Merchant cash advances — also known as business cash advances, and credit-card or charge-card receivables factoring – offer one more financing alternative for small-business owners seeking short-term working capital when strapped for cash.
While the cost of such financing is typically more dear than a bank loan or a credit line — credit-card factoring companies may charge rates of perhaps 30% — it may be worth looking into if traditional options are closed to you.
Credit-card factoring companies, often called factors, will look at your past documented credit-card receivables and advance you a percentage of your expected future credit-card receipts, usually on a short-term basis of less than 12 months.
“You might be able to get a $5,000 or $30,000 or $100,000 advance, based on your history of sales volume or credit-card sales,” says Lawrence Gelburd, a lecturer at the Wharton School and a former entrepreneur. A poor credit history isn’t generally a problem because the credit-card receipts provide assurance that the money is indeed coming in.
Factoring companies will work with any kind of merchant account, including charge cards. And businesses usually can get their cash quickly. Some factors advertising online promise turnarounds of 24 hours.
Merchant cash advances often are used by companies that typically have a lot of credit-card receipts, such as:
- service businesses
Unlike a loan, there is not a fixed amount for the repayment installments or a fixed term. The factoring company will collect a small percentage of your card receipts until the amount you owe (the initial advance) is paid back — often at a rate of around 8% to 10% of your sales coming in through charge or credit cards. But just because a factor offers you a deal, it isn’t necessarily wise for you to accept the rate, even if it’s a low portion of your ongoing sales. That’s especially true heading into a business downturn.
“You need to leave yourself room,” says Gelburd, who advises small companies on business strategies. “You have to make sure that if your future business takes a hit, you’re going to be able to meet the terms.”
Gelburd offers the following additional cautionary tips:
- Before you sign up with a credit-card factor, find out what the company would do if your sales fall off a cliff. “What’s their legal recourse?”
- If possible, don’t pledge your personal assets as a guarantee. “That’s fine when it works, and it has very sad consequences when it doesn’t, but it’s extraordinarily widespread.”
- If you can’t get financing unless you sign a personal guarantee, look for another source of funding. “It’s very hard, but you have to find another way to do it.”