What Does a Loan From a Merchant Cash Advance Lending Company Entail?

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It is not entirely clear to lots of business owners what a loan from a merchant cash advance lending company entails. The thing that is predominantly echoed is how much expensive merchant cash advance is. Although merchant cash advance is relatively more expensive than a conventional bank loan, the whole issue of its cots is often blown out of proportion.

Even though it is a fact that a merchant lending company charges somewhat exorbitant rates for their services, it is not helpful for the same to be said of others. Indeed, there are lots of merchant cash advance providers that change moderately. With some exceptions, the factor rate for some merchant cash advance transactions, when viewed regarding interest rates, turn out to be almost the same with that of some term loans.

What exactly is behind the cost of merchant cash advance?

A merchant cash advance lending company, much like other financial institutions evaluates the risk associated with a particular loan request to determine what the reasonable interest rate should be. But for traditional lending institutions such as commercial banks, collateral, and personal guarantees are often required to provide security for the bank for example as against the risk.  

When a business defaults in payments, banks have the advantage of being able to foreclose the collateral and enforce personal guarantees. In spite of all of the security that banks have when issuing loans they still charge significantly for their services. Businesses that even delay in payments are also penalized by commercial banks.

But the case of a merchant cash advance lending company is quite different. For one thing, a merchant lending company does not insist on collateral or any form of a  personal guarantee before alone is issued. That is because by its very definition merchant cash advance is not a loan, at last in the traditional sense of the word. It is a sale of future receivables to a merchant cash advance provider and does not call for any form of security for the buyer.

Because the risks taken by the merchant cash advance provider far exceeds that taken by commercial banks, it is only a matter of sound business practice for merchant loans to cost higher. Those crying foul over the cost of merchant cash advance, are often blind to its benefits. They also appear to be ignorant of how a merchant lending company can serve the overall interest of small business lending.

How is a merchant cash advance agreement structured?

Merchant cash advance transactions are based on merchant cash advance agreements that are signed by the merchant cash advance provider and the borrowing business. The central elements of the agreement often revolve around such things as factor rate, total payback amount, withholding percentage and the mode of payment. 

The factor rate is the amount by which the advance is multiplied to arrive at the total payback amount which the business is required to pay through fixed deductions from its daily credit card sales. The merchant lending company usually determines the factor rate by looking at the volume of sales of the business, the amount that is advanced as well as other factors that are peculiar to the business. Once the factor rate has been decided, the next most important thing is the withholding percentage.

The withholding percentage

The withholding percentage is the portion of the daily credit card sales that is deducted for use in repaying the merchant cash advance. It can either be in the form of a fixed percentage or a fixed amount. If the lending company decides on a fixed amount, the business pays a fixed dollar amount every day regardless of the volume of sales for that day. It is quite obvious that this method of repayment can impose serious constraints on the cash flow of the business. Indeed, businesses prefer the fixed percentage method.

In this method, the actual dollar amount that is paid on a daily basis to the merchant cash advance provider varies by the volume of sales. Businesses choose this method as it imposes less strain on cash flow. But with the method of a fixed percentage, it is not possible to correctly estimate how long it would take for the loan to be repaid, something which the lending company might not favor. In any case, it remains the most widely adopted.  

The mode of payment

How the business makes payment to the merchant cash advance provider is also an issue that has to be sorted out before the cash advance agreement is signed. While there are some options including ACH, many a lending company have the option of batch splitting which is the one most favored by business owners. The reason is of course not far-fetched. Batch splitting gives the business greater control over the repayment process. In batch splitting the business authorizes its processor to forward the agreed percentage or the fixed amount to the merchant lender and after that credit the business with the remainder.

Benefits and conclusion

So far so good all of the basic elements of a merchant cash advance transaction have been examined. It can be seen that the whole process is much more straightforward when compared with conventional bank loans. And of course, there are good reasons why a business might want to opt for a merchant cash advance ahead of other lending options.

Merchant cash advance providers offer speed and ease since with the minimum of efforts the business can obtain the required business funding.  Furthermore, without a good credit score, small businesses can obtain funding through a cash advance lending company. That businesses do not have to worry about obtaining collateral and offering personal guarantees is another upside of merchant cash advance, one that can be said to be the main reasons why small business are drawn to merchant vendors.  All in all, the fact remains that small businesses have found merchant cash advance instrumental to their survival. That alone explains the continued growth of the industry.


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