The world of business lending has gone through some drastic changes in the last couple of years just like other sectors of the economy. The change in the lending sector has been introduced by alternative sources of lending championed by Merchant lenders whose goal has been to make business loans much more readily available to small business owners.
These groups of lenders have continued to pull their weight in the lending industry in ways that were hitherto not anticipated. In one single year, alternative lenders accounted for over 4 billion dollars of the entire lending to the small business sector. Even though this figure might seem minute when compared with the total lending from traditional financial institutions for the year in question, it is still indicative of the fact that there is has been a gradual shift from conventional financial institutions such as commercial banks when it comes to the issue of obtaining loans.
Merchant lenders have on their part gained popularity for making cash available to small business owners in the shortest possible time. Before the emergence of alternative lenders, there were specific critical issues in the lending industry especially when it has to do with commercial banks. Merchant cash advance providers have tackled a significant portion of these problems efficiently. Before taking a closer look at the concept of merchant lending, it is essential that we examine some of the other sources of alternative funding which are relatively accessible. The aim is to show how some of these other sources are limited and how merchant cash advance stands as a better option when compared with the other sources.
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One of the most popular sources of alternative financing in recent times is online lending. The emergence of internet technology in the later part of the 20th century has undoubtedly had its contribution to the world of business lending. Online lenders, as the name implies, provide loans to small businesses through the internet. Unlike the Merchant lenders, online lenders do not manually underwrite loan applications as the online platforms are built with compelling software which uses complex mathematical formulations to underwrite loans.
In short, when it comes to speed one could argue that online lenders provide the fastest loans. Loans from online sources could take less than 24 hours to be delivered. Of course, Merchant lenders do not lag behind much in the area of speed in that they sometimes make loans available in less than 48 hours, depending on the amount that is involved.
In spite of the fact that online lenders are becoming quite popular there are still valid reasons for one to be concerned when seeking loans from virtual entities.
For one thing, it is always more preferable for one to deal face to face when it comes to the issue of loans. This is because loans from online lenders do not come from a single source as do those from merchant cash advance providers. In actuality, there are lots of investors who provide the loans on the platforms—making for a somewhat complicated process. On closer examination, one should also recognize that online lending is at its budding stage and as such could experience some hiccups.
In short, it has sometimes happened that online lenders suddenly went out of business. This is not to say that it is impossible for Merchant lenders to go out of business; but, statically the chances are quite slim since the merchant cash advance industry is one that has been more firmly established.
Invoice Factoring Firms
One other popular source of alternative business funding is through invoice factoring. Invoice factoring involves a business selling its debts in the form of unpaid invoices to factoring firms to generate the required capital for fulfilling business obligations such as equipment financing, paying of workers, or even repaying of some other debt.
When a business has a significant amount of invoices, it could contact a factoring company for them to be evaluated. What factoring firms do is to determine the likelihood of repayment of the debt. It is how likely the debt is to be repaid that determines how the debt invoice is factored. In most cases, factoring firms offer cash equivalent to 80 to 90 percent of the value of the invoice. One agreement has been reached between a factoring firm—the sort that is entered into between Merchant lenders and small business owners—the factoring firm becomes responsible for collecting the debt.
Although invoice factoring is one way of getting working capital without recourse to commercial banks, it has some limitations. The most significant barrier to invoice factoring is that a business cannot get more than the value of its invoices as loan even though it might require it. Another problem with invoice factoring is that it is not exactly that easy to obtain. And even when one finds a factoring firm nowadays the factor rate for the loans can be quite low since most of the debts might be very old.
Merchant lenders, on the other hand, provide cash advances that are almost always beyond what a business could obtain through invoice factoring. Also, merchant cash advance could well be the cheaper option. Having looked at two of the other most popular sources, it is time to take a closer look at merchant cash itself.
A closer look at Merchant Cash Advance
There has always been controversy surrounding merchant cash advance and Merchant lenders partly because they have been widely misunderstood. Merchant cash advance is a form of alternative funding in which a business sells a portion of its future credit card sales in exchange for a lump sum of cash which it is meant to receive in the shortest possible time.
Merchant cash advance in this regard is primarily a commercial transaction which involves two businesses. And because it is a commercial transaction involving two enterprises, laws that govern business to customer relations do not apply, although such laws as the uniform commercial code and the fair credit reporting act are well compatible here with the operation of merchant cash advance.
Indeed the entire merchant cash advance industry is unregulated by both the federal and state governments. And efforts to get the government to shine their searchlight on the activities of the sector have often proved abortive. As it is, the industry remains unregulated. In spite of this, Merchant lenders have general rules and conventions which guide their operations.
How is a merchant cash advance different from a loan?
As should already be apparent, a merchant cash advance is not a loan and is not structured as one even though both a loan and an advance serve the same purpose of making capital available to businesses, capital which has to be repaid at some time in the future. But in the case of a cash advance, there is no fixed time frame for repaying the advance.
As such there is no such thing as punishment for late payment nor are there rewards for early payments. If for example, the merchant chooses the fixed percentage method of payment—one in which the actual amount paid to the merchant provider varies but the percentage remains fixed—the time it would take to pay up the loan will depend on the level of sales for the given period.
When the sales are higher, the actual amount that is remitted to the merchant cash advance provider is higher; but when sales plummet, the exact amount paid is smaller. On the other hand, the method of fixed amount ensures that a particular amount is remitted to the merchant cash advance provider on a daily basis regardless of the prevailing business conditions. Merchant lenders have often noticed that the vast majority of borrowers seem to favor the method of a fixed percentage. Whatever the option the business chooses it is quite clear how an advance differs from a loan.
How merchant cash advance is processed and the benefits it offers
The main elements of a merchant cash transaction are factor rate, withholding percentage and the total payback amount. A factor rate is a number usually less than 1.5 which is used to multiply the actual cash advance to obtain the total payback amount which is what the business pays in return.
The essence of the factor rate is accounted for the discounted sale of the future receivables of the business. Once all of the following has been agreed on, Merchant lenders proceed to issue businesses with the advance. Upon receiving the advance, arrangements are made with the credit card processor of the business for the agreed portion of daily sales to be automatically remitted to the merchant provider. The daily payments are made to the cash provider until the advance has been repaid and then the merchant lender loses its entitlement to the future receivables of the business.
The benefits that come from utilizing merchant cash advance are quite numerous. Some of them have been discussed at an earlier stage. But, the one seems to stand out the most is that of collateral and credit score. True, Merchant lenders do not require collateral or personal guarantees neither do they require businesses to have a good credit score before they can be issued with loans.
These two factors alone have drawn several business owners who had been rejected by commercial banks to merchant cash advance. At the moment, small business owners consider merchant cash advance first and do not even waste time seeking bank loans. And, although there is still some skepticism regarding merchant cash advance, all factors indicate that the industry is on a growth path—one that cannot be reversed.