Business cash advance introduction
Securing a traditional business loan can be difficult. You're required to fill out extensive paperwork, endure lengthy background and credit checks, and provide adequate collateral - and that still doesn't guarantee you'll be approved. If you need quick cash for your business with less documentation than a standard loan requires, a business cash advance (also known as a merchant cash advance) can help.
With a business cash advance, you sell a percentage of your business's future credit card transactions to a provider. The provider reviews your credit card transaction history, and advances you cash based on your average monthly revenue. Then, they take an agreed-upon percentage of your future credit card receipts to repay the advance.
This type of short-term financing doesn't carry the same restrictions as a standard business loan, and with good reason - a business cash advance is not a loan, but rather a purchase and sale agreement. The provider buys the right to take money from your credit card transactions and sells those rights back to you for a fee.
Since this transaction is risky for the provider, you pay a steep premium for the money - as much as 40% of your total advance. But for businesses that don't qualify for loans and need funds immediately, a business cash advance may be well worth the expense.
This BuyerZone Business Cash Advance Buyer's Guide will explain:
- How to qualify for a business cash advance
- How the business cash advance process works
- Suggestions for finding reliable providers
- Typical pricing information
Once you review the information in this buyer's guide, submit a free request for business cash advance quotes to be matched with multiple cash advance providers.
Business cash advance overview
A business cash advance comes in handy when you don't qualify - or have time- for a lengthy loan process. By submitting a quick, one-page application and providing basic documentation, you could be approved within 24 to 48 hours and have the cash in hand within 7 to 10 days.
Business cash advances can be used for almost any business expense:
- Purchase new equipment or inventory
- Pay a tax bill or other debt
- Invest in new marketing activities or advertising
- Expand facilities or open new store locations
- Take advantage of short-term purchasing opportunities (liquidations, sales)
Be prepared to explain how you plan to use the funds from your business cash advance. Some providers will only allow you to use the money to grow your business. These providers need to know you're actively working on paying off the advance by increasing sales. Others may be more flexible, provided you maintain a steady flow of credit card transactions.
Part of the lure of a business cash advance is its simplicity. Unlike business loans or equipment leasing, which almost always requires collateral or a personal guarantee, the business cash advance process is far less restrictive. To qualify, you only need to prove your business has:
- Operated for at least one year
- Processed credit cards for a minimum of six months
- No prior bankruptcies or property liens
- One or more years left on a property lease
- No existing business cash advance agreement with another company
While you don't need a strong credit rating to get a business cash advance, it certainly helps. Providers can offer better rates and larger advances if you show a solid financial history.
A business cash advance isn't for everyone. You may not want to pay such high rates or give control of your incoming credit card revenue to a provider. Instead, here are other funding sources to consider:
- A business loan requires collateral and extensive documentation, but can provide more money, better rates, and flexible payment options over a long period of time.
- If you need new or better equipment, an equipment lease lets you spread payments over time without a large, up-front investment.
- Factoring is a similar service to a business cash advance - you sell your accounts receivable to a provider at a discounted rate for up-front cash.
One approach to avoid is borrowing against the credit limit on your personal or business credit cards. You'll pay high fees for credit card cash advances, and they could have a negative impact on your credit history. Unless you have a very short-term need for cash, credit card cash advances are an inefficient choice.
Who uses business cash advances and why?
Almost any business that processes credit cards and needs quick cash can use business cash advances.
The top candidates are typically retail or restaurant businesses that have difficulty securing traditional business loans. Banks and other lenders are wary of these types of businesses because of their high mortality rate, especially during their first two years. Business cash advances provide immediate funding to help these businesses succeed.
Cyclical businesses, like florists and tourist attractions, also rely on business cash advances to buy new inventory. Since these types of businesses experience seasonal lulls, a cash advance ensures they're ready when customers return during the busy season.
Keep in mind that this type of financing is a short-term solution intended to help grow your business, not to sustain it. If you use business cash advances as a way to meet payroll or keep your company afloat, you risk overextending yourself.
Benefits of business cash advances
- Limited restrictions - None of the typical loan requirements such as collateral, application and processing fees, or personal guarantees are required, providing you with a greater chance for approval.
- Possible tax advantages - Since business cash advances are considered purchases, you may be eligible to write off the expense (but check with your accountant first).
- Speedy funding - Funds can be wired to your account as quickly as 72 hours after approval.
- Ebb and flow repayment process - Instead of maintaining a fixed repayment schedule, your payments are based on a percentage of your daily credit card transactions.
- Minimal credit impact - Applying for a business cash advance doesn't show up on your credit report so you won't negatively impact your rating.
- Low risk - The provider assumes most of the risk for this transaction; if you go out of business, the provider doesn't have much recourse to get their money back.
Drawbacks of business cash advances
- High rates/fast repayment - A cash advance is an expensive funding source that must be paid back within 6 to 8 months. Since the industry is largely unregulated, there's no cap on how much a provider can charge on an advance.
- Certain businesses won't qualify - Few providers will fund start-up companies or home-based businesses. You may also struggle to get a business cash advance if your net credit card receipts are below $10,000/month.
- Cash advance limits - The amount of the advance is solely based on recent credit card statements, which may not provide sufficient funding for your needs.
- Must maintain consistency - If the provider sees that your business is falling off or notices unusual activity, such as lower-than-normal credit card processing or more cash transactions, your account may go to a collection agency for repayment.
