Merchant cash advance lenders have proven over the years to be a viable alternative for a significant number of small businesses because they provide funding that might not be available through other channels. Because merchant finance is regarded as a factoring product, in which a small business sells its future receivables at a discounted price for upfront cash, it is not subject to government regulation. Merchant cash advance, in spite of its many benefits, has often been the subject of debate among skeptics.
Why are some small business owners skeptical about merchant cash advance?
Merchant finance is sometimes criticized for its relatively higher cost. While one cannot dismiss the fact that merchant funding is quite more expensive than, say, term loans from commercial banks, it is important for one to understand the unique context of merchant loans. In practice, merchant loans are unsecured, meaning that merchant lenders take a huge risk in lending to small businesses. Understanding the level of risk associated with merchant funding and the fact the business is under no obligation to repay the advance enables one see why it is merchant lenders charge considerably higher for the service. And, if one is to examine the benefits of merchant funding, as shall soon be done, one realizes that the benefits far outweigh the cost.
Looking beyond the surface: what does merchant cash advance entail?
Before coming to why merchant cash advance might be considered a better option than term loans, one must understand the merchant finance transaction itself. As has been said earlier, merchant cash advance is a business to business transaction, in which the borrowing business sells its future credit card sales to the merchant lender. Because of this, laws that apply to conventional loan transaction do not apply to merchant cash advance. In spite of the lack of government oversight, businesses are not permitted to engage in activities that could deprive the merchant lender of his due.
Merchant cash advance transactions are quite simple and do not have the legal complexities of conventional loans. This means that a merchant finance transaction can be completed without the input of legal experts. In its simplest form, merchant cash advance transaction begins when the merchant cash advance agreement is signed. Before the signing of the agreement, certain details have to have been worked out. Such things as the factor rate and the holdback percentage or amount need to be agreed on before the contract is entered into.
How is remittance made to the merchant lender?
For a merchant finance transaction payment of the loan so to speak is something that is done on a daily basis and not on a monthly basis as is the case with commercial bank loans. There are quite some options when it comes to the issue of remittance. The most common is that of split funding—or batch splitting—in which the borrowing businesses authorizes its processor to transfer an agreed fraction of the daily credit card sales to the merchant lender. The remainder after this is then transferred to the account of the business. This method of split funding is the most preferred as it is less risky and convenient for the business.
The second method involves the use of escrow account. In this arrangement, daily sales are deposited into the escrow account by the processor and the agreed percentage or amount is debited by the merchant lender from the escrow account as an ACH transaction. The merchant lender after that transfers the remainder to the account of the business. Because this option gives the merchant less control of the payback process it is not usually chosen.
The last approach to remitting funds in merchant finance transactions is that of direct debit. In the case of direct debit, the merchant cash advance lender directly debits from the bank account of the business through ACH. This is quite like the method of an escrow account, and just as it is with escrow funding, the merchant also has less control of the payback process. In fact, direct debits sometimes cause the business to overdraft.
Reasons Small Businesses are leaning towards merchant finance vendors
If one is to give one reason why merchant finance has become popular over the last decade, one might simply say that it is because merchant lenders are filling some gaps in the traditional lending sector. This is, of course, quite vague. To be more specific the success of merchant cash dance providers appears to depend on a few factors.
One thing about merchant cash advance transactions is that there are no fixed terms. The practice is often for the merchant finance lenders to estimate the term for repayment based on the sales records of the business. Even though merchant lenders will often want to recoup their investment within 12 or 18 months, the business is not obligated to pay within that the frame. How long it takes the business to repay the advance has everything to do with whether sales are high or low. In any case, there are no penalties in the form of fees which the business is required to pay for “late” payment.
The fact that merchant finance is issued to businesses without being required to provide collateral or personal guarantee is something that small business owners find quite appealing. For one thing, lack of collateral is one of the chief reasons businesses are unable to obtain loans from banks. That personal guarantees are not offered by small business owners also means they cannot, for example, forfeit personal assets if the advance cannot be repaid.
Above all, merchant finance providers are known to deliver funds to businesses in the shortest possible time. A typical advance application could take from a few hours to a few days to be completed. Businesses save a great deal of time when they opt for merchant funding. Documentation is also minimal. Overall, the entire process of obtaining a merchant cash advance is quite simple and straightforward. Little wonder it is fast replacing term loans as the number one choice of funding for small business owners.