When the recession hit in 2007, lending to small businesses came to a screeching halt. It wasn’t long before businesses — even those with a comparatively strong record and owners with perfect credit — struggled to get funding from banks.
The decline of bank lending lead to an increase in alternative sources of funding for businesses. One alternative source that has received a lot of attention is the Merchant Cash Advance, or MCA. In short, when a business takes a merchant cash advance, the lender will provide a lump sum amount of capital in exchange for a percentage of the daily credit and debit card receipts. That percentage depends on the amount of money borrowed, the fees for borrowing that money, the typical amount of daily receipts, and the length of the loan term.
The cash advance industry has received some bad press in the past, and as a result, many business owners have been reluctant to consider them as a source of cash. That’s unfortunate, because a merchant cash advance might be exactly what a business needs in order to grow and prosper.
When an MCA Is a Great Idea
Although the credit crunch appears to have eased somewhat, not all businesses can get money from banks. An MCA can be a great deal, then, because it opens up funding options to businesses that might otherwise be out of luck. More specifically:
Payment Is Flexible
When you take out a loan or use a credit card, you’re locked in to specific payment terms. If you have an off month, and the coffers are getting low, making that payment could present a hardship. Not paying is even worse, and defaulting could cause you to lose your business. A merchant cash advance, on the other hand, is repaid based on your sales. On good days, you’ll pay off more toward your balance. On slower days, the payment is lower — but you are always making progress.
You Don’t Need Perfect Credit
Lending standards are stricter than ever these days, and if you have less than perfect credit, like most people, getting money for your business could prove difficult, if not impossible. With a MCA, how much you can borrow depends largely on your future sales projections, not your credit history.
You Don’t Need Collateral
Traditional bank loans generally require entrepreneurs to leverage personal assets as a guarantee — meaning that those who do not have assets, or aren’t willing to risk losing their family home or other assets usually cannot get funding. Not to mention, most banks will not allow merchants to use stock, perhaps their greatest asset, as collateral.
MCA’s, on the other hand, do not require collateral, making them a good choice for a merchant who is just starting out.
You Can Access Money Quickly
Most business owners who take out merchant cash advances can access the money in a few days, unlike the weeks or months that it takes for conventional loan applications to be processed and approved. If you need money quickly, for something like vital repairs or upgrades, then an MCA could be the way to go.
When Merchant Cash Advances Aren’t a Solution
Despite the many benefits of a merchant cash advance, there are some situations in which a conventional loan or other source of funding is a better idea. Obviously, MCAs aren’t appropriate for businesses that do not collect credit and debit card payments on a daily basis; in other words, it’s not usually a viable source of funding for a business like a consulting firm or insurance agency.
It’s also not appropriate (and probably won’t be approved) if your sales are on the decline with no reason to expect they will bounce back. For example, an MCA might work for a seasonal business, since the receipts in the high season will offset the lower returns during the slow period, but an ongoing period of decline is not the time to take an advance.
It’s also important to consider how you plan to use the money. If the return on your investment is going to be less than the cost to take the advance, it will not make financial sense. Taking a cash advance to repair a vital piece of equipment is one thing; doing it to make cosmetic changes to your menu is another.
A merchant cash advance is not for everyone, and it isn’t without costs. As with any time you borrow money, is important to read the fine print and know exactly what you’re getting into and what it means for your business.