What is a Merchant Cash Advance?

In this article we will attempt to explain what a merchant cash advance is and how it functions within a typical YieldStreet offering.

What is a Merchant Cash Advance?

Merchant cash advances provide short-term lump sums of working capital to a business for a specific and immediate need. In return, a business pays a percentage of their future sales for the security of an instant cash injection.

Merchant Cash Advances vs. Traditional Bank Loans
A business can apply for and receive funds from a merchant cash advance company within a few days, versus a bank loan, which can take a few months. The application process for a merchant cash advance is significantly less burdensome than it is for a bank loan. Unlike the process for Purchase Order Financing or Invoice Factoring, a merchant cash advance company will look for sources that show a business’s cash flow, like recent bank, sales volume and credit card statements. A bank loan would rely more on credit history and hard collateral.

The way in which a merchant cash advance gets paid back differs significantly from a traditional loan, which requires monthly or scheduled interest or principal payments. In a merchant cash advance, a predetermined percentage of the company’s daily sales is paid back to the merchant cash advance company on a daily basis until the purchased amount is fully repaid. The percentage that the merchant cash advance requires to be returned daily is called the holdback percentage

How is the Factor Rate Calculated?
The interest a business pays on a merchant cash advance is calculated differently from a traditional loan. Interest rates tend to be higher because of the short-term nature of the advance and the added risk the merchant cash advance company is taking on with an advance. If a business is looking for an advance of $10,000, the merchant cash advance company may use a factor rate of 1.20x, and would require a final purchased amount of $12,000 to be repaid. The rate is always presented as a factor rate as opposed to a percentage – in this case the factor rate would be 1.20x.

Here’s a Hypothetical Example of How it Works:
Tahoe Charlie’