If you’re having trouble getting approved for a traditional loan, merchant financing can provide you with the funds needed to cover daily expenses or other funding needs. It is typically easier to get and rarely requires any additional collateral since your sales are considered collateral for the loan. Additionally, since repayments are often calculated based on a percentage of your future sales, it can be beneficial from a cash flow perspective.
However, it is generally much more expensive than other loan types and may not provide as many features or flexibility. As such, I recommend considering the pros and cons of merchant financing before signing on the dotted line.
| Pros of Merchant Financing | Cons of Merchant Financing |
|---|---|
| Results in zero equity loss in the company | Is offered by few traditional lenders, who can be difficult to find |
| Allows for lower payments in lower-revenue business cycles | Is very expensive |
| Is easy to get approved for | Has limited flexibility in payment terms |
| Offers fast funding speeds | May not help build business credit |
| Doesn’t require a personal guarantee or collateral | Is typically less ideal for low-revenue businesses |
Pros of Merchant Financing
If you are in a tough spot financially and need funding for business expenses, merchant financing can be a good option. Funds obtained can typically be used for any business-related item, such as working capital, payroll, inventory, and utility costs.
1. Results in Zero Equity Loss in the Company
Merchant financing can come in different forms, such as revenue-based financing or a merchant cash advance (MCA). Regardless of which form you choose, you will rarely be required to give up any equity in your company. By comparison, some other forms of funding require you to give up a small percentage of ownership in your business.
Venture capital, angel funding, and funding from friends and family are three such examples. If you’re considering these sources, be aware that even a small percentage of equity given up now could mean a significant amount of future earnings—especially if your company continues to grow and expand. This is especially true for companies considering venture capital, as it’s typically best suited for fast-growing companies.
As such, while these other funding sources may be appealing in the short-term, remember that they could result in a substantial loss of revenue in the long run.
2. Allows for Lower Payments in Lower-revenue Business Cycles
Merchant financing repayments are typically based on a percentage of a company’s sales. As a result, payment amounts are less likely to cause undue financial burden for the business. Months with lower revenue figures will result in lower payment amounts—and while months with more revenue will have larger payments, the profit recognized should still make it affordable for the company.
Let’s take one example of merchant financing. An MCA is typically structured such that payments are determined by a percentage of your company’s future credit card sales. Although less common, MCAs can also be structured such that payments are fixed, determined by your company’s historical earnings. Regardless of which method is used, you can rest easier knowing that you will not be locked into a high payment you may be unable to afford.
3. Is Easy to Get Approved For
Merchant financing is typically easier to get approved for than traditional loans. There’s typically no credit score requirement, and criteria for time in business and annual revenue figures are generally much easier to satisfy.
Since MCAs and revenue-based financing are two common forms of merchant financing, I’ve provided a quick comparison table below of how the qualification requirements compare with a traditional working capital loan.
Typical Merchant Cash Advance | Typical Revenue-based Financing | Typical Working Capital Loan | |
|---|---|---|---|
Credit Score | None | None | 620+ |
Time in Business | 6 to 12 months or more | 6 months or more | 6 to 24 months |
Annual Revenue | $30,000+ | $360,000+ | $100,000 to $250,000 |
Collateral | Not typically required | Not typically required | Sometimes required |
Personal Guarantee | Not typically required | Not typically required | Sometimes required |
4. Offers Fast Funding Speeds
Some forms of merchant financing, such as an MCA, can offer funding in as little as 24 hours. Other forms of financing, by comparison, can take several days to weeks to get approved and funded.
Merchant financing is typically fast due to the nature of the financing. Companies offering merchant financing know that their clients are likely in a cash crunch and in desperate need of money on a short timeline. As such, many of these companies streamline their processes to allow for quick turnaround times on approval and funding.
Outside of merchant financing, approval and funding speeds are dictated by a wide range of factors. This can include the type of loan you’re applying for, the lender providing the funds, and the complexity of your company’s finances.
5. Doesn’t Require a Personal Guarantee or Collateral
Merchant financing almost never requires a personal guarantee or additional collateral, something that can help minimize losses and protect your personal assets in the event of a default.
Personal guarantees and the requirement to pledge collateral may be needed for other types of financing if a lender deems it necessary to reduce the risk of lending money to a borrower or business.
With a personal guarantee, a lender has the ability to go after a business owner’s personal assets to recoup losses in the event of a loan default. This can include taking possession and ownership of things like vehicles, equipment, and real estate. Pledging collateral for a loan works similarly but limits the lender to taking only specific item(s) specified in the loan agreement.
Cons of Merchant Financing
Although merchant financing can be beneficial, it also carries some downsides. For starters, it’s a type of financing that can be difficult to find. The associated rates, terms, and costs also mean it’s only suitable for certain types of businesses.
