have a confession: Until recently, I had no real understanding of the merchant cash-advance business. I suspect like many others both inside and outside the payments space, I viewed merchant cash advances as something akin to payday loans.

I was wrong. Merchant advances aren't predatory (the big complaint about payday loans). That is, unless the company providing the advance has less than honorable intent. Rather, cash advances seem to be a viable funding option for small businesses to access working capital by leveraging future credit card sales.

I came to understand this last month while touring the headquarters of AdvanceMe Inc., a merchant cash advance company based in suburban Atlanta. AdvanceMe says it has made 30,000 such advances worth an estimated $600 million since opening for business in 1998.

"This is a purchase and sale of goods," said Glenn Goldman, the company's Chief Executive. "It's not a loan."

AdvanceMe is one of about a dozen companies in this space today. While specific policies and processes may differ, the basic model transcends individual corporate structures.

When bank loans aren't an option

Here's how it works. Say a restaurant owner wants to add a dining room. Lacking a strong business track record and necessary collateral, however, bank loans aren't an option.

"These folks may not have the kind of collateral a bank is looking for," Goldman said. "But many are able to demonstrate that they can generate credit card sales, and that's what we're looking at."

Merchant cash advances get repaid through deductions from future credit card sales. Let's say, for example, that a restaurant owner needs $20,000 for improvements. In exchange for that money upfront, the restaurateur agrees to let the cash-advance company, working in tandem with the merchant's card processor, deduct funds from future credit card sales.

Payments are made only when the restaurant generates credit card sales. No credit card receipts means no payments to the funding company.

For the sake of illustration, let's say the agreed-to payback amount on the $20,000 advance is $25,000, and the restaurateur agrees to cover that amount by earmarking 5% of credit card sales for the cash advance company. From that point on, the card acquirer/processor diverts 5% of all credit card sale deposits earmarked for the restaurant's bank account to the cash-advance company.

The benefits for small to mid-sized merchants seem obvious enough. Strapped for cash, many can't qualify for bank loans.

A recent survey of small businesses by AdvanceMe's parent company Capital Access Network Inc., for example, found 90% considered traditional bank loans appealing.But only one in four of these businesses actually ever apply for loans.

Expanding inventory or, in the restaurant's case, adding tables should bring in more money, so the reduction in credit card deposits should be indiscernible.

The acquirer/processor benefits, too. When merchants take a cash advance, one of the key requirements is that they continue to process card transactions with the company that routes payments to the cash advance provider.

Goldman, for example, noted average funding from AdvanceMe takes a merchant between eight and 10 months to pay off. Even more impressive, he said upward of 80% of businesses taking cash advances from the company qualify for future advances.

For ISOs and merchant level salespeople (MLSs), this is yet another product to add to their slate of merchant offerings.

Things to consider

Plenty of companies offer merchant cash advances tied to credit card receipts. And as with any business sector, some are more experienced, and some use more sophisticated technologies and procedures than others.

So here are some things to consider when thinking about partnering with one of these firms to offer merchant customers cash-advance services. It's not a comprehensive list, but it should provide a good start.