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Your business is struggling. You’ve been turned down by the banks. And your brother in law won’t take your calls. What do you do? Many small businesses are forced to go get a merchant cash advance, also known as a merchant advance or merchant cash. This may be a reasonable solution for survival or growth despite the high costs of this business capital.
Can you afford to pay the merchant advance back. The answer will be very different for every business. You must assess the costs carefully and decide if your projected future sales will allow you to meet the repayment terms.
These high-cost cash advances are only made for businesses that do at least $3,500 monthly credit card sales. The merchant advance amount is based on the average monthly total credit card sales. This is done to help ensure merchant funding companies that they will get repaid. Typically, a funder will advance a merchant between one to two times the average monthly credit card sales.
Let’s look at an example of a Merchant Cash Advance to understand the costs. One important point that is often overlooked is this: A Merchant Advance is NOT a loan. The cost of funds for an advance would be considered usury by every U.S. state if set up as a loan.
If you take a merchant advance for $10,000 you will typically be contractually obligated to pay back between $13-15,000 for the advance. Most merchant cash agreements are set up for periods of four months to one year. The longer the term the higher the cost of funds.
The reality is also clear. The merchant funding companies must take extremely high risks in this high-default industry. The banks and other traditional funding sources won’t touch this kind of risk. These advances are not loans. A merchant cash funder agrees in writing to buy a specific amount of your future credit card sales at a discount.
In our example above he is buying $13,000 of your credit card sales for the next 4 months by advancing you $10,000 now. Or you may need more time and he agrees to buy $15,000 worth over 12 months for the same $10,000. The funder will require the merchant account or processing company to “holdback” or reserve the agreed on percentage of all your daily credit card sales to pay directly to the funder’s company until he is paid.
This holdback will often range between 5% and 25% of your credit card sales. Let’s assume your cc sales are $12,000 monthly and your holdback is 20%. Then you must pay $2,400 per month until the advance is paid off.
The good news for merchants is you do not have to personally guarantee a merchant advance, no collateral is required and poor credit by itself will not disqualify your application. The most important advice I can give you is to do your homework by asking questions.
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