Since we have touched on Merchant Cash Advances people have asked us if they are the same as a business loan. They are really are not but the confusions sets in when a merchant cash advance is called an alternative business loan.
Technically a merchant cash advance is a business loan because you are borrowing money for your business but traditionally most people think of a loan is going to a bank and getting an SBA loan. Creative ways to finance businesses have always been around but saying that they are equivalent to a business loan is simply not true. It does not mean they are necessarily bad but they are definitely different than what we commonly believe a business loan to be.
Some would argue that a business cash advance is actually better for those with questionable credit because the terms focus more on what may happen in the future than what has happened in the past. Considering today’s economic climate, there are lots of business borrowers out there with less than perfect credit and this may be what makes this type of loan seem appealing.
Although we do not endorse any type of business cash advance, proponents of these programs definitely make them sound terrific. They are touted as a solution for start ups without any credit history and require no collateral. They point out how quickly their approval process is and that there are no personal guarantees required to get funding. Further, there are never any hidden fees because you know exactly what you will pay back before you get your money.
It really does sound great, but the same could be true for many other business loan alternatives so don’t let the sales pitches fool you.
What Will I Pay For This Alternative Business Loan
We are glad you asked because we don’t really know. This is where it gets confusing. Even as stated above, there is no requirement for business age order to get a cash advance but your time in business will reflect in your fee. Also, most of these types of loans are based on credit card sales. So first things first, you need to accept credit cards as a form of payment to qualify for a business cash advance.
If you do not take credit card payments there may be hope because even this creative financing can get creative, but typically accepting credit cards is part of the program. The actual fees and required payback period are generally dependent on your sales volume over the previous 6 months. This program is considered high risk for the lender and that risk is reflected in the fee.
Here’s how this Business Loan really works
You often here about the flexible terms that coincide with a business cash advance and while this is true, again it does not mean it is necessarily good. Your payment is based on your gross sales. If your sales go down then you pay less at that moment and if they go up you pay more until your loan is paid off. Let’s make this simple.
Business Cash Advance Amount: This is the amount you receive as your business loan and is usually based on your sales for the 6 months prior to application. We see loans granted between 80% and 125% of the average monthly sales.
The Fees: The fees are called factors in the industry and they are quite high due to the risk. We see them average between 20% and 45% of the total cash advance amount but have seen them higher for businesses that are more risky for a lender.
Retrieval Rate: This is the amount a lender takes out of your daily credit card sales in order to pay back the loan. The retrieval rate will be less than your Factor Rate so there is enough money on hand to keep the business going but it is usually between 15% and 25%.
Let’s Do the Math. If your “business loan” is for $50,000 with a rate of 35% (fee) and a daily retrieval of 25%, then you owe the lender $17,500 in interest and this will be paid back daily as part of your sales. The higher your sales, the quicker it will be paid back but your fee is still the same.
The good part is that a business owner will not have a high interest rate business loan hanging over their heads because it will be paid back shortly. If the business fails, then the lender takes the hit. But, it is a good bet that the lender has received most of their investment back should this ever happen.
It is true that the business cash advance is quick and easy but should never be confused with a traditional business loan. It is what it is and it is nothing more than a cash advance which should be treated with the same apprehension as they are on the consumer side.