Merchant Cash Advance Guide
This guide has been assembled to help Canadian business owners understand what are merchant cash advances, how they work and which companies are offering them to Canadian companies.
Merchant cash advances (MCAs) are essentially the sale of a business’s future sales, in exchange for immediate cash. The lender approves a lump sum payment to a business in exchange for a pre-determined percentage of that company’s future credit card (and sometimes debit card) sales. The percentage taken continues until the full payback of monies is fulfilled. This is becoming a popular financing alternative especially for small or mid-sized businesses that cannot or will not get a bank loan. The borrower gets immediate cash flow by selling a portion of his future receivables at a discounted price. His obligation is recouped, often by a third party, as his business earns.
Merchant cash advances usually require no credit check or collateral, and offer flexible terms. They are marketed as being convenient and fast, with many companies offering an online application process. Amounts of advances are usually based on projected credit card sales, so records of business performance are necessary.
This industry is becoming established, but since it is relatively new to Canada, it remains heavily influenced by providers who are U.S. based, mainly in regards to business model and pricing. Legislation varies with each area. There is still some mystery around the Canadian rules and regulations governing the industry.
Where this this advance may once have been most appealing to a small business that couldn’t get other financing, it is gaining popularity as a growth strategy. Cash up front allows a business to increase inventory (usually at a better price) when needed and this can generate a new cycle of growth.
Merchant cash advances are unlike bank loans or lines of credit and do not have the same terms those traditional types of financing have. They are not long term loans and do not have fixed payments or fixed interest rates. This financing may be seen as a ‘short term sale’ or the ‘discounting of future credit card sales.’
The funding is unsecured, meaning that the monies lent are not attached to any collateral that the lender could retrieve should there be a default on repayment. This represents a situation where the lender is taking a large risk, basically trusting the borrower’s promise to repay his lump sum. This risk, in turn, is offset by higher rates of lending, and may include borrowing premiums and associated fees. Unsecured financing often relies on credit history in its approval process, but the MCAs do not as they are interested in a cut of a business’s future sales. It’s through these future sales that the lender takes their cut, to the point of repayment. The interest rate, terms, fees, premiums and other related costs may or may not be factored together when calculating APR (annual percentage rate) as APR calculations vary.
Funding, cost, eligibility and requirements all vary depending on provider. Small business financers in Canada vary by size, geography, and financial capability. As with any other funding, experts recommend that those seeking funding deal with a firm that is in the same geographic area, is experienced with the business niche, is suited to the type and size of business, and who has a solid reputation and track record.
Growth in merchant cash advance usage
Although the general concept that merchant cash advance funding is based on has been around in some form for centuries, it has galvanized into an industry since the late 1990s. When the credit environment tightened in the 1990’s, many smaller businesses found it a challenge to raise capital - so the environment was ripe for alternative forms of financing to boom.
The merchant cash advance industry is starting to explode and observers expect a huge amount of growth. Estimates say that providers have only penetrated a very small portion of the potential market.
The merchant cash advance industry has a big marketing machine behind it that purports great advantages over other, traditional types of financing.
Fast and easy?
One of the most highly touted advantages is that it said to be a fast and easy application process. In fact, most companies offer online applications. Approval rates tend to be high and the turn-around time on applications can be as short as a few business days. Bank loans, in comparison, require a lot of lead time and have a complex application process, heavy documentation and strict lending restrictions.
The amount of personal and business information that is examined when applying for an MCA is much less than a bank loan application demands. Credit ratings are often not checked since providers are not assessing your credit-worthiness like a bank would when assessing a loan application.
Retail merchants have long been considered risky by the banking industry. Failure rates are very high for small retail businesses, service companies and restaurants.
Immediate cash flow
Another advantage that a merchant cash advance can provide is that of immediate cash flow or working capital. When used properly, this can allow a business to improve sales and profit. A business gains an advantage when they get immediate cash that can be used to purchase inventory at a cheaper price. Suppliers sometimes offer a small discount (around 2%) when they get paid immediately (or usually within a 10 day period.) In this case, it can work out that the discounted supplies and subsequent profit made from them offset the cost of borrowing money. When this strategy works in a business’s favour, they have gained financial power. The bottom line is that it’s up to the business seeking financing to get all the necessary information, read the fine print and to develop their strategy from there.
The flexible repayment plan is another selling point as repayment fluctuates along with the ebb and flow of sales. (This continues until the advance and the premium are recouped; generally this happens within less than one year.) This can be beneficial as it allows the business’s repayments to slow as its sales do; a bad month won’t put a borrower behind the proverbial eight ball in payments. Bank loans have a firm repayment date and fixed payments to be made according to a strict schedule.
A merchant cash advance does not require any collateral. Retail or cash businesses with an inventory are rarely approved for loans with Canadian chartered banks. Bankers’ reluctance increases when a business does not have much equity or collateral (either business or personal) as is the case for most small businesses.
