Merchant Capital: What the Heck is It?

“Merchant capital” might sound kind of unfamiliar, but if you’ve been looking for business financing for awhile, you’ve probably heard of one of its many aliases. But whether you call it a merchant cash advance, a cash advance, or merchant capital financing, this fast and easy business financing option is also a pretty expensive way to get your hands on funding.

Let’s learn a bit more about it, so you can make the right decisions for your business.

Merchant Capital Advances vs. Business Loans

Merchant capital is basically an immediate lump sum offered to a business by a lender. In exchange, you agree to pay that cash lump sum back—plus a fee.

So far, so good. Sounds a lot like a normal term loan, right?

But here’s the big difference: that payment will come from your business’s future sales, because you’re agreeing to let your merchant capital provider to automatically deduct a predetermined percentage of your business’s daily credit card and/or debit card sales. In other words, you’ll make less on every credit or debit card sale until your merchant capital lender gets paid.

While traditional lenders make money from the interest they charge on loans, merchant capital providers make money off that agreed-upon fee we mentioned earlier. And the fee remains the same, whether you pay off the total amount in a few weeks or a few months. So on the one hand, you don’t have to worry about late payments or gathering interest by not paying early… But on the other, you can’t get out of a situation that could close up your cash flow until you’ve paid everything back.

Who Is Merchant Capital For?

In some ways, merchant capital advances are similar to short-term loans: they provide money quickly, with short approval times and easy qualifications. They appeal to business owners who need money now, but don’t have a lot of financing options.

Merchant capital might be useful when a business has bad credit—or not enough credit, because they haven’t been in business long enough. They’re also used by businesses with cash flow issues but steady debit and credit receivables, like restaurants, corner stores, and retail shops.

That said, be careful of how your merchant capital advance will affect your cash flow. By taking a bite out of every credit card and debit card sale you make, the merchant capital provider could actually put an extra strain on your spending.

No Collateral Required

While traditional business lenders might require security for loans, not all entrepreneurs are willing or able to offer specific collateral. So going the merchant capital route sounds good when collateral for a business loan is an issue, because the providers don’t need any. And with no collateral to lose, if the business fails, the capital provider has limited legal options to recover the cash advance from the business owner.

But since the providers are dealing with “high-risk” business borrowers, merchant capital advances aren’t cheap—and they’re also not regulated as carefully as traditional business lenders are.

How Merchant Capital Works

To get a merchant capital advance, submit an application to your chosen provider. You’ll hear back within a couple of days, and you get a lump sum of cash in your bank account if you’re approved.

After that, a percentage of every day’s credit card and debit card transactions—sometimes called a withholding amount—gets sent to the merchant capital provider until the cash advance amount, plus the fee, has been paid back.

If you went the traditional loan path, you’d be making fixed payments daily, weekly, or monthly, according to a preset repayment schedule. With the merchant capital scenario, you’re making daily payments that’ll probably change from day to day, because each payment depends on the percentage of that day’s receivables.

Important: When it comes to calculating the fee for the capital advance, many providers use what’s called a factor rate. The cash amount you’ll receive is multiplied by the factor rate to get the total amount you’ll be paying back. A factor rate is not an interest rate. Don’t be fooled by a factor rate of 1.54—this doesn’t mean you’re paying 1.54% on your $10,000 loan. It means you’ll pay back 1.4 times that amount, or $15,400, amounting to an interest rate of 54%. 

It’s also important to understand that the higher the portion of your daily revenue allocated to paying back the provider, the faster you’ll pay off what you owe. And when business is slow and your receivables are down, your payments are lower, which can be helpful for businesses that struggle with cash flow. There’s a flexibility that comes with merchant capital that traditional loans, with their fixed payments, don’t offer—and that could be a decisive factor in what kind of financing you choose.

If You Get Merchant Capital Financing…

Read the fine print. Make sure you see all the fees before you sign, and of course, make sure you understand what each fee is for. Don’t forget to carefully review the terms. What percent of your credit card sales will be held back?  And when do you have to pay the money back? Figure out how this financing will affect your cash flow, and if the cash is worth the cost.

It’s a good idea to get your APR (annual percentage rate) in writing as well. This lets you better compare this merchant capital deal against others, as well as against other forms of borrowing. Shop around for alternative lending options before committing to a merchant capital financing agreement. In many cases, if you can qualify for merchant capital financing, you can also qualify for other kinds of alternative financing—and often at a much lower APR.

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from Fundera Ledger https://www.fundera.com/blog/2016/03/29/merchant-capital/