One of the biggest problems small businesses have when they seek small business financing is that they don’t know all the options. In my experience working with hundreds of business owners seeking capital, I find most of them know about bank loans, but many don’t know about alternatives such as merchant financing.
You may also hear merchant financing called a merchant loan ormerchant cash advance. A quick tutorial in how merchant finance works:
In essence, instead of taking out a loan from a bank, in merchant lendingone of your vendors fronts you the money your business needs, often to purchase inventory. Another scenario is that a credit-card company offers the merchant advance.
In either case, there’s a catch, of course. You secure the loan by pledging to turn over some of your receivables — your pending customer credit-card charges — to the lender, which will get to collect the money owed. So you give up some of what you’re owed to get merchandise you need for your shelves.
Here are eight ways a merchant advance differs from a bank loan:
1. Faster approval. A merchant loan is often approved within a week, where a bank loan process can drag on for months.
2. Simpler paperwork. The application process for a merchant advance is much less onerous than applying for a traditional bank loan.
3. Only good for companies with credit customers. If your customers all pay cash, you can’t take advantage of a merchant loan. Likewise, if you don’t have a well-established track record of making a substantial amount of monthly credit-card sales, you may not qualify for a merchant loan. On the other hand, a small business loan might be available to a company that doesn’t have many customers paying on credit.
4. Shorter term. A merchant advance is generally for a short period of time, perhaps a few months. A bank loan, on the other hand, might have a several-year term.
5. More credit flexibility. If you have bad credit, a bank loan may be out of the question, but you might still be able to secure a merchant advance.
6. No loan payments. That’s right — a merchant advance is not a loan! The vendor is purchasing your future receivables.
7. No payback if you bust. Hopefully you won’t need to take advantage of this angle, but if your business ceases operations and you don’t generate the receivables, you have no obligation to repay a merchant advance. With a bank loan, depending on how you set up the loan, you might still be on the hook for the loan payments.
8. Higher costs. One dark side to merchant loans is that costs can be higher than you might pay for business bank loans.
A merchant advance can be a handy financial tool when your business needs money fast — to purchase inventory in bulk at a better price, to do critical marketing activities, to repair broken equipment, or just to plug a cash-flow hole. Once a merchant advance is paid off through your receivables, you can often get another advance, too.