Merchant Cash Advance. Is it right for your business?

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1 Merchant Cash Advance Is it right for your business? This guide explains what a merchant cash advance is; how it works; how to avoid the pitfalls; and, how to best take advantage of a merchant cash advance for your business. TESO Merchant Consultants 12/29/2012

2 Table of Contents Merchant Cash Advance 3 How Merchant Cash Advances Work 4 Top 10 Most Funded Industries 5 Merchant Cash Advance Qualifications 5 Strategic Uses of MCA 6 Why Credit Card Purchasing is Worse than a Merchant Cash Advance 6 Finding and Negotiating with a Merchant Cash Advance Provider 9 Glossary 10

3 Merchant Cash Advance What is a merchant cash advance? A merchant cash advance is working capital given by a private provider to a business based upon its future sales. Advances differ from bank loans in several ways. An advance is technically a sale of your future sales. Advances are not regulated, and, in most cases, the amounts are limited to your monthly sales revenue. The payments are not fixed and the funds are unsecured. A loan is a form of debt. Because the loan amounts are higher, bank loans are highly regulated. The payments are at a fixed interest rate and the funds are secured by collateral in most cases. Below is a quick comparison between merchant cash advances and bank loans. MCA VS. Bank Loan Money lent based on cashflow and/or Advance on Future Sales collateral Funds lent at a fixed Factor Rate rate of interest Loan Amount may be Amount of Advance much greater than an Limited by future sales Advance Unregulated Industry Highly Regulated Application and approval processing is quick and easy. High approval rates Bad Credit = Approvals No personal Gurantee No fixed repayment amount No fixed repayment terms Will not show on credit report Fees are tax deductible Application process is usually lengthy and high decline rates Much lower approval rates. 60% of bank loans declined. Bad credit = Decline May require personal guarantee Fixed repayment amount Fixed Repayment Term Will show on your credit report Fees are deductible Merchant cash advances are not considered loans. The cash advance providers do not charge an interest rate. They use a factor which is the percentage the provider charges on the advance. A typical factor may be To get the total payback amount, you simply multiply the factor by the advance amount. $10,000 x 1.30 = $13,000. The $3,000 is the factor fee.

4 Because the factor can be quite steep, it is advisable to first check with your bank to obtain a loan or a line of credit. If your business is in need of quick cash or does not qualify for a traditional bank loan, a merchant cash advance may be your best option for alternative financing. As you will see, your business credit card is your worst option because in most cases, you will pay more in interest. We have established that the best source for cash is the bank. However, a bank loan has many pitfalls. First, the process can take several weeks to several months. Secondly, you need great credit to qualify. Even with good credit, the approval rate is quite low. A recent study by Pepperdine University found that 60% of small business loan applications were declined. You could find yourself needing funds and waiting a long time only to be turned downed. Finally, most bank loans require some sort of collateral. Do you really want to put up your house or another precious asset? If things do not go as planned, you could end up losing your house. It is important to weigh these risks. With merchant cash advances, you do not have those issues. In most cases, the application process and funding can take less than 72 hours. Merchant cash providers will fund merchants with bad credit, bankruptcy and/or liens. Since the funds are unsecured, you are not putting your assets at risk. How Merchant Cash Advance Work Merchant cash advance companies will typically advance an amount that is equal to or less than your monthly credit card volume or your monthly gross sales. Although there are some exceptions, most companies will not advance you more than 150 percent of your monthly credit card processing volume. If your monthly credit card volume is $10,000, you can expect to get an advance up to that amount or maybe slightly more. If your monthly sales gross revenues are two to three times your credit card volume, then you can expect a larger advance. Once you ve been approved for a merchant cash advance, the advance provider will deposit the agreed upon funds into your business bank account within a few business days. A reputable merchant cash advance company will work with you to ensure that the payback schedule and the daily retrieval fee are manageable. A good merchant cash advance company is there to help you not put you out of business. The daily retrieval fee will be taken in one of two ways, either through your credit card processing or through a daily ACH withdrawal from your business bank account. The most popular is through your credit card processing. The daily retrieval fee may range from 10 to 40 percent of your daily gross sales if by ACH or 10 to 40 percent of your credit card processing sales. Cash advance companies are fairly sophisticated now. You no longer have to switch your credit card processor as there is a lock box solution that allows you to avoid the hassles of switching. If you go with the ACH withdrawal, you avoid dealing with your credit card company at all. Typically, the payback period is six to nine months. Since you do not have a fixed payment, the payback period may vary. You may set up a nine-month payback period. If your sales increase, your payment period will be shortened. In the case, where your sales drop, then your payback period will be longer. Once you have paid back the cash advance you are free to sign on for another round of funding if you so desire although it is not required. Your cash advance company will send you a letter informing you that the payback is completed. The daily retrieval fees should cease immediately but it is important to check your bank statements or your card processing statements to make sure that the daily retrieval fees have stopped.

