How Merchant Loans Can Help You Grow Your Business
While merchant loans have been heavily criticized by traditional lenders, they offer a convenient way for small business to obtain the capital they need when banks are turning them down.
Critics of these loans claim that now the payday loan industry has come to the business world and that small business owners are lured in a cash and interest trap, of which they can hardly escape. Interest rates for merchant cash advances can range from 60% to 200% effective annual rates.
Proponents say that you can't compare them with traditional loans. Merchant lenders rather advance cash in return for a share of future credit card charges. By only collecting a fixed portion of monthly credit card sales business owners don't need to worry about having to pay back the loan when the business is slow. But when business is better than the loan is paid back faster.
So how does it work. Let's say you are a small business owner that runs a dry cleaning business. You find yourself in a situation that you urgently need a loan of $20,000 to cover working capital needs. Banks have turned you down, as they only tend to lend money when you are flush with cash and you don't need any. In times of need it is almost impossible to find a traditional loan.
So what are your alternatives? If you would invoice your customers, you could try to find a factoring company and sell your accounts receivables to them for a discount. But as you deal mainly with walk in customers that pay you by credit card, that is not an option for you. This is where the merchant lender comes in.
By looking at your average monthly credit card sales, they will determine an amount that they can advance you. In your case the lender is advancing you $20,000, he charges a fee of, let's say 20%. So you will pay back $24,000 through your future credit card sales.
Now the advance provider wants to make sure that the portion of future credit card sales he is taking of the top is not hurting your business and allows for enough cash flow for you to continue to run your business. Typically he would try to limit his take out to no more than 10% of your monthly sales. In our example that means that you would need to have average monthly sales of $20,000 to cover for the advance.
Now if your business is doing much better because you had access to the working capital you needed, your revenue might increase to $40,000 a month. In this scenario you would still pay 10% of your monthly sales and you would pay back the advance in 6 months rather than 12.
On the other hand if your business slows down because the economy took a nosedive suddenly, your revenue might drop to $5,000 a month. You would still only pay 10% and you would now take 4 years to pay back the advance.
This flexibility and the monthly payments that automatically align themselves with your cash flow is what really make merchant loans attractive loan alternative for small business owners.