Business Merchant Loans for Startups and New Businesses

You made it happen. You stopped dreaming and launched. An LLC was filed, an logo designed, initial customers trickling in. Until reality sets in,  you need initial funding beyond what you anticipated. Equipment budgets bust, inventory isn’t moving from the shelves, or that "last minute" deal requires cash now.

You hurry to the bank with excitement, only to be greeted by the familiar roadblock: “We’d love to help, but you’ll need to show at least two years of business history.” For startups, in order to obtain the funds to create the track record the bank needs to advance the funds, you need the funds to create the track record.

This is where Merchant Cash Advances (MCAs), among other alternative sources, takes over, offering what amounts to a lifeline for businesses too young for loan applications. However, is it a wise choice or a slippery trap? Here’s the truth.

Why Banks Pass on Startups

It’s not that banks are being unkind; it’s that they’re being prudent. The numbers are not pretty:

• About 20% of start-ups fail in the first year, and half never make it past five years.” 
• To a lender, when a start-up doesn’t have hard cash flow, an established credit record, or collateral, it’s more a roll of the dice than a safe loan.”

Bankers seek tax returns, sound financials, consistent cash flow, and, better yet, profitability. Your business being six months old means you lack those qualities, irrespective of your brilliant concept or your ability to make a compelling pitch.

This can be quite an obstacle because that is where the pressing demand for capital is often found, to be sustained while transitioning from traction through growth phases.

The Merchant Advance Appeal for New Businesses

• Merchant cash advances operate under a very different set of principles than banks do. Rather than pursuing two years of tax returns, MCA lenders examine what is currently going on. Are customers making purchases? Are Visa sales occurring? Is cash being generated?
• Credit card sales of $30,000 monthly for an online business or daily sales from your food truck can qualify you for MCAs if banks are unwilling to lend. Approval requires your bank statements from the previous three to six months and your monthly sales at present. If you are producing sales, sometimes you can qualify even if you don’t have business experience.
• Speed counts. Startups have tight time frames. You may identify an opportunity to purchase a bulk order with a discount of 40% or a competitor's store may vacate. It may be too late depending on the waiting time to seek approval from your bank. With an MCA, you will be operational in as little as 24 to 48 hours.

The Real Cost of Quick Capital

• “The hard truth? MCAs are costly,” as compared to bank lending, which may charge interest rates of 7% to 10% while MCAs employ a rate called the factor rate, usually between 1.2 to 1.5, equivalent to a yearly rate that exceeds 40%
• For example, you might borrow $25,000 on a 1.4 factor rate, then repay $35,000, borrowing $10,000 for the convenience of quick cash. Such fees tighten up fast in a new business where the profit margins are slim and the cash flow uncertain.
• The payments are made daily or weekly, so money is constantly going out of your accounts. This is different from a loan, whereby money is going out monthly, but here you see money going out daily.

When MCAs Make Sense for Startups?

Despite the high cost, the MCAs are not always flawed when it comes to new businesses. They actually have their place in the following situations:

• Hard Return on Investment: If you invest $25,000 in inventory, which results in another $50,000 in sales in two months, the advance might pay for itself. Crunch the numbers brutally before borrowing.
• Exhausted better options: What have you tried: Personal savings, friends and family, crowdfunding, small business grants, microloans, SBA microloans? These should be first. MCAs should be the last resort."
• Runway to profitability: If you are on the verge of becoming profitable and all you need is a little time, it may be the right kind of advance for you. Be truthful about your situation; taking out a loan to postpone the inevitable isn’t going to help.
• Building towards traditional financing: Apply the money from the MCA to build a revenue history and business credit that will qualify you to better terms in six to twelve months. Plan your exit strategy.

Better Choices for the Intelligent Consumer

Before committing to merchant advances, exhaust these options:

Business credit cards offer revolving credit with potentially lower costs if paid responsibly. Microloans from nonprofits like Kiva or community development financial institutions provide smaller amounts with better terms and mentorship. Equipment financing allows you to finance specific purchases using the equipment as collateral. Revenue-based financing provides capital repaid as a percentage of monthly revenue, similar to merchant advances but often with better terms. Angel investors or venture capital might be appropriate if you're building something scalable.

The Startup Reality Check

Not every company needs to be in business, and not every company that needs to be in business needs to raise funding immediately. If you fail to qualify for decent funding, it could be an indication that the market sees your company as requiring more traction, more models, more bootstrapping, et cetera. MCAs can be helpful for startups; however, they are expensive resources requiring due respect. These instruments must be wisely used as part of a larger strategy that incorporates loan repayment and graduating to better sources. The future is at stake when securing funding.