Alternative Financing Options When Traditional Sources Fail
Although the economic conditions have continued to improve over last few years, there is a large portion of businesses nationwide that still feels many financial effects from the recession.
Whether it’s a situation of slowly climbing out of debt created when business was crawling, adapting to increased operational costs yet lower margins, desperately needing to update/upgrade inventory, or simply not having the volume of business you once had, business owners are finding themselves still in a financial pinch.
In the past, credit was a lot easier to obtain—maybe a little too easy.
I remember in 2005 when I was concurrently in escrow for three different mortgages. I had good credit, but my business was only a few years old, I had minimal “documented” income, and the majority of my money was being dumped back into my business.
Like many others, I soon owed more than the home was worth on a couple of these purchases.
I was fortunate and creative enough to avoid any credit damage, but I lost a ton of money. These scenarios became more common than not, and I don’t have to tell you what happened next .
Today, the long-term relationship you had with your bank doesn’t necessarily mean as much as it used to.
This has given way to a trend of alternative financing, an industry that is booming now more than ever.
Remember, these types of services are for those who may be in a jam, need cash quick and can’t easily get the credit they need from traditional sources. Here’s how they work.
How Merchant Cash Advances Work
Many owners are taking advantage of a program called “merchant cash advance” to help their businesses. Also known as “MCA”, the program has been around for about a decade but has skyrocketed in the past 3 years.
In the chauffeured transportation industry, for example, I have seen MCA triple in the last 18 months.
MCA historically is an advance of future receivables based on credit card sales.
Funding companies will purchase future sales at a discounted rate and collect the repayment of the advance by taking a daily percent of the operator’s credit card sales until repaid.
For example, if an operator qualifies for $100,000, the advance company will fund $100,000 and may withhold 15% of the operator’s daily batches until they receive the total payback amount.
Generally these deals are structured from 4 months to 15 months, the most common being 6 months.
The payback is based on a money factor where an advance company may buy $130,000 worth of your future business but may only be willing to pay you $100,000 (1.30 money factor) due to the great risk involved.
These money factors include financial stability, credit, length of time to repay, and overall risk. They can range from 1.15-1.49, which may be expensive to some but is the best option for others.
Easier Payment Options
There is a common misperception that interest is charged on an MCA. After all, if I borrow $100,000 and pay back $120,000, I can argue that I’ve paid 20% interest.
Traditional interest, however, is calculated much differently.
MCAs are not a fixed payment; they are paid as money comes in.
If business is good, the advance may be paid back sooner that projected. If business is bad, it may take longer.
With a customary fixed interest loan, there is a set APR and monthly payment that must be met regardless.
In the last year, another variation called the MCA loan product has been more popular, especially for higher-credit borrowers.
The cost of the money is similar (possibly a little bit less expensive), but the repayment of the advance is the main difference. It is repaid via a fixed daily payment for a specified number of days.
This gives the advance company a bit more security and the borrower an easier way to reconcile or determine the repayment. It’s typically 6 or 12 month repayments with a fixed daily payment being debited from your account on every banking day.
Going into this scenario, the merchant and funding company both know exactly what to expect, and for how long. The qualification process is a bit more difficult, and the repayment will be a fixed daily withdrawal as opposed to a percentage of credit card sales.
Who Merchant Cash Advances Work Best For
This type of funding is not cheap money. It’s not meant for the company owner who can walk into a bank and get a line of credit at 67 with a signature.
It’s meant for those who need cash for a variety of reasons, like making payroll, acquiring another company, or floating some bills to bridge the slower months with the busier seasons.
It is for those who have no other “cheap” options, but know they will have future business coming in to pay this back.
It’s generally a 24-hour pre-approval based on bank and merchant statements.
Underwriting is usually less than 72 hours, and qualification is much less than banks are requiring (above 500 credit and steady flow of monthly sales). The weight of the decision to approve is based on the borrower’s monthly income, and no collateral of assets are needed.
Should You Get an MCA for Your Business?
MCA companies understand many were hit by financial turmoil and may have bankruptcy and lingering debt affecting their credit scores, which they are willing to look past if the company’s business is improving—but the lack of security means that it’s not cheap money.
That being said, I always ask the question: if it costs you $10,000 to get $50,000, will you make more than $10,000 by getting that money?
If yes, then this financing option might be something to consider.
If spending 10k to get 50k will keep your business afloat, allow you to pay off urgent debt, or any other personal or business reason that is worth 10k, then this financing option may be for you. But understand that it’s expensive money.
Areas to Watch
If you are serious about pursuing this type of funding, get some quotes and pay attention to the following:
- Broker or application fees: Some companies charge nothing, others will tack on a nominal fee
- Loan origination fees: You should only be charged if you go with the MCA loan product, however it should not be a high fee.
- Lockbox accounts: This is necessary in the event that you have very poor credit and the funding company wants to carry less risk, or if the funding company is not set up to split the batch amounts with your credit card processor; it is a joint account between the borrower and the funding company where the daily batches go to, then the funding company gets their percentage and the merchant gets theirs.
If this type of alternative financing seems like something beneficial to your business, then make sure you deal with a known and legitimate company that not only is involved in MCA, but also understands your particular industry.
Factors can vary from lender to lender, so comparison shop and get all the information you need before you sign for it.
A good place to start is with the MCA experts at Chosen Payments…
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