5 Top 10 Most Funded Industries Merchant Cash Advance Qualifications: Retail or restaurant business (there are some exceptions) Business that accepts credit cards or has a high monthly gross sales (typically $15,000 and above) Processes $5,000 or more in credit card however some merchant cash providers will go as low as $2,500 At least 15 batches (card settlements) per month In business six months or more Able to provide six months of credit card statements or other financial documents Not currently in bankruptcy If already in merchant cash advance, 50% must be paid off in order to switch providers No open liens in excess of $25,000 (amount may vary) Not a home-based business

6 Some merchant cash advance companies make exceptions to those qualifications as this is an unregulated industry and they use their funds. They are mainly looking for several factors in order to determine the approval and amount to approve. They need proof of sales volume, longevity, and cash flow. Strategic Uses of Merchant Cash Advance As mentioned earlier, a bank loan or line of credit is your least expensive option. However, a merchant cash advance serves as a good alternative if you need cash quickly. On an average merchant cash advance of $10,000 at a factor rate of 1.30, you would need an internal rate of return of 29 percent over 24 month period to make the advance pay off in your favor. What that means is that whatever you do with that advance money, you need to invest it into something that is going to provide good growth. However, there are some exceptions such as an urgent bill or tax assessment. For example, John has a pizzeria. He wants to get rid of his conventional ovens and get a wood fire grill. The wood fire grill costs $10,000 and he wants to spend another $5,000 on promotion. John believes that his sales will increase because wood fire grills are popular. He also plans to charge a premium for his better tasting pizzas. The wood fire grill is less expensive to operate than his conventional ovens. A bank loan will take up to 2 months to process and there is a strong possibility that he will be turned down. His bank, as with most banks, does not like to make loans to restaurants. Because of this, John is a perfect client for a merchant cash advance. He needs the money for a definite purpose that will enhance and grow his business. He also has solid estimates that the investment will pay off over time. He does not want to lose time and labor waiting for a loan approval from his bank. A merchant cash advance offers him quick access to the cash he needs. In another case, Sally has a café that is badly outdated and in need of renovation. Her menu needs updating as well. The café is in debt and Sally is barely hanging on. She must pick up sales or the café will go out of business. Sally has a friend who is an interior designer and married to a man who owns a construction company. He will do quick and cheap renovating within 48 hours. Sally figures she needs at least $10,000 for the material; $5,000 for the labor; and, $2,000 for the consultation. She is not going to qualify for a bank loan and will only qualify for $15,000 from the merchant cash advance provider. To lower some of her costs, Sally invites the local TV station and newspaper to do a story about her plan to save her café in these hard economic times. This will give her café free publicity as well as free publicity for all those involved. In exchange for the publicity, her friends give her discounts so that she can meet her $15,000 budget. Within a week, Sally has the cash and has transformed her café and business quickly picks up. Sally fits another typical merchant cash advance client. But unlike most, she has a strategic plan on how to use the money to improve and grow her business. She has giving her business the best chance to grow and is willing to make the necessary changes to make that happen. Why Credit Card Purchasing Is Worse Than a Merchant Cash Advance Many business owners have large lines of credit on their business credit card. It is very tempting for merchants to make large purchases on these cards. Actually, it actually costs merchants more to purchase with a business credit card than to take a merchant cash advance. Although, the business card interest rate may be half of the corresponding factor rate, most merchants end up paying nearly three times as much in fees versus a cash advance. So how could it cost the merchant more? The main reason is credit card companies extend card payments for dozens of years. This means that merchants essentially pay interest and very little principle for a

7 long time. Merchant cash advances are paid off much more quickly usually in six to nine months with no compounded interest. For example, Jim the Mechanic purchases new equipment for his auto shop for $10,000. He puts the purchase on his credit card which charges 15 percent interest. Jim pays the minimum card payment or just a little more each month. By the time he finishes paying off his outstanding balance, Jim will have paid $8,861 in interest on his $10,000 purchase, even though the interest rate is lower than a merchant cash advance factor rate. Had Jim received a merchant cash advance, he would have paid only $3,000 to $3,500 as a factor rate on that advance saving him $5,000. Repayment on $10,000 advance: CREDIT CARD Interest Rate Cost to Company 15% $ 8, % $ 9, % $ 10, % $ 10, % $ 11, % $ 12, Versus FACTORING Factor Rate Cost to Company 1.20 $ 2, $ 2, $ 3, $ 3, $ 4, $ 4,500