1. Is Offered by Few Traditional Lenders, Who Can Be Difficult to Find
Regardless of whether it comes in the form of a revenue-based loan or an MCA, not all lenders offer merchant financing. This is partly due to the fact that some lenders consider it a non-traditional lending product with a low number of clients that would be interested in getting it.
It is also partially due to the fact that it’s generally considered a higher-risk loan to issue, given that it can be considered a last resort for companies unable to qualify for traditional means of financing due to bad credit or poor financial performance.
2. Is Very Expensive
Merchant financing is often much more expensive compared with traditional forms of financing. To illustrate this, Annual Percentage Rates (APRs) can be in excess of 100%. The most expensive traditional loans, by comparison, will generally still remain under a 40% APR.
Fees are often charged in the form of a factor rate rather than a traditional interest rate. For this reason, it can be difficult to understand just how expensive merchant financing, such as an MCA, can be.
Factor rates reveal the total amount that must be made. A factor rate of 1.20x on a loan amount of $100,000, for example, means that a total of $120,000 would have to be repaid. Considering the short-term nature of MCAs and the fact that no prepayment discounts exist, it’s easy to see why we recommend MCAs as an absolute last resort for financing.
3. Has Limited Flexibility in Payment Terms
Repayment for merchant financing is typically based on a percentage of either your past or future sales. Beyond this, there is rarely any flexibility to change loan terms, such as the length of the loan, frequency of required payments, or payment amounts. Other loan types, depending on the lender, may allow for customized payment schedules, including deferred payments for a short period.
4. May Not Help Build Business Credit
Depending on the lender you choose and the type of merchant financing you select, your business credit may not be positively impacted even if you pay back the funds in a timely manner. Since merchant financing is typically used as an option for companies unable to qualify for traditional and more affordable means of financing, this can result in a continuous cycle of having to borrow from expensive sources.
Loans that help a business build credit, on the other hand, can eventually be used as a tool to qualify for more affordable loan programs.
5. Is Typically Less Ideal for Low-revenue Businesses
Since merchant financing requires repayments to be made from a percentage of sales revenue, many lenders require a sizable amount of historical sales as a minimum requirement for qualification. Revenue-based financing generally requires $30,000 monthly revenue, while MCAs may allow for as little as $30,000 annually.
Even if you do meet the minimum revenue requirements, be aware that since repayments are based on your company’s sales performance, having poor revenue figures means that you’ll be making repayments for a longer period. That’s something that can hinder your future cash flow and take away from your company’s ability to invest in continued growth and expansion.
Alternatives to Merchant Financing
Given the high cost of merchant financing, we recommend considering alternative sources of funding first. Merchant financing should be considered as a last resort if you’re unable to get approved for a loan elsewhere, but knowing the steps involved with getting a small business loan can help improve your approval odds and the chances of getting funding more quickly.
- Term loans: With a term loan, you’ll get a lump sum of funds that can be used for specified business purposes, and many carry APRs between 5% and 30%. Working capital loans are one example of a term loan, and you can view our top-recommended working capital loans for options.
- Small business credit line: A credit line provides flexible access to additional funds on an as-needed basis. Repayment terms are generally short, between 24 and 36 months, but APRs are also generally more competitive than merchant financing. Check out our picks for the best small business credit lines.
- Small business credit card: With this, you can make purchases directly with the account. It’s a good option for small to midsize purchases, as credit limits typically range from $5,000 to $50,000. APRs can be as high as 30% to 40% if you do not pay off the statement balance in full, but it’s still more affordable compared with merchant financing. Our list of the leading small business credit cards can help you find one that fits the bill.
- Home equity loan (HELOAN) or home equity line of credit (HELOC): If you don’t have good business credit or finances but have good personal credit and equity in your home, then a HELOAN or HELOC can be a good option. APRs are often under 10%, but first consider all of the risks involved with using a HELOC to fund your business, as you could lose your home in foreclosure if you default.
Frequently Asked Questions (FAQs)
Merchant financing is a type of financing or funding option that collects payment through a payment processing system based on a percentage of sales. MCAs and revenue-based financing are two examples of merchant financing.
Merchant financing can be very expensive, so we recommend considering it as a last resort if you’re unable to get approved for other forms of financing.
Depending on the type of merchant financing you get, APRs can be over 100%. Revenue-based financing can have you paying 1.30x to 1.80x times the amount of the amount borrowed, while MCAs can have factor rates between 1.10x and 1.50x.
Bottom Line
If your business cannot get approved for a traditional loan, merchant financing can provide the funds needed to cover a wide range of business expenses. Qualification requirements can be easier to meet, and funding can be completed quickly. However, it is an expensive form of financing that may not be suitable for all businesses. Before signing on the dotted line, consider merchant financing pros and cons as well as alternative loan options.
