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Originally, merchant cash advances were structured lump-sum payments businesses received in exchange for agreeing to pay a percentage of future debit or credit card sales. Today, the term commonly describes a number of small business financing options that are characterized by short term payments and regular, often daily, small payments instead of large monthly payments associated with the traditional loans banks usually issue. Merchant cash advance can also describe the purchases of short-term business loans or future receivable credit card sales.
A Unique Concept
Companies that offer merchant cash advances provide money to businesses and receive a percentage of the daily credit card income of the business directly from the company that processes the credit card payment. The remittances are taken from the debit and credit-card purchases of customers each day until the lender is paid in full. Most lenders form partnerships with the companies processing the payments and receive a variable or fixed percentage of future credit card sales of the merchant. Instead of loans, merchant cash advances are a sale of a percentage of the future debit and credit-card sales of the company.
Higher Interest Rates
This arrangement frees the merchant cash advance companies from having to comply with state usury laws which prevent lenders from charging customers very high interest rates. Using this technicality, merchant cash advance companies are able to operate in a market that’s largely unregulated and charge interest rates much higher than those charged by banks. This type of structure offer several advantages over conventional loans. The most important one is payments made to a merchant cash advance company can fluctuate with the sales volume of the merchant. This provides the merchant with greater flexibility in managing their cash flow, especially when sales are slow.
Faster Access To Capital
Merchant cash advances are processed must faster than a conventional loan. This gives the merchant quicker access to capital. Merchant cash advance providers usually give the performance of a business more weight than the personal credit score of the business owner. This makes merchant cash advances a good alternative for businesses owners who don’t qualify for conventional bank loans. For example, it allows a business owner to sell $25,000 of the future credit card sales of their company for an immediate lump sum payment of $20,000 from a finance company. Every time a debit or credit card sale is made, the finance company usually collects between 15-35% until they have collected the entire $25,000.
There are three common repayment methods used by companies that receive merchant cash advances. They are Split Withholding, Trust Bank Account Withholding and ACH Withholding.
With split withholding, the daily credit card sales are automatically split between the business and the merchant cash advance company. This process is preferred by both the business and the finance company.
In trust bank account or lock box withholding, all debit and credit card sales go into a bank account the finance company controls. They keep their share and forward the rest to the business. This method delays payments to the business by a day and is the least preferred payment method.
With ACH withholding, if the money isn’t considered a loan, the merchant cash advance company gets the processing information for the credit card and deducts the agreed upon portion directly from the checking account of the business. If the cash advance is set up as a loan, the finance company withdraws a fixed amount from the business’ account each day regardless of the amount they make in sales.
Merchant cash advance is an industry that generates over $3 billion a year.