Tie Repayment to Revenue with a Merchant Cash Advance

merchantcashadvance

Business schools teach that a solid business plan consists of meeting market demand with the proper product, by the proper business owner. When this happens, getting the proper funding is generally the next step. The goal of funding is to obtain sufficient working capital while matching the loan risk to the business risk. Generally, lenders are the first to make sure that the loan type matches the risk. For instance, banks generally consider a small business loan as a moderate risk loan. They will not extend it to what they consider a high-risk venture. When lending institutions consider a startup as high-risk, the entrepreneur still has the option to assume a high-risk loan. One of the most useful of these is the merchant cash advance.

Matching Repayment to Revenue


Owners of high-risk startups often look to two types of loans to finance credit. One of these is the home equity line of credit. This is high risk to the owner because a business failure can mean a home loss. Similarly, using a credit card to finance a startup can lead to both business and personal insolvency. However, lenders offering a merchant cash advance assume the high risk themselves. They do this by varying the monthly loan payments according to the sales. A traditional loan has a payment schedule based as a percentage of the loan principal. In contrast, the monthly payment for a merchant advance is a percentage of the sales revenue. If the sales do not reach targets, then the lender reduces the merchant advance payments accordingly.

The benefit of this arrangement is that it greatly reduces the chances of the small business owner’s greatest problem: insolvency. With traditional loans, sales may fall below estimates for a month leading the business to run out of cash. Even if the sales revenue is only delayed, the business may become insolvent. This is not the case with the merchant advance. The repayment follows the business cycle, and the owner maximizes his or her chance to stay in business.

The Costs

Because lenders who offer the merchant cash advance assume the risk, they charge accordingly to stay in business. A rough estimate of the monthly repayment is 60% of revenue. This allows a lender to recoup approximately a 10% profit in an environment where 50% of their clients fail. For the borrower, when high-risk loans are the only option, a merchant cash advance may make the difference to staying in business with volatile sales revenues. It also precludes risking a home, or risking bankruptcy. However, business owners can only choose this option for businesses with a profit margin of at least the maximum repayment percentage (roughly 60%).