A merchant cash advance is a unique type of loan finance available to businesses that meet certain criteria. But what are they exactly, and when are they most useful? Learn about merchant cash advances, how they work, and how they compare to more traditional business loans with this helpful guide.
A merchant cash advance is an alternative type of business finance that works somewhat differently to a traditional loan. With a merchant cash advance, rather than repaying the loan amount in a series of regular, set value repayments at specific intervals, the lender instead takes a small percentage of your business’ cash flow (called a holdback amount) until the loan is repaid.
Because the repayments are a proportion of your cash-flow, that means your repayments vary with your cash flow – meaning if cash flow slows down, your repayments get smaller, making it easier to keep paying the bills.
With a merchant cash advance there’s no interest rate – not in the traditional sense. Rather, the amount your business owes to the lender is the amount borrowed with a payback amount added on top – a set percentage of the borrowed amount, agreed to at the beginning of the loan. This percentage varies depending on the amount borrowed and the specifics of your business, but is generally in the area of 20-40% of the loan amount. Once the lender has deducted enough from your cash flow to cover both the original loan and the payback amount, the loan is repaid.
A merchant cash advance doesn’t suit every type of business. Because merchant cash advances generally deduct money from your electronic transactions, it’s generally more suited to businesses which do the majority of their trade via EFTPOS or credit. Businesses which deal predominantly with cash or invoices might not be able to make use of these loans, and in fact too much business done in cash could breach your agreement with the lender. This means it’s well suited to retail businesses, but not necessarily to tradies.
Merchant cash advances have quite short loan terms, and need to be repaid within 12 months of the original loan. This, combined with payback amounts starting at 20%, can make merchant cash advances not suitable for large amounts. But the fact that the repayments flex with your cash flow can still make them a useful option – especially for smaller, short-term loans.
In general, the high cost and flexible repayments of a merchant cash advance make it best suited to a business with limited cash reserves, but a steady flow of electronic transactions.
Merchant cash advances are generally very quick to turn around with a simple application process, potentially getting approved and funded within a day or two.
A merchant cash advance doesn’t require security or a deposit. Technically the security is your future income – as odd an idea as that might seem.
Merchant cash advances are generally no difficult to get approval for, if your business is eligible. They also place very little weight on your credit rating, so they’re generally quite suitable for a business which has had financial struggles in the past but is now recovering and doing steady trade.
One of the most obvious advantages is the fact that the repayments flex with your cash flow. In addition to keeping repayments affordable, it also means that in a season of plenty the payments increase, and the loan automatically pays itself off faster.
Although the payback amount can be substantial, the fact that the overall cost of a merchant cash advance remains set can be helpful – you know exactly what you’re dealing with, cost wise.
There’s no getting around the fact that a merchant cash advance isn’t cheap. A 20-40% payback amount over 12 months means they effectively have an interest rate of at least 20% p/a – which is higher than most credit cards.
The dependence on electronic transactions limits the number of businesses a merchant cash advance is useful for. It can also potentially limit your business possibilities while the loan is being paid off.
A maximum loan term of 12 months puts merchant cash advances among some of the shorter loans on the market. It also means the holdback amount (that you lose out of your business cash-flow) needs to be on the high side, to repay the money in that time frame.
Obviously, the cash flow of your business affects your ability to make repayments, meaning your cash flow needs to be maintained a certain pace – potentially you need to be a little bit conservative when it comes to business decisions, so as not to disrupt cash flow.
You need to be careful reading the fine print on a merchant cash advance agreement, as they can include more restrictions than an average loan – potentially limiting things like changes to operating hours, or offering cash discounts.