How Merchant Cash Advances Work

If you’re a small business owner and you need quick cash for capital uses, one of the options you may have are merchant cash advances. Although this is an industry that started only about 10 years ago, today, more than 50 providers are available to those who need quick capital access. In addition, today’s “belt-tightening” in the credit industry makes this option even more attractive.

Here’s how it works. In exchange for a share of your future sales, a cash advance provider will give you a lump sum payment up front. If you are a small business owner with strong credit card sales, you may qualify, especially if you have little to no collateral or if you have a spotty credit history.

Again, this isn’t necessarily bad, especially if it’s a short-term arrangement you simply have to have to keep your business going or to cover a temporary cash shortfall, but it can get you in the red very quickly if you try to use it as your only capital. In essence, you could sell future profits right out from under you. Therefore, these types of cash advances need to be used very prudently by those who take advantage of them.

Things to remember:

If you decide you want to take a cash advance from a provider, make sure you understand that it is basically a loan with specific characteristics and costs. Now, these companies will say that this is not a loan, and technically, they are right. What they’re really doing is buying future profits from you in exchange for a lump sum percentage of those profits up front. And, again, that’s fine. Just don’t sell your business out from under you by selling future profits to a point where you’re actually going to see little to no profit yourself because you are paying these companies back with your profits.

Second, remember that merchant cash advance companies are not bound by the same rules and regulations that control traditional lenders, and limit the interest rates they can charge you. Therefore, you have to be very careful to read the fine print and make sure you can pay what it’s going to cost you to get a cash advance done this way.

Advantages:

There are advantages to cash advances, too. With a traditional loan (albeit with a lower interest rate and fees), you pay back what you’ve borrowed on a fixed schedule of monthly payments, usually, regardless of what you’re actually earning an income. What you’ve borrowed is paid back commensurate with your business income flow. That means, if you have a slower month, you pay back less; a more profitable month, and you pay back more.

Is this right for you?

It really depends. If your business is usually very solvent and you’re just having a slight cash flow problem temporarily or your business is growing and you need extra cash now, taking advantage of a cash advance company’s services is probably going to help you, especially if you can’t get funding through traditional means. However, if your business is already struggling and you are thinking of using a cash advance to keep you going until things “pick up,” it’s probably not a good idea for you. What will end up happening in that case is that you will simply sell all your profits out from underneath you and will likely never catch up.

Therefore, only use cash advances when you are in a flush and solid position financially already and simply need some extra cash fast for the short term. Done right, they can certainly help you out when things are “just a little bit tight” on a temporary basis.

Checking out cash advance companies carefully.

If you do decide to go with a cash advance company, make sure you check it out carefully. Although industry leaders are trying to cultivate “best practices” strategies so that they remain above board and in full regulation of themselves, many third-party brokers especially may be a bit shady. These people are major sales avenues for the industry, but the cash advance industry itself says that potential customers should be careful. They may not be above board; instead, work with a cash advance company directly.

Here to stay?

With the recent economic downturn, cash advances are becoming an ever more attractive way for business owners to get cash fast when they need it. Nonetheless, even in times of prosperity, they can be useful for already profitable business owners. Used properly, they are a good alternative to traditional lending when that’s not available for whatever reason.