A merchant cash advance is an upfront lump-sum payment for the purchase of a contractually specified percentage of a business’ future receivables. That’s a mouthful, so let’s break it down into simpler terms. As a business owner, you sell either goods or services. Each sale that you make is called a receivable. Sales that you expect to make in the future are referred to as ‘future receivables.’ A merchant cash advance is simply the purchase of some of your future receivables, which are really speculative investments for the funding provider, for payment now.
Is that really it? No, there’s more.
Merchant Cash Advances Are Speculative
For you as a business owner, merchant cash advances can provide the working capital necessary to pay your operational expenses, purchase new inventory, hire additional staff, or expand into new markets. For merchant cash advance providers focused on providing business owners like yourself such working capital, they’re speculative investments. Let’s say you approach a merchant cash advance provider, such as Knight Capital Funding, for working capital. This provider will ask you for several months’ business bank statements and a few other pieces of information to verify your banking information and identity and determine whether your business will likely be able to generate the future receivables.
Providers of merchant cash advances come to this determination based on identifiable trends within the business’ past and industry.
What industry is the business in?
Is the business profitable?
Has the business experienced serious financial hardships?
Is the business over-leveraged?
After answering each of these questions and others, merchant cash advance providers determine whether the merchant will likely generate the future revenue and the purchased future receivables.
Merchant Cash Advances Use Factor Rates
Unlike percentages, which are commonly used for loans, factor rates are decimal figures that generally vary from provider to provider. Factor rates are merchant cash advance providers way of charging merchants for the risks associated with the merchants’ likelihood of generating the future receivables.
Merchant Cash Advances are Not Loans
It’s important to understand the distinction between a merchant cash advance and a loan. Merchant cash advances are not loans. The two are very different. As described above, a merchant cash advance is the acquisition of a contractually specified percentage of your future receivables in exchange for an upfront lump-sum payment. Merchant cash advance providers expect the funds to be remitted on a flexible schedule based on the amount of money remitted each day along the way, generally referred to as a ‘turn,’ along with a factor rate of x (e.g., 1.4) for administrative and other fees. Merchant cash advance remittances are generally made to the provider daily or weekly via an ACH withdrawal, with amounts varying based on the revenue generated by the business. The amount varies because merchant cash advance providers purchase a percentage of your receivables up to a specified dollar amount, not guaranteed remittances of $y daily.
Loans, on the other hand, are a bit different. In fact, loans are almost the opposite of merchant cash advances. The loan process usually begins with a lengthy look at both you as a merchant and as an individual. Loan officers require several detailed financial documents. For example, loans require you to have been in business for several years and rely heavily on your personal credit history. Once approved for a loan, you receive a specified amount of money for a set term with $y to be remitted to the loan issuer monthly. With a loan, you’re borrowing someone else’s money to achieve your goals. Loans, on their own, do not entitle the issuer to any percentage of your future receivables. Loans carry with them an absolute right of repayment.
What’s Better, Merchant Cash Advance or Loan?
It depends. There’s no correct answer to this question because it’s wholly subjective from situation to situation. The simple answer would be as follows: whichever source of funds best enables you to achieve your short-term goals without deviating from your long-term goals.
Let’s dig a bit deeper and see if we can come to a more definitive determination.
Merchant cash advances are great for business owners to obtain the cash they need in a quick and efficient manner. Some providers, Knight Capital Funding included, can provide small business owners with working capital within 24 hours. The speed with which small business owners can obtain large amounts of cash (Knight Capital Funding offers up to $250,000) makes it an attractive option for situations where a key piece of equipment breaks, or a time-sensitive business opportunity requires immediate action. Loans, on the other hand, are good for small business owners who have both the documentation necessary to obtain the loan and the time to go through the loan process.
How do you come to a decision that’s right for you and your business?
Determining the best source for your business’ next cash infusion should be considered on a case-by-case basis. At each point, your business will likely have different needs and the options you consider should be determined on where your business is at that point in time. However, you should ask yourself the following questions:
First, start by writing down what you need the funds for and whether such expenses are necessary.
Second, ask yourself if your business meets the requirements to receive a loan. If not, a merchant cash advance or another source of alternative funding might be right for your business.
Third, determine whether your business will likely generate the purchased future receivables.
Fourth, research merchant cash advance providers and loan issuers.
Fifth, develop a list of questions and ask for clarification from provider and issuer customer support teams.
Sixth, apply for a merchant cash advance or loan with the provider or issuer you think can best meet your needs.
Seventh, spend the funds wisely.