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Merchant cash advances are becoming a popular form of credit for all types of businesses. Once a tool offered mostly by credit card companies, merchant cash advance loans are now available to many businesses through payment processes including PayPal, Stripe and Square.
If you process payments regularly through certain services, that might make this form of credit readily available to you—but is it a good choice for your business? Find out more below.
What Is a Merchant Cash Advance?
A merchant cash advance is a type of debt tied to the revenue your business processes via credit cards or through a specific payment processor. Some providers, such as Stripe and PayPal, refer to this debt as working capital loans, but others simply call it a cash advance.
Depending on the provider of the merchant cash advance, this form of debt can have different impacts on your credit and future revenue.
How Does a Merchant Cash Advance Work?
While the details of merchant cash advances vary according to provider and contract, the basic principles are typically the same. You apply to borrow money via your merchant network or payment processor. That entity usually works with a partner bank to provide the loan.
Whether or not you get the loan and how much you’re approved for usually depends on how much revenue you generated within the past year or so. In some cases, the bank may also check your personal or business credit.
Once the loan is approved, you receive the funds quickly. In some cases, it’s less than 24 hours. Within a few days, loan repayments begin via holdback processes.
What Is a Holdback?
Holdbacks are the amount that is withheld from your revenue to pay back the merchant cash advance. When you accept one of these advances, you agree that the payment processor can take a certain percentage of your daily receipts processed through that agency in payment of the loan.
For example, if you borrow $20,000 and agree to a 10 percent holdback, then 10 percent of your revenue processed through that payment processor each day is held back until you pay off the loan. If you have $1,000 in revenue for a specific day, then you would only receive $900 of it.
Merchant Cash Advances: Pros
Merchant cash advances are popular with many businesses because they’re easy and convenient. Check out some of the benefits of this financing source below.
You Don’t Have to Risk Your Assets
This form of debt is tied to your future sales and isn’t secured by any of your assets. If your sales through the relevant channel are less than expected and you don’t meet the minimum payment requirements of the cash advance agreement, you might be billed or turned over to collections.
But, the merchant doesn’t have the ability to force the sale of your assets to recoup the debt in the same way it would if you used those assets for collateral.
You Can Get Money Quickly
Merchant cash advances are one of the fastest ways to access funds via credit. In some cases, once approved, these entities might fund your merchant account within minutes.
Because many banks determine whether you qualify for these advances based primarily on the strength of your revenue, you also usually aren’t required to provide a lot of documentation. The payment processor already has all the information they need about how much revenue you process through them.
You Can Use the Money However You Like
Typically, as long as you’re using the funds for business purposes, you can use the money as you like. You aren’t tied to a specific loan purpose or rules about whether the funds are for working capital or equipment investments.
Merchant Cash Advances: Cons
As with any form of debt, merchant cash advances aren’t perfect for every situation, and they do come with some downsides. Learn about the potential disadvantages below so you can make the most informed decision for your business.
It’s a Short-Term Solution
Merchant cash advances can be a great short-term solution for cash flow issues that are temporary in nature. For example, if you need to invest in more inventory for a holiday season before the higher revenues associated with that season roll in, merchant cash advances can help you do that.
But it’s still only a short-term solution, and if your business doesn’t generate enough income to cover expenses on an ongoing basis, cash advances are at best a metaphorical money Band-Aid that covers up real issues.
Before you rely heavily on these advances in the long term, make sure you fully understand your business’s financial state and are managing accounts and cash appropriately.
Your APR Could Be Very High
The debt obviously isn’t free. Often, merchant cash advances come with flat fees that are baked into the loan. The amount you pay might be determined in part by how much you borrow and what holdback rate you agree to.
For example, if you borrow $5,000 and agree to a 30 percent holdback to pay it off faster, you might pay a smaller fee than if you borrow $5,000 and agree to a 10 percent holdback, which would lead to a longer repayment time.
Fees for cash advances can be thousands of dollars, and when you convert those fees into an APR, you might be surprised that the cash advance isn’t quite as affordable as you thought.
Depending on the terms, how much you want to borrow and how you can pay it back, you might be better off with the APR on a traditional business loan if your credit is good enough to support one.
Merchant Cash Advance Companies Aren’t Federally Regulated
Companies that offer merchant cash advances aren’t typically federally regulated. That means you don’t always have the same protections as a consumer that you would have when dealing with a traditional lender. If you decide that this type of funding is right for your business, make sure you deal with known, reputable organizations to help protect yourself.
Is a Merchant Cash Advance Right for Your Business?
Whether a merchant cash advance is right for your business is a personal decision, but you can ask yourself the following questions to help you make this determination.
- Can you afford to lose a certain percentage of your income through this revenue stream in the near future? If your profit margins are very low or you’re already barely covering bills, you may struggle once that percentage is being held back.
- Are you using the cash advance to fund growth or get through a temporary, known issue, or are you using it as a Band-Aid for larger financial problems? If it’s the latter, a merchant advance may at most delay the problems a little bit, but it’s not likely to solve them.
- Do you understand all the terms of the cash advance, and is this the most affordable way you can get financing for your business? Compare options and ensure that a business loan, a line of credit or another financing method isn’t an option or wouldn’t be less costly in the long run.
Merchant Cash Advances and Your Credit
How merchant cash advances are impacted by your credit—or impact your credit—depend on the way the lender operates. In many cases, you don’t need good credit because approvals are based on your historical revenue numbers.
Some lenders don’t check your credit at all, but others do, and that can lead to a hard inquiry. If you default on the loan, you might also end up with a negative collections item on your credit report. Balancing personal and business credit can be complex.
If you discover that your two worlds are colliding, consider Lexington Law’s credit repair services to help address any inaccurate negative items on your personal credit report.
Reviewed by Daniel Woolston, an Assistant Managing Attorney at Lexington Law Firm. Written by Lexington Law.
Daniel Woolston is the Assistant Managing Attorney in the Arizona office. Mr. Woolston was born in Houston, Texas and raised in Sugar Land, Texas. He received his B.S. in Political Science at Brigham Young University and his Juris Doctorate at Arizona State University. After graduation, Mr. Woolston worked as a misdemeanor and felony prosecutor in Arizona. He has conducted numerous jury trials and hundreds of other court hearings. While at Lexington Law Firm, Mr. Woolston dedicates his time to training paralegals and attorneys in credit repair, problem solving, and ethical and legal compliance. Daniel is licensed to practice law in Arizona, Oklahoma, and Nevada. He is located in the Phoenix office.
Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.