Additionally, fluctuating Interest rates are not a concern with a MCA since it is a flat percentage of future sales. This financing can be a good fit when a business has predictable future sales, based on their merchant credit card sales history and bank statements. It can also work well for businesses with good margins who can manage the cost of borrowing while being able to benefit from that infusion of money.
It seems that the biggest disadvantage of a merchant cash advance over other types of financing is that of cost as they generally cost more than a bank loan or line of credit.
A columnist with the American Institute of CPAs cites that, ultimately, the equivalent interest rates can range from 60-200% annual percentage rate (APR). Whether this is true or not depends on a range of factors and it’s up to the business seeking funding to ensure that they understand these factors, or else their costs can soar.
Since an MCA is not a loan, but rather a purchase of future sales, this means that they are not bound by the same laws that limit interest rate and regulate lenders.
Dishonest providers, irresponsible providers, lack of transparency and lack of best practices can be found in all industries and the merchant cash advance industry is no different. The disadvantages of MCAs, as with any funding, can be understood, foreseen and often avoided with serious due diligence and thorough investigation.
Another disadvantage happens when a merchant cash advancer takes such a large cut of a business’s sales that the business can’t survive. A business running on a very small margin is wise to tread carefully when looking at this financing. A business with very little collateral, equity, or stability can find themselves on equally thin ice. Experts agree that using an MCA as an emergency rescue plan is a bad idea. Although repayment (or retrieval) rates are set out in advance, there can be unexpected or unforeseen events that could affect the ability to meet repayment.
The merchant cash advance industry is not regulated, although they often consider themselves to be ‘self-regulated.’ Some experts fear that this is a false image aimed at keeping the regulators’ attention off them. In the cyber world, however, lack of attention is nearly impossible. There are many online forums dedicated to commentary on the industry from both lender and borrower perspectives.
Marketed by third parties
There is also the issue of third-party brokers, who act as sales channels for MCAs. It’s questionable how well any given broker understands, explains and presents the product. Business practices, levels of expertise and integrity have recently been questioned since the MCA industry saw an influx of out-of-work mortgage brokers.
Critics condemn MCA providers for being lenders who don’t have to abide by usury laws. There have been federal class action suits filed in the United States; a California suit claimed that MCAs are basically loans and therefore should be subject to the same rules, regulations and laws.
Experts urge caution, and add that it’s up to each business to perform due diligence before entering into an agreement with any financier to ensure that he is legitimate, credible and experienced. It’s up to the business seeking funding to vet the fine print, the offering and the terms and conditions, before signing on the dotted line.
Rates and costs
Merchant cash advancer’s rates and costs vary. There are no fixed amounts for repayment instalments and no fixed term because this is not a loan. The percentage of credit card sales taken as repayment can be as reasonable as 8 or 10 %. Some companies claim that, in the case of low-margin businesses, they may collect as little as 1% of gross sales. In general, the percentages of future sales that are extracted seem to run from 10% to 25%.
Some companies charge premiums on the money they advance (which can be as high as 30% or more.)
Overall ‘interest rates’ vary, in part, because a company with slow sales will take longer to fully repay than would a company with rapid sales. This period of time affects the overall rate: a company that takes two years to repay would have a lower annual interest rate than one that has fast sales and repays all in six months.
Many companies are trying to promote industry standards around the premiums and percentage of sales.
Amount of funding available
Amount of funding varies and depends on factors such as: past credit card receivables (thought to predict future receivables), sales volume, the history of the business, etc.
In general, the amount of funding is typically equal to a few months’ worth of the business’s sales. Some providers approve up to 125% of the business’s average credit card sales over recent months.
Funding amounts can run anywhere up to $1,000,000, and are generally repaid within a year or less.
Merchant cash advances are targeted mainly at small businesses, particularly those who may have strong credit-card sales in the future but who don't currently qualify for traditional bank loans because of bad credit, lack of collateral, etc. The scope of industries served is very wide.
Preferred businesses include retailers that process several credit card transactions per day. Restaurants are desirable for this type of financing due to the number of smaller dollar amount transactions they process daily. Retail and service companies are also highly approved for MCAs.
Eligibility criteria vary between lenders, including: length of time the company has been in business, type of business, location, average credit and debit card receivables per month, who the current credit card processor / provider is, etc.
The required length of time that the business has been operating for may be as little as several months, while others require a minimum of one year in business. Some funders require that the business be a physical one and one who uses a card processing terminal to swipe through transactions. These companies admit that it’s difficult to audit transactions that happen online.
Requirements and application process
Besides online applications, many MCA providers use phone interviews; ultimately, this financing need not be done face to face. The application process begins with basic information to see if the business ‘pre-qualifies’ for funding. If so, there will be an offer for how much funding the company qualifies for and the repayment terms which include an estimated time frame and a daily percentage rate (daily, not annually) that the lenders will take out of future credit card sales. The time-frame has to allow for variations in sales volume.
