Merchant Financing: Is It Right for Your Business?

Business owners face funding challenges every day. If your business involves a storefront or accepting payment via credit card, then merchant financing could be the right funding opportunity.

It’s an especially useful choice if you need to cover an unexpected expense or fuel your business’ growth. But typically expensive terms make it not the right fit for every business.

Key Points:

• Merchant financing involves funding solutions for business owners with a storefront of some kind. 
• Merchant financing is an umbrella term for all funding types that require automatic collection from your credit card sales. 
• In many cases, merchant financing is used interchangeably with merchant cash advances. However, merchant financing is technically a loan, while a merchant cash advance is an advance. 

What Is Merchant Financing?

Merchant financing is a loan solution for business owners with a storefront. Typically, a merchant includes any business that is regularly accepting credit card payments.

• Merchant financing is a broad term to describe all loan options for business owners with a storefront.
• But most commonly, merchant financing refers to a loan repaid through automatic collection based on credit card sales for a storefront. 

How Is Merchant Financing Different from a Merchant Cash Advance?

Merchant financing is often used to describe merchant cash advances. However, there is a difference between merchant financing an merchant cash advances.

• Merchant financing: An actual loan that the business repays. 
• Merchant cash advance (MCA financing): A lump sum advance based on repayment with a fixed percentage of credit and debit card sales. Essentially, a company provides an advance to purchase a percentage of your sales. 
• The difference: On the surface, merchant financing and merchant cash advances are very similar. But the major difference is that a merchant financing solution is technically a business loan. That’s different from a cash advance which is actually a purchase of your future credit and debit card sales. 
• Why it matters: Although the repayment is structured in a similar way, the fact that merchant financing is a loan comes with benefits for the business owner. Typically, merchant financing is more affordable than a merchant cash advance.

How Does Merchant Financing Work? 

Merchant financing is based on several factors. But one of the most important metrics is your credit and debit card sales. The lender will set up a system to collect a percentage of your credit card transactions.

• Credit and debit card transactions are key: When a customer pays by card, a set percentage of the sale will go directly to the lender. The payments will continue daily or weekly until the loan is repaid. 
• Payments fluctuate: Since repayment is based on a percentage of your sales, you’ll pay more on some days than others. If business is slow or you take a day off, you won’t have to worry about meeting a specific payment threshold. 

How Much Merchant Financing Can Business Owners Get?

The amount of merchant financing you can get varies. You can generally expect to find merchant financing opportunities between $2,500 and $250,000. But with some lenders, you can find financing for up to $2 million.

However, the volume of credit and debit card sales that your business produces will greatly impact the amount you can borrow. After all, lenders want to ensure they’ll get their money back within a reasonable timeframe. 

What Can You Use Merchant Financing For?

When you receive the loan, you can spend it on anything business related. A common few uses for the money include:

• Purchase inventory
• Hire employees
• Renovate your storefront
• Launch a new marketing campaign
• Purchase new equipment

What Interest Rates and Fees Are Charged On Merchant Financing?

Merchant financing doesn’t come with a regular APR. That’s because the lender has no way of knowing how long it will take for you to repay the loan based on the unique structure. So, you’ll find factor rates attached to merchant financing options.

• Factor rate: A factor rate indicates how much the loan will cost, regardless of the amount of time it takes to repay it. Factor rates often mean more expensive financing costs. 
• Origination fees: Some merchant financing options come with an origination fee. 
• Cost: Merchant financing isn’t very affordable. Factor rates can translate into triple-digit APRs. But it can help you get your hands on the funds you need. 

How Do You Repay Merchant Financing?

Merchant financing is a loan. Here’s how the business owner repays the loan:

• Holdback: A holdback is the percentage of daily credit and debit card sales that must go towards loan repayment. Generally, the holdback percentage is between 10% and 20%. 
• Automatic repayment: On a daily or weekly basis, the lender will collect the agreed-upon percentage of sales. 
• Repayment terms: Although there is no specific term, there is often a cap on the amount of time you have to repay the lender. You can find merchant financing options with terms between 6 to 24 months. 

How Do you Determine the Cost of Merchant Financing?

Merchant financing is an expensive way to obtain funds. Before you jump into a merchant financing loan, make sure to run the numbers. Here’s how:

• Consider origination fees: Origination fees occur right off the bat. Check to see if you’ll encounter any upfront costs that the lender might add to your loan amount. 
• Calculate factor rate costs: Let’s you receive a 6-month loan with a factor rate of 1.25. With that factor rate, you’d need to pay back $12,500 if you borrow $10,000. 
• Convert the factor rate into an APR estimate: We are used to looking at loan costs in terms of APR. Converting the number into an APR can help you make a more informed decision. Start by determining the total cost of the advance. In our example above, the cost of the advance is $2,500. Next, divide that cost by the advance amount, or $2,500 by $10,000 for a percentage cost of 0.25. Finally, multiply that number by 365 and divide the product by the total days of the loan term. In this case, you’d multiple 0.25 by 365 to equal 91.25 and divide that by 180 days to obtain an APR of 50.69%. 

What Do You Need to Secure Merchant Financing?

Like other loan types, you’ll need to qualify for merchant financing. The exact requirements vary based on the lender. But here are some of the basic requirements to expect:

• Payment methods: Must allow customers to pay by credit card.
• Business criteria: Must be open for at least one year with an annual business revenue of at least $50,000. 
• Provide documents: Must provide driver’s license, voided check, bank statements, personal credit score, and business tax returns. 

Which Lenders Offer Merchant Financing?

Merchant financing isn’t available everywhere. But a few options include:

• American Express
• PayPal
• Square
• Rapid Advance

Pros and Cons of Merchant Financing

Merchant financing has advantages and disadvantages. Here’s what you need to know. 

Pros of Merchant Financing

• Relatively easy to qualify for: The main piece of the puzzle is your credit card sales. 
• Automatic repayment: You won’t have to keep up with the payments because it’s an automatic transaction. 
• Lower daily payments: Instead of making a big payment once a month, you’ll make smaller payments every day. The fluctuations can help you manage cash flow more efficiently. 

Cons of Merchant Financing

• Frequent payments: Frequent payments can be a drain on your business. 
• Large repayment amounts: Depending on the factor rate, you’ll have a big debt to repay. 
• Short repayment terms: The daily repayment amount is flexible. But you’ll need to repay the entire amount within a short loan term. 

Is Merchant Financing Right for My Business? 

Merchant financing isn’t the right fit for everyone. But it’s a valuable financing strategy for some.

• When it makes sense: If you have a specific short-term funding need with ample revenue to support the high fees of a merchant financing arrangement, then it could be the right move. 
• When it doesn’t make sense: If you aren’t comfortable with the short terms and high fees, then consider other financing opportunities. Also, it won’t work if a deeper business issue is at the root of your cash flow problems. 

How to Apply for Merchant Financing

Decided that merchant financing is right for you? Here’s how to apply:

• Research lenders: Comparison shop for the best terms and rates. You don’t want to overpay!
• Confirm credit card processing requirements: Lenders work with certain credit card processors to make daily repayments seamless. Make sure the lender you are considering is willing to work with your current credit card processing system. 
• Submit an application: Be prepared to provide extensive information about your business credit card sales, credit history, and any other requested documents. 
• Wait for approval: If approved, you can take the money and spend it how you see fit. 
• Start making daily repayments: The daily repayment system is automated. But you should keep tabs on it to ensure everything is running as scheduled. 

FAQs about Merchant Financing

Your questions about merchant financing answered!