Small Business Blog

In May of 2009, small business credit card provider Advanta Corporation announced that it would shut down roughly one million small business credit card accounts. The news is a sign of the times: economic conditions are taking a toll on small businesses and their lenders. If the profitability of small business lending continues to decline, small business owners will be increasingly challenged to locate the credit they need to fund expansions and special projects.

One option that’s becoming more popular for entrepreneurs and small business owners is the merchant cash advance. Merchant cash advance providers offer cash upfront in exchange for a piece of the business’ future sales. While this arrangement technically isn’t an extension of credit, it does generally function like an unsecured small business loan: the business obtains a lump sum of cash and repays it, along with a fee, over time.

Banking on credit card sales

The merchant cash advance provider is usually a credit card processor that takes its repayments from the business’ future credit card sales. Therefore, the approval of a merchant cash advance is dependent on the business’ credit card processing history; businesses with higher levels of credit card processing activity will be approved for larger cash advance amounts.

While the business’ historic credit card processing activity drives the cash advance amount, it is the future credit card activity that determines the amount and timing of repayment. The merchant cash advance provider will collect a percentage of each credit card transaction processed by the business until the amounts owed, including fees, are fully repaid. Essentially, this creates a repayment schedule that matches the business’ sales activity—when sales are good, the repayments will be higher, and vice versa. For seasonal businesses, this type of repayment is easier to digest than a fixed, monthly loan payment.

Bad credit not an issue

Candidates for a merchant cash advance include retailers, restaurants and service providers who process a reasonable amount of credit card sales monthly. As long as the credit card sales are sufficient, a business’ bad credit won’t be an issue. Also, many merchant advance providers will not require a personal guaranty or any type of security in the business’ assets. Therefore, businesses that don’t qualify for non-guaranteed, unsecured small business loans, for whatever reason, may find the merchant cash advance is their only workable option for fast cash.

Cost and cash flow considerations

The primary disadvantage of the merchant cash advance is cost. A merchant cash provider may be quick to explain that the business doesn’t incur interest charges, because the advance is not a loan. But the business will incur fees, and those fees can be high. Any business considering a merchant cash advance should evaluate the quoted fees as finance charges; as a percentage of the advanced amount, those fees will probably be more expensive that what a business might pay for a conventional, unsecured small business loan. Of course, when the small business loan isn’t available, the merchant cash advance begins to look increasingly attractive.

The small business owner should also carefully consider how the repayments are going to impact the business’ cash flow going forward. Paying out 15 percent of all future credit card transactions, for example, can be burdensome if the business is already barely making ends meet. On the other hand, if the advanced funds will be used for a project that increases sales, the repayment might be easily managed.

Here’s the bottom line on merchant cash advances: they have a place, but they’re not appropriate for businesses that are barely keeping the doors open. Business owners should evaluate the opportunity carefully to ensure that the merchant cash advance is indeed the right solution.