The merchant cash advance process
To get the merchant cash advance process started, you need to set up an initial consultation with a provider, usually by phone. He'll gather basic information about your company, why you need the advance, and how quickly you need the money. Afterwards, the provider will arrange to meet you in person to assess your business and ensure you operate from a physical store or office.
Reviewing your financials
When you meet, the provider reviews your last 3 to 6 months of recent credit card statements to learn your revenue trends. He'll also collect information such as how much time you have left on your lease and your current debt load.
You'll complete an application that permits the provider to pull your credit report and check for previous bankruptcies, liens, or judgments against your company. The provider also ensures you don't have outstanding merchant cash advance transactions.
Once they review your credit history, the provider can typically approve you for an advance within a few hours. Less-than-stellar credit won't necessarily impede your chances of getting an advance, but you may have to agree to less favorable terms.
Based on your business's financials and the size of the advance you're approved for, the provider will calculate your safe retrieval percentage - the maximum percentage he can take from your daily credit card revenue without endangering your business' financial health.
You'll sign a contract that outlines the amount of the advance, the rate, and the retrieval percentage, and your advance will be ready to go.
Switching merchant account providers
As part of a cash advance, you may have to switch merchant account providers. The merchant cash advance provider can't take their daily percentage unless they have access to your merchant account. This may require you to pay penalties to your original processor if you break a long-term agreement.
Once you switch over, the provider will work with an automated clearing house or set up batch processing to hold back their percentage of your daily credit card take. After the provider runs some small test batches for a few days to ensure everything works properly, the cash is wired to your account.
Choosing a business cash advance provider
Although the business cash advance is a relatively new product, a variety of businesses are already grabbing their share of the growing market.
Providers range from large merchant account vendors who offer cash advances as part of their services, to small, independent companies who focus exclusively on advances. Even traditional financial businesses like banks and leasing companies are getting involved by aligning with small providers to offer business cash advances to customers.
The background of the provider shouldn't matter - quality is far more important. You want to work with a company that takes the time to understand your cash flow needs and determine rates that let you get the money you need without compromising your company's stability.
What to look for
Any provider you work with should offer solid, reliable customer service before and after you agree to work together. You should be confident that your provider will be there when you need him most. For instance, if you face an unexpected business slump or accelerated expenses, your provider should work closely with you to come up with a solution that benefits both parties.
The provider should help you feel comfortable with the transaction. Taking a business cash advance means you'll have to make sacrifices like switching merchant account providers and operating with a smaller cash flow. Your provider should help you understand that these temporary changes can benefit your company's future.
Look for providers with significant financing experience. Since the business cash advance industry is fairly new, look for providers who have guided businesses through financial hardships in other ways. Research each provider's background, how long they have offered business cash advances, and which companies they've worked with. You want to develop relationships with companies that plan to be around a long time and aren't just jumping aboard the latest hot trend.
Quality providers will learn as much as possible about your business to find out how much money you need and if you can pay it back. Once they do, it's also important they share any bad news immediately. If you only qualify for unfavorable payment terms, it's better if they reject your request than gouge you with excessive rates.
Finally, take your time when selecting the right provider: it's an important decision that could impact your business's long-term stability. You need to carefully compare price quotes from multiple providers and perform your due diligence on each candidate. You'll find plenty of providers who are patient enough to wait for your decision - if one seems pushy or tries to strong-arm you into signing an agreement before you're ready, walk away.
Business cash advance rates
While it's easier and faster to get approved for a business cash advance than a traditional business loan, it's also much more expensive. Providers charge very high business cash advance rates, as much as 45% or more, to account for the risky transaction.
Determining business cash advance costs
Three criteria determine how much you'll pay:
- Advance amount - How much cash you'll receive
- Factor rate - The provider's fee
- Daily retrieval rate - The daily percentage withheld from your credit card processing
The advance amount is based on your average credit card receipts over the previous six months. Depending on your credit history and business strength, a provider can advance you between 80% and 125% of the monthly average.
The factor rate is how much the provider charges to advance you the money, typically 20% to 45% of the advance. Most businesses pay between 30% and 35%, but that rate varies depending on your credit rating and business health. Although uncommon, providers can charge factor rates as high as 50% to 75% or more, depending on how risky they consider your business.
Based on the amount you owe and your typical daily credit card sales, the provider will set a daily retrieval rate, which is the percentage they take when you process your credit card transactions. This rate, which ranges from 15% to 25% per day, determines how long it will take you to repay the advance.
Providers typically want to get their money back within six months. However, since there's no fixed timetable for repayment, providers can negotiate the daily retrieval rate to leave you with a comfortable cash flow to run your business.
Business cash advance rate example
Here's an example of a $20,000 advance with a factor rate of 30% and a daily retrieval rate of 20%:
|Advance amount requested||$20,000|
|Provider fee ($20,000 x 30%)||$6,000|
|Average daily net credit card processing||$3,000|
|Provider's daily take ($3,000 x 20%)||$600|
|Repayment timeframe ($26,000 / $600)||43 1/3 days|
Note that this still leaves you with a daily net of $2,400 from credit card transactions, allowing you to continue your day-to-day operations.
If your business exceeds expectations, the provider may increase the daily rate to pay off the debt sooner. In contrast, the provider can drop your rate if you experience a sales slump so you don't struggle during lean periods.
Make sure to review the contract terms carefully before signing anything. Check the fine print to understand what your obligations are and what services the provider offers. If the contract contradicts information shared during the negotiations, the provider should offer an explanation and agree to make changes as necessary. Also, look out for additional charges like application or processing fees, which are not typically part of this type of transaction.