Finding The Right Funding Can Be Tricky


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Reasons To Be Concerned About A Merchant Cash Advance

Finding the right funding for your business can be challenging.  You don't want to make a financial decision that will hurt your business, but you need the money.  How else are you going to get past this next hurdle in your business and get to the next step?


...but is taking out an expensive merchant cash advance worth it?  How concerned should you be? 


Of course, if you could get a business bank loan, you would.  You don't have to be a finance expert though to figure out that a business bank loan is close to impossible to get approved for, especially if you aren't the perfect mold of what the bank is looking for. 


Reality is, your credit isn't perfect or maybe you don't have 2+ years tax returns to provide (or at least returns that show the profit they are looking for).  Or even worse, maybe you are considered "high risk," which basically describes any small to midsize business.  Additionally, who has 2-4 weeks to kill on the application process just to get declined.  The banks want to see that you don't need the money before they will lend to you, but come on... if you didn't need the money, you wouldn't be looking for a loan. 


There's got to be a better way... maybe a merchant cash advance isn't so bad...


Banks aren't the only game in town.  Of course, you already know this because you just conducted a Google search and found out about private business lenders offering merchant cash advances.  This could be a viable option right...?


The first question you are probably asking yourself is, "What in this world is a merchant cash advance?"


This has got to be expensive... what if I can't pay it?  Am I just going to dig a bigger hole?


Maybe you've heard about merchant cash advances before.... or you've asked around and heard some pretty bad things. 


You need to know the good, the bad, and the ugly to make an informed decision.  You Google some more and there it is.... it's the bad that you were sure you would find. 


You need the money, but do you need it in the form of a merchant cash advance?  Now you are getting more nervous about the idea of a merchant cash advance.  You already need more money than you have and how is paying for an expensive merchant cash advance going to solve your money needs?


This better not be a payday loan on your business... that sounds like a horrible idea.. but is that what it is? 


What happens if you get one of these loans and it doesn't work out... did you just make a decision that brought your company down?  After all the hard work you've put in, after all of the sacrifice, that's the last thing you want to do. 


So, let's talk merchant cash advances... let's get to the "nitty gritty," straight up reality of what these merchant cash advances really are. 


What exactly is a merchant cash advance?


Merchant cash advances are a type of business funding offered by private lending companies.  These lenders are able to lend to companies banks cannot, because they don't have to play by the same rules.  Banks have to underwrite loans based on very specific lending criteria outlined by the government. 


Why do banks have to lend to these guidelines you may ask...?


The answer is simple.  If your bank is FDIC insured (federally backed), they took a buy-out during the big crash.  The government is in no hurry to bail out these banks again.  That's why they came up with all of these requirements.  They only want to lend to you if you can prove you don't need it. 


If you can, by some chance, prove to the bank that you are worthy of their money, you better believe they will be including your real estate and personal assets as collateral.  It can take quite some time to get to the point in which you qualify for a bank loan but that's the goal, that's how you expand... All I can say is "good luck with that," and by all means, make sure you don't fail... after all, you used your house as collateral to get that great rate.  If the unexpected occurs and you lose the house... what now?  But that's the risk you take when you put up your assets and get the good rate to avoid the expensive merchant cash advances right?


With a merchant cash advance, the rates are going to be higher because the risk is higher... but how much higher?  Lenders who do merchant cash advances will actually lend you money when you need it. 


There are pros and cons to bank loans and merchant cash advances.  The merchant cash advances are easier to get, so your gut is telling you  the downside to these must be much greater than a bank loan.  Logic tells you, that you're probably right about this.  It makes sense that you feel nervous about this "easy money."


You should listen to your gut and by all means, run the numbers if you are seriously considering a merchant cash advance.  Making sure you are doing the right thing for your business and future is a top priority. 


The criteria for people to qualify for a merchant cash advance is very different than a bank loan...


Just about anyone in business can get approved for a merchant cash advance.  There isn't any collateral needed and you can often times get funded the same day you submit an application.  Credit really isn't all that important either.  Merchant cash advance lenders are looking at your sales and lending based on your volume. 


So what's the catch...?


The good and the bad is there isn't an interest rate associated with a merchant cash advance.  Interest rates can be deceiving, but if you can get a low rate on a bank loan that should be the best, right?  You should be all good to go.  Actually, it sounds like a small percentage but getting a loan of any kind is never really cheap by any means.  By the time you are done paying the balance off, you've paid a ton more than you imagined you ever would, even on the "good rate" bank loans.  The only time interest rates are really the way to go, is when you qualify for a 0% rate or you have the funds to pay off the balance before the interest becomes due.  Otherwise you are paying a ton, but probably don't fully realize it.  


Instead of an interest rate, merchant cash advances operate on what is called a "factor rate".  A factor rate is a set number used to calculate the amount, in total, that you will pay back.  The factor rate is determined on a multitude of different factors.... pun intended.  Factor rates can be intimidating at the very least on merchant cash advances, and the sticker shock can really be.... well, a shock! .


