductions can be disruptive: The automatic deductions from a business's credit card sales to repay a merchant cash advance can be disruptive to the business's cash flow. This can make it difficult to plan for expenses and manage the business's finances.
- No credit check required: While it can be a pro that a merchant cash advance does not require a credit check, it can also be a con, as the lender is not taking into account the business's credit history or credit score when determining the terms of the advance. This can make it more risky for the lender, and the higher cost of the advance may reflect this risk.
In conclusion, a merchant cash advance can be a fast and convenient way for a business to obtain funding, but it is generally more expensive than traditional loans and can be disruptive to a business's cash flow. It is important for a business to carefully consider its financial needs and options before deciding whether a merchant cash advance is the right choice. It may be helpful for a business to speak with a financial advisor or lender to determine the best course of action.