How do Merchant Cash Advances Work?

A merchant cash advance is a type of financing that provides businesses with a lump sum of money. Unlike traditional business loans that require entrepreneurs to repay the money in fixed monthly installments, these loans are repaid with a set percentage of monthly sales.

Recommended: Get approved and funded in the same day with a Business Loan from Uplyft Capital.

What To Consider When Getting a Merchant Cash Advance

Businesses facing uncertain or fluctuating sales month to month may find merchant cash advances helpful. They also guarantee that the loan originators will receive some money each month as long as the receiving business continues to generate sales.

Here’s what you need to know about merchant cash advances:

  • They are loans. Recipients must repay this money.
  • They often come with higher rates of interest. Be careful when planning for these loans because the interest can add up over time if your business has lackluster sales.
  • They originate from lenders via the business owner’s merchant services account. Business owners automatically repay the money as a percentage of credit card sales transactions.
  • Tracking their interest over time can prove challenging for tax purposes. Businesses who opt for these loans should keep careful records as they repay the money based on regular sales.

Get Started with Lendio

Answer a few questions to see what kind of loan you qualify for.

Why Should a Start-Up Business Apply for a Merchant Cash Advance?

Start-up businesses may find it more advantageous to take out a merchant cash advance than a traditional bank loan.

Why? Because they won’t have to worry about coming up with the money to make loan installment payments and can repay a merchant cash advance loan as a percentage of their credit card sales.

Here are some other advantages merchant cash advances offer:

  • They have easier approval requirements. Lenders can simply evaluate your previous credit card sales to assess how well your business is doing and how likely you are to repay the loan.
  • They require less paperwork. These loans require far less paperwork than traditional bank loans.
  • They’re short-term loans. Business owners usually take out these loans with the intention of repaying them quickly.
  • They feature smaller amounts. Business owners typically need small loans to handle short-term problems. For example, they might need to pay a “net-30” vendor on time or a higher-than-usual utility bill.

Prerequisites for Getting a Merchant Cash Advance

Business owners must meet certain requirements before they can apply for a merchant cash advance. Those requirements include:

  • A Healthy Business Credit Score: Lenders judge business credit like personal credit — by the business’ credit profile and business credit score. To qualify for a merchant cash advance, like most other loans, a business must have a good credit score.
  • An Understanding of the Merchant Cash Advance Interest Rate: Different merchants charge different rates. You may find you need to rethink the loan if the interest rate is too high. If this is the case, you may want to shop around for another type of loan.
    A Merchant Account and Credit Card Processor: Because these loans are transactional, based on a percentage of each credit card transaction, you’ll need a merchant account to qualify for a merchant cash advance.

How To Apply for a Merchant Cash Advance

Businesses with credit card machines and a point-of-sale (POS) terminal can easily apply for a merchant cash advance. A business may want to apply for this type of loan to cover unexpected costs while building its business credit profile.

Follow these tips when applying for a merchant cash advance:

  • Have the right documentation ready. A merchant cash advance application typically includes just one or two pages. You must provide your Employer Identification Number (EIN), Social Security number, and other business information required by the lender.
  • Have your credit card transaction history handy. The lender will ask you about this history to better understand your sales.
  • Expect a fast approval process. In most cases, a lender will approve your application within 24 hours.
  • Be prepared to set up a new credit card processor. While not always the case, some lenders will require a business to switch merchant companies before they’ll qualify them for a merchant cash advance. You’ll have to weigh the pros and cons before deciding to switch because such an action may incur high fees and costs.
  • Know the terms. Business owners should understand all the terms associated with a merchant cash advance. You’ll also want to know how to calculate the interest rate and annual percentage rate (APR) for this loan.
  • Watch your merchant account for your loan money. Lenders will deposit this business loan money directly into a business owner’s merchant bank account. The repayment will happen automatically as future credit card transactions occur.

Final Thoughts

As you consider whether or not a merchant cash advance makes sense for your business, make sure to take these important steps:

  • Read the fine print carefully. Like personal cash advances, these loans can stretch into the territory of predatory lending practices.
  • Ask if it’s possible to repay the loan early. To save yourself paying further interest, find out if you can pay off your loan early without incurring additional costs.
  • Decide if another loan option would work better. If you need a few hundred dollars, it’s possible a family member or friend might lend you the money without charging you any interest.
  • Ask if — and how often — the lender reports payments to the business credit bureaus. It’s important to leverage loans to help build your business credit. If the lender doesn’t report this information, find one that does.
  • Think of merchant cash advances as an opportunity to free up cash flow whenever necessary. It’s a good idea to have strategies in place that can help your business free up cash flow. Approximately 80 percent of businesses fail because of cash flow shortages. A merchant cash advance may make the difference between failure and success.

Related Articles

Have a Question? Leave a Comment!