8 Finding and Negotiating With a Merchant Cash Advance Provider The merchant cash advance industry is unregulated making for some unscrupulous companies. You should not let that stop you from pursuing a merchant cash advance as there are many reputable providers who can provide you with advances to help you grow your business. CHARACTERISTICS OF UNETHICAL PROVIDERS Below are actions to avoid when considerations for selecting a merchant cash advance company. High Retrieval Rates: Anything over 20 percent of your daily gross revenues is too high. AdvanceMe, the industry s leading merchant cash advance provider, did a study of 40,000 merchant cash advance transactions and found that such high daily retrieval rates ruin businesses. Work with your merchant cash advance provider to ensure that you can safely pay the daily retrieval rate. Short Payback Period: You should not accept anything less than six months unless it is for an amount less than $3,000. Dog piling: Some merchant cash advance providers continue to add one advance on top of another which is predatory and destructive. It is imperative to avoid this scenario at all costs. Increasing Daily Retrieval Rates: Please carefully read your agreement. There are terms and conditions in some agreements that allow the merchant cash advance provider to increase the daily retrieval rate. Remove those terms or get in writing that the merchant cash advance provider will not increase the daily retrieval rate without your consent. CHARACTERISTICS OF A REPUTABLE PROVIDER In order to select a qualified, reputable and ethical merchant cash advance provider, it is important to consider the following key points: Know Your Merchant Cash Provider: A reputable merchant cash advance provider should do no harm to its clients. The provider should be looking out for your interests as well. You should discuss in detail what you are planning to use the money for. Then you should discuss your financial situation so that the provider can set a safe daily retrieval rate that won t put you out of business. The merchant cash provider should be honest and helpful. If he is short, rude and inpatient, do not consider him as a provider. Full Disclosure: All fees should be fully disclosed. Additionally, you should not have to pay extra fees including set up fees, application fees, credit check fees, statement fees, or others on top of the daily retrieval fee. If these are listed, find another merchant cash advance provider. Excellent Customer Service: A reputable merchant cash advance provider should provide excellent customer service. A good test is to call them after hours and see how they respond. If they give you a prompt and courteous call back, then you can expect the same when you use their services. Multiple Cash Advance Quotes: Getting multiple quotes allows you to get to know the company with which you are about to engage in business. Multiple quotes will let you evaluate several options and allow you to negotiate a better deal. Remember to negotiate the lowest daily retrieval rate and the longest payback period possible even if that means accepting less money. In the end, go with the merchant cash advance company that you feel most comfortable with.

9 Switching Credit Card Processors: A merchant cash advance provider should be able to provide you with a lockbox solution rather than forcing you to switch credit card processors. The company with the lowest factor rate is not always the best option in selecting your merchant cash advance provider. There are two important other things to consider: the daily retrieval rate and the payback period. Ideally, you want the lowest daily retrieval percentage and the longest payback period possible. To see the difference, check out the following scenario: Take a $10,000 advance at 1.30 factor rate with a payback period of six months versus a payback period of 24 months. The internal rate of return on the six-month advance is 151 percent. In other words, you need to make 151 percent on the advance money in that six-month period to make that transaction worthwhile. Now, say you are given payback period of 24 months. The internal rate of return is 29 percent. You would need to get a 29 percent return on your advance investment over the two-year period to make this transaction worthwhile. This percentage is much more manageable. Remember, unlike a loan, the factor rate is set, you do not pay any more in additional fees even though you took a longer time to pay.

10 Glossary ACH (Automated Clearing House): The ACH network is the primary electronic funds transfer system (EFT) used by agencies to make payments, and the Financial Management Service anticipates that agencies increasingly will use the ACH system to collect funds. Some merchant cash advance companies can set up the daily retrieval through ACH. Cash Advance Provider: A private lender (possibly a bank) that purchases the future sales of a business in need of cash now. Factoring Service Provider: A business that purchases account receivable loans from other businesses. Advance Amount: The amount of funds that a cash advance provider has agreed to give to the merchant in exchange for a percentage of future revenues. Factor Rate: The percentage, usually written in a decimal format, that the cash advance provider charges on the advance. A factor rate is typically 1.25 to 1.35 but can be higher or lower. To calculate the total payback, multiply the factor rate by the advance amount. To convert the factor rate into an interest rate, multiply the factor rate by 24. (1.25 x 24= 30%) Daily Retrieval Rate: The daily payback amount the provider collects from a business using its advance services. The collection may be from the business s credit card processing or a daily withdrawal from the business bank account. Lockbox: This is a DBA account set up between the merchant cash advance provider and the merchant. The lockbox allows for split funding of daily credit card processing revenues. The advantage of a lockbox is that it allows the merchant to pay the daily retrieval fee without having to switch credit card processors. Payback Period: The time it takes to repay the advance and the factor fee. Typically, this is six to nine months. Safe Retrieval Percentage: The daily retrieval fee that does not overly burden the business and put it into financial trouble. Some businesses may prefer a higher daily retrieval percentage to pay off the advance quicker. Such high daily retrieval fees may jeopardize the business. A good merchant cash advance company will set a safe daily retrieval percentage as a fall back in case there are financial issues.