Yesterday, we covered the positives of a Merchant Cash Advance as a source of working capital for your business. To recap: they are fast (funds are usually available within 5 – 10 business days); unsecured; don’t show up or tie up your personal credit; and are available to those with less-than-perfect credit and in industries that traditional banks won’t touch (i.e. restaurants).
Now, let’s look at the downside….
The MAJOR drawback when it comes to a Merchant Cash Advance is that they are expensive. Very expensive. Take our earlier example – you would payback $14,000 on an advance of $10,370 (structured to be paid back within 7 months). That is a fixed cost of $3,630 to use the money for 7 months! Unless you’ve got a very specific use for that money that will result in a solid return on investment (ROI) – this kind of money might not make sense for your business. (We’ll discuss a variety of scenarios where the use of this money does make sense in a future post).
The natural inclination here is to frame that fixed cost in terms of a corresponding interest rate – but that isn’t accurate. Because this isn’t a loan – (remember – its a true sale involving the transfer of an asset) – you are actually looking at a discount rate. In most cases, the discount rate on a Merchant Cash Advance is anywhere from 26 – 40%. In some cases, it can go as high as 50%. Most retailers are familiar with this concept and actually use it as a standard practice in their business. For example, if a tire store offers a “buy 3 tires and get the 4th one free” – they are using a 25% discount rate. By the same token, restaurants promoting a “buy one lunch, get the second one free” are offering a 50% discount. In these cases, the merchant has evaluated (hopefully!) the impact of making this trade off with the positive outcome of bringing in the additional business.
This same concept applies with a Merchant Cash Advance. If you can use this money to make more money than it costs – it makes sense. If you can’t, it doesn’t.
It really is as simple as that.
Tomorrow, we’ll take a look at some other drawbacks to the Merchant Cash Advance (hint: the industry is unregulated and there are plenty of seedy characters running around) and how to find a reputable funding company (they exist, but do your homework first).
Til Then,
No related posts.
Related posts brought to you by Yet Another Related Posts Plugin.