Your factor rate will reflect how well you have managed your personal and professional life, mostly they are looking at the professional side of things... like, do you have multiple NSF's each month or do you have a positive balance throughout the month and is it clear that there are some profits to be had.  In addition to the merchant cash advance being a little more expensive due to the increased risk of lending to those that aren't "cookie cutter" perfect, like the bank likes to see, is the fact that a merchant cash advance is UNSECURED. 


Unsecured means you don't have to put up collateral. If you default on the merchant cash advance, there really isn't much if any recourse for the lender.  The lender does not have the right to any of your assets.  Not to mention that there isn't any personal credit reporting with a merchant cash advance.  Your biggest downfall would be the inability to seek additional funding. 


The private lenders who facilitate merchant cash advances all talk to one another.  If you have defaulted on a loan like this before, there will be a record of this that's shared within the industry and nobody is going to want to do another one with you.  You are stuck, at this point, with the inability to find funding through a private lender and you must get into a position where you can adhere to the guidelines of a bank loan.


Oaky, so we get it. The factor rate instead of interest rate makes it a little more expensive, but buyer beware!


...so let's address the big "downside" of the merchant cash advance a bit more...


The cost of the money!  Because of the ease of approval and the funds being unsecured, you are going to pay a premium.  It takes money to make money.  No way, no how, is any lender going to lend to a business with no collateral and super relaxed qualification criteria without making enough money on the deal to justify the risk. 


So just how much money is enough for them?


The idea of lending a business funds when it isn't claiming a substantial profit on their tax returns and has next to no recourse if defaulted upon, means it's just going to be more expensive.  End of story. 


Worried yet that you can't afford something like this...?


Well, you have every right to be worried!


There are two different types of situations in which a merchant cash advance makes sense. 


One, you need the money to save your business.  If you have a tax debt and will be suspended or worse, if you had an incident and can't make payroll or other expenses that are crucial to functioning.... then, yes, absolutely yes, paying a premium for funds to keep moving forward is a business expense that must be incurred.  However, the fact that it's a business expense means that it can also be a tax write off. 


Secondly, the money is being used to increase business and the return on investment (ROI) justifies the cost. 


So let's talk return on investment.  If you sell a product for $299 and the cost per acquisition (expenses associated) is $140, you have $159 left over after expenses.  If you can't afford the $140 upfront, you aren't going to sell the product and you aren't going to make your $159.  You make a whooping $0 when you can't get the deal done because you just don't have the working capital.  However, if you finance the cost associated with making the deal happen, you could be in a much better place, even if you are paying a premium for the cost of the working capital, right...?


Let's look at those numbers...


Say you take out a merchant cash advance totaling $10,000 and you use the funds to cover your cost per acquisition (expenses).  You now have the ability to make 71 deals happen (that's $10,000 divided by $140, the cost of each deal).  Take your 71 deals and multiple it by $299.  You have $21,229 in total deposits.  Now subtract your cost of $9,940 (that's 71 deals multiplied by $140) and you are left with a profit of $11,289.  Now, let's say the merchant cash advance was very expensive because you've only been in business a couple of years or months, you had a bankruptcy years back or just some credit issues when you went through a divorce etc.... and you pay a total of $14,000 back on the $10,000 borrowed.  That's a 1.4 factor rate which is on a bit of the higher end.  Your total amount pocketed after making $21,229, covering your cost per acquisition of $9,940 and covering the cost of the money, $4,000, is a total of $7,289 in profits.  Good job on getting the deal done!  You just made yourself $7,289. 


 $21,229        Revenue Generated 

($ 9,940)        Cost per acquisition (a.k.a., operating expenses, marketing, materials, labor ect...)

($ 4,000)        Cost of the merchant cash advance

________________________________

$7,289            Profit


Congratulations on taking out the merchant cash advance, paying the premium, and getting the deal done!  It all comes down to the numbers.  Not everyone is built to be a business owner.  Some people can't get over their fears and "pull the trigger."  For many, fear stops them in their tracks and they don't even get to the running the numbers part. 


Here's another example of when the return on investment (ROI) makes a merchant cash advance worth the premium price associated... 


ABC Trucking Company has 3 trucks that all bring in 20k per month.  That's a total of 60k in deposits each month.  Say the cost of operating each truck is 75% of the funds brought in... that's $15,000 per month in expenses and a take home of $5,000 per month for each truck in operation.  Now imagine you have 2 trucks that have a mechanical issue.  You can cover the cost of repairs on both, which is $30,000 ($15,000 each), if you save up for 12 months.  In the 12 months, you make $5,000 per month with one truck operating and put 50% in a savings account.  This means that you made a total of $60,000 (12 x $5,000) and half went into your savings account so you can pay for the repairs with cash. 


