I recently had dinner at one of my favorite local restaurants. I have known the owners for several years and have become friends with them. I asked how business was since this was their slow season and they replied that they were struggling, as always, during this time of year. They had tried to obtain a line of credit with their bank but did not qualify yet.

They are one example of many small business owners in the restaurant, retail, franchisees or seasonal businesses that are having difficulty in obtaining credit from traditional financing institutions. The life of a small retailer is tough these days and there are few signs that it’s getting easier. So what is available to them?

These merchants rely heavily on credit card processing, so there are cash advance programs that offer a number of benefits. In most cases, business owners put up no personal collateral and make no personal guarantees.

Merchant cash advances have been steadily increasing over the last five years. According to the Green Sheet, a new chapter is opening for the industry as analysts’ report the merchant cash advance market is expected to grow within the next several years. Green Sheet estimates that alternative lending through merchant cash advances may reach $3 billion to $5 billion within the next several years. The market is currently valued at $500 million to $700 million.

How does it work?
When a company gets a merchant cash advance, the deal is the purchase and sale of future credit card income. No regular fixed payments are required by the company. The lender collects a set percentage of the company’s daily credit card sales. The collection continues until the lender recovers what it advanced to the company along with its premium. Usually, the lender tries to collect the advance within one year.

One thing that is attractive to companies about the merchant cash advance is that, when they have a slow sales month, their payment to the advancing company is lower since they collect a set percentage of credit card sales. Another attractive feature is that there is no actual due date for the advance to be paid off. It is paid off when enough credit card sales are made for the advancing company to recover the advance and its premium. In addition, no collateral is required to secure the advance.

What is the cost?
There is no interest rate attached to a merchant cash advance because it is not a loan. Instead, the company making the advance collects what it calls a premium or a percent of the credit card sales of the company receiving the cash advance. For example, the advancing company may collect 25 cents for every dollar of credit sales the company makes until the advance is paid off. As you can see, merchant cash advances can be very expensive. You do need to check around and compare to find the best rates.

Another thing to consider is if you obtain a merchant cash advance from a company that requires you to switch to a different credit card transaction provider, is there a cost associated with breaking the agreement with your existing provider?

Who can qualify?
Most merchant cash advance lenders require a business to be open for 60 days, to generate at least $4,000 monthly in credit card sales and have no open bankruptcies in the last 12 months. Your advance can be as high as 125% of the average monthly credit card sales. You can obtain these funds usually within 72 hours.

A merchant cash advance is an alternative source of financing for small businesses that can’t get a bank loan and have the following concerns:

  • Do you need funds quickly for business improvements or investments?
  • Do you need to pay off outstanding debt or taxes?
  • Do you need to make emergency repairs to your space or equipment?
  • Do you need funds to make rent or mortgage payments or meet payroll demands due to a slow season?
  • Do you need to order inventory and need the cash to pay for that?

If you answered yes to any of these questions and if your business currently processes Visa and MasterCard, a merchant cash advance could be a viable alternative if a business has a cash flow problem and an immediate need for cash.

Here are some scenarios in which merchant cash advances helped these businesses:

A dinner playhouse was slow during the summer months and needed money to keep rent payments current and to meet payroll demands.

A dry cleaner owed some outstanding taxes and needed the money ASAP to bring current or otherwise they would have to pay a sizable penalty.

A restaurant needed to renovate its outside dining space to accommodate more customer seating.

Merchant cash advances are only one of several alternative financing options for small businesses. Just like with any financing option, there are positives and negatives. In a tight credit market, small businesses often have to take funding where they can find it. A merchant cash advance is a targeted receivables financing with the only receivables being used is the credit card transactions.

Cheryl O’Neill Gowen is president and CEO of Alternative Funding Options. She works with business owners seeking cash flow from non-traditional sources, drawing on more than 30 years’ experience in banking, financing and staffing. Contact her at: [email protected].

Article as it appears in the Business Observer.