Some repayments are made daily when credit card receipts are processed (“batched out”) at days’ end other plans have monthly payments. The exact end date of repayment can’t be identified because neither lender nor borrower can know exactly what the business’s future credit card sales will be. Average repayment periods range from 6 to 12 months, though there are usually no penalties for early repayment.
Example customer experience
Applications are usually one to three pages long. Relevant business and personal information will be requested. Contact information for the business’s bank, vendors or landlord may be required. A credit review will likely be asked for. Recent (from 2-12 months’ worth) of credit card statements will be requested in order to assess average daily sales.
Although many companies claim that a credit check is not an issue when it comes to getting a MCA, it’s common for many to request business and personal credit information (which may include credit rating or credit score.) Issues likely to result in a declined application include tax liens, court cases or outstanding judgements, current or prior bankruptcy filings, foreclosures, lapse in mortgage payments and more.
Applicants for a MCA will submit merchant account statements and business bank statements so that the funder has a good idea of sales history, seasonal ups and downs, and cash flow activity. All of these affect repayment.
Additional supporting documentation
Verification of business location is commonly requested: this may be in the form of a property lease or mortgage. This is done to ensure that the business is legal, stable and that all information is accurate. Further documentation such as a voided cheque from the company bank account, a business license, and personal documentation such as photo ID may be requested. There have been reported cases where tax returns and financial statements were asked for.
Establishing repayment method
Before funding is put into place, the lender and borrower must establish a method of transmitting credit card revenues. This is where the merchant account processor comes into play. There can be restrictions around the merchant account processor used.
Interview and reference check
The MCA provider will seek an interview when an application is under consideration or about to be approved; often, this is done by phone. The provider is likely to vet references such as the business bank, business property landlord and perhaps vendors, in order to verify information. Sometimes the references need to be put into writing, other times a verbal reference is acceptable.
Confidentiality and privacy
Details of an agreement are generally supposed to be kept confidential, but again, it is wise to confirm in advance.
Other issues with applications
Incompatible credit card processor
There have been reported issues where merchant cash advancers don’t use the same credit card payment processor as the business they approve to fund. Reportedly, some merchant cash advancers have a list of processors that they will deal with. A change in processor can cost a business time, money and a new set of fees.
There have also been reports of businesses being ‘put in the middle’ between their MCA funder and the credit card processing company, and being required to facilitate among the three providers to ensure that all necessary transactions run smoothly. This has caused frustration to businesses who didn’t anticipate this extra dimension of work.
Few standards and competition
The Canadian market has less industry competition than other markets (most notably, the U.S.) and some experts feel that increased competition will lead to higher standards.
The burgeoning industry is reportedly using telemarketing calls to solicit business.
Privacy and confidentiality
The disclosure of detailed personal and business information is often seen as a security risk. Victims of unapproved information disclosure recommend that details should not be given out until a written agreement of a funding deal has been negotiated and closed. The question of what happens to sensitive information that the MCA provider has collected is another question that a business may be wise to ask.
Brokers and third parties
There is a chance that brokers may misrepresent merchant cash advance offerings, may be poorly informed about their details, or may be desperate enough to compromise honesty in order to strike a deal.
Many companies that market cash advances are, in fact, resellers. In this sense, they are acting as a broker for a funding company. Things can get confusing when there is one company involved as broker and another company involved as funder, especially if this is not made clear up-front. This reseller should be transparent as to who the funding company is, but again, it’s up to the consumer (in this case, the borrower) to ensure that they know who the “underwriter” is.
Terms and conditions
Different MCA companies have different policies, terms and conditions, etc. There can be a lot of research, analysis and due diligence required by the little guy who needs some capital for his business. A lot of confusion can be avoided by a clear understanding of the terms and conditions of the policies. Ultimately, this may require someone who knows the industry well or who, at least, can decipher legalese.
Laws of other countries can impact what a MCA funder can or can’t do. In the U.S., the merchant cash advance transaction is recognized as a sale of future receivables, but in other countries it can be much more complicated.
Legal recourse will vary depending on the country and jurisdiction. In America, for example, a breach of contract can go before a judge, and loans in default may be turned over to collection agencies. Every country governs such situations differently. There is very little information, as yet, pertaining to the Canadian industry.
Cautionary warnings to borrowers include asking the MCA exactly what they would require should the borrower hit very hard times and not generate sales. What kind of legal rights and recourse would the lender have? They may, in such cases, ask for a promise of personal collateral.
Companies offering merchant cash advances in Canada
Some of these are Canadian companies, some of them are based in the U.S. but also operate in Canada. This is not a comprehensive list.
|Advantage Capital Funds||http://www.advantagecapitalfunds.com/||U.S.A.|
|Business Financial Services||http://www.businessfinancialservices.com/||U.S.A.|
|My Merchant Cash Advance||http://www.mymerchantcashadvance.ca/||U.S.A.|
|Company Capital Inc||http://www.companycapitalinc.com/||Canada|
|Canadian Capital Advance||http://www.canadiancapitaladvance.com/||Canada|
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