You did well, right...?  You saved up, didn't have the high expense of a merchant cash advance, and you got the repairs done.... Yeah, this sounds like a success right?


Wrong!


You just lost out on some major profits!  Say you took out $30,000 in a merchant cash advance, you had a 1.4 factor rate and a total payback of $42,000.  You are paying $12,000, which sounds like a lot on $30,000 for the cost of the borrowed money but check out all of the money you will put in your pocket because of it.  Even if you take a whole month just for repairs (please hire a faster mechanic) you are pocketing $5,000 per operating truck per month. 


 $ 5,000      Revenue generated month 1 (you still only have one truck for the first month)

$165,000   Revenue generated for 11 out of the 12 months at $5,000 per month with 3 trucks operating ($15,000/month for 11 months)

($12,000)   Cost of the merchant cash advance

_________________________________

$158,000    Profit


Holy smokes!  If you would have kept on with your $5,000 per month while you saved up you would have brought in $60,000 for the year... it would have felt like $30,000 because you were putting half in savings for repairs.  You would have lost out on the additional $5,000 per month x 2 for both trucks.  That's $110,000 in lost profits because you didn't want to pay the "expensive" $12,000 cost for the merchant cash advance.


....the ROI talk should stop you in your tracks when you feel the fear of the cost of money creeping in.  It's funny though, how many business owners think that they are doing the "right thing" by paying cash, not incurring high financing cost and getting it done on their own terms.  They never even get to the running the numbers stage as the fear of being in a position of only making $5,000 per month and now adding an expense of $12,000 stops them in their tracks.  Ultimately, running the numbers and not acting with emotion is why some business owners do really well and some will always struggle.  It all comes back to, "It takes money, to make money."


So, let's look at some situations in which a merchant cash advance is bad. 


...and there are a few!


For one, your business does not have a profitable strategy.  


If it costs you $200 to make a product that you sell for $150, and buying in bulk does not lower your cost significantly... the plan is you'll figure it out as you go and if you could just buy some equipment, expand etc...  I mean, there's big companies selling the same product and they are huge so there must be money in it....


If any of the above sounds like you, your better off just walking away and cutting your loses.  There has to be a plan and there has to be margin for profit. 


Secondly, if you currently spend every dime that comes in. 


Maybe it's your first time having big numbers being deposited into your account and you feel you've earned the splurge.  The idea is you'll take a bit of the borrowed money and and use it in the "responsible way" and the rest... well you earned that BMW so you shouldn't feel bad about spending it.  What you just did, is added an expense but what you forgot to do was add significant revenue to compensate.  If you can add at least the amount of revenue to counteract the added expense, that's one thing.  If you aren't thinking that far ahead, it's a whole other thing. 


Thirdly, you have a family member that has offered to lend you funds with a flexible payback term, it's unsecured of course, and the rate is great.  Unless you have something against taking money from family and friends... it's cheeper this way, go for it!


Forth up.... you don't really need the money.  


If you don't have a plan for expansion and the money isn't needed to keep you going.... your wasting your time and the lenders!  If you don't need the money, why pay for it?  If maybe down the line, you could see yourself needing it but you are comfortable now... my question is, why take on an expense?  Probably a better idea to keep trudging along, make sure your credit is impeccable, wait out the time in business, maintain accounts with high balances, don't take too many business deductions so profits are seen on your tax returns, buy some real estate and pay on it for awhile so you have equity to be used as collateral down the line and get the bank loan you'll qualify for.  If you have more than enough money coming in, great credit, equity, time to wait... by all means this is the point in which you stop reading this and you go on your merry way. 


Bottom line is, the money needs to be used to keep you afloat or as working capital to build your business.  If you aren't doing one of those... what are you doing?  Paying any amount on money you don't need is just a waste. 


In conclusion, if you need money and you aren't in a position to get a bank loan or just don't want to, a merchant cash advance is a fantastic option.  It's going to cost you, but when you break down the ROI, it's all of a sudden a full steam ahead type of situation. 


A merchant cash advance, if used properly can be an exceptional tool in propelling your business forward.  For those who are already "rocking and rolling" with your business, just the fact that credit isn't crucial and it's unsecured should seal the deal right there. 


There are many benefits that can be seen with merchant cash advances, and the benefits can definitely out weight the risk.  Just remember, this isn't your "party" money, this is unsecured working capital.  So use it like you intend to build your business and you'll be a-okay. 


Furthermore, once you build a relationship with these lenders, next comes unsecured working capital in the form of business credit cards, lines of credit, and small business loans from these private lenders.  You can bypass the big banks and go the private money route in which the limits are high and so are the rewards.  Building a relationship with private money means, fast approvals (within hours usually), fast close (as quick as same day) and forward movement that will blow your mind. 


If you are serious about building your business and you have your head on straight, there is absolutely nothing to be worried about.  Spend your time growing your business and get deals done!


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