The Green Sheet Online Edition
April 25, 2016 • Issue 16:04:02
The merchant cash advance
I want to begin this article by reiterating that I believe the time when the field of merchant services is based on actually selling merchant services is coming to an end. As detailed in my inaugural Street SmartsSM article, I believe the future of the merchant level salesperson (MLS) will be to rebrand as something totally different.
To remain competitive, MLSs must find ways to integrate multiple areas of merchants' businesses into creative, new solutions, so MLSs can bring in multiple revenue streams with one sale. Merchant services or merchant processing will no longer be a direct lead in for the sales process. Instead, it will be a part of the value-added package of whatever new solutions MLSs choose to sell.
The MCA product
Since I've been selling merchant cash advance (MCA) since November of 2009, I will begin the rebranding discussion with the MCA product. In this case, MLSs would rebrand themselves as alternative financing specialists. In researching the market challenges of small businesses, they will discover that many such businesses have issues in raising working capital based not on any derogatory credit or financial situation, but based on the fact that they are small businesses in general.
Many small businesses need business financing of only $25,000 to $40,000, and many banking institutions do not feel that the costs of underwriting warrant such small requests when they could invest their resources in underwriting loans in the $250,000 to $1 million range.
An MCA is the purchase of future credit card receivables using a factor rate, or cost factor, which is multiplied by the amount borrowed to determine the amount to pay back. There are no interest rate calculations, annual percentage rates (APRs), origination fees, fixed terms nor fixed payments associated with MCA transactions. As a result, if a merchant tries to calculate the "APR of the MCA," you should immediately inform the merchant that this is a different alternative financing transaction, and interest rates are not applicable to said arrangement.
With the MCA, you will have a purchaser (the MCA company) and a seller (the merchant), with said seller looking for working capital tomorrow and said purchaser looking to make a sizeable return on investment by advancing capital to the seller.
For example, the purchaser would take a look at a merchant's previous credit card processing statements and note that the business has been doing $25,000 a month in Visa and MasterCard processing volume over the previous 12 months. So the purchaser would propose to the merchant, "How about I buy $25,000 of your credit card processing receivables in exchange for advancing you $20,000 tomorrow? To collect my purchase of the $25,000 credit card processing receivables, how about I keep 15 percent of your monthly Visa and MasterCard processing volume going forward until the full $25,000 is collected?"
In this example, the MCA deal would be quoted to the merchant as follows:
- Approval: $20,000
- Factor rate: 1.25
- Total payback: $25,000
- Holdback: 15 percent
As long as the merchant continues to process Visa and MasterCard card transactions the same as he or she has done over the previous 12 months, with no slowdown in business volume, and as long as the merchant is not perpetrating fraud, such as running sales through a different terminal than the one programmed with the holdback by the MCA company, then the merchant should complete payment in full in about seven months, give or take.
Main MCA value points
The MCA product is a resource for:
- Alternative capital: The merchant's future credit card receivables become a new asset that they can tap into today for working capital usage.
- Seasonal businesses: The absence of fixed payments and no fixed term works well for seasonal merchants who might not be able to afford fixed payments during slow periods of their business cycles.
- Growth investments: The cost of the product can be high, but so can potential return on growth investments. Let's say a merchant has the opportunity to buy a piece of equipment for $75,000 that will enable the merchant to produce $300,000 in revenue in one year. Let's assume conventional sources aren't available for the capital, and even though leftover profits from the business might be utilized, the business isn't large enough to deploy them for this purpose.
Instead of limiting the growth of the business, the merchant could respond to a call from an MLS to advance $75,000 to the merchant tomorrow, with a cost factor of 1.30 to buy the equipment. The cost factor for the $75,000 advance would be $22,500, which would come right out of the profit of the growth investment, leaving over $200,000 in profit on the table for the merchant before taxes.
- Emergencies: If the merchant has an equipment malfunction or needs to repair a roof, he or she can use an MCA to resolve said issues, and the funds can be available within five business days, give or take, assuming the merchant's conventional sources aren't available, and the profits from the business aren't enough to execute a traditional loan.
Merchant processing tie-in
For the collection procedure (otherwise known as the payback procedure), a merchant can utilize direct split funding that will require the merchant to switch processing to a merchant service provider that partners with the MCA company to split funds for a direct holdback on Visa and MasterCard processing batches.
Alternatively, the merchant could use a lockbox, which is a separate Federal Deposit Insurance Corp.-insured business bank account where transactions will settle into initially, and then settle back into the merchant's bank account within 48 hours after the MCA provider takes its holdback percentage.
As the sales rep, try to get the merchant to switch over the company's processing so you can obtain the additional processing revenue. Explain to the merchant that the lockbox would add one to two days to the time it takes for the merchant to receive processing settlements, whereas switching processors would allow settlements to flow as they normally would.
As I mentioned previously, the MCA involves no APRs or interest rate calculations. However, the MCA has a "cousin" in its alternative financing family tree: the alternative business loan. This product does involve an interest rate calculation, APR, fixed payment, fixed term and origination fee, as well as the side benefit of having a merchant build a positive business credit history. In the next edition of Street SmartsSM, I will continue this discussion on rebranding the MLS by discussing the alternative business loan.
John Tucker is Managing Member of 1st Capital Loans LLC, as well as an M.B.A. graduate and holder of three bachelor's degrees in accounting, business management and journalism. Tucker also has over nine years of professional experience in commercial finance and business development. You can contact him by email at firstname.lastname@example.org or by phone at 586-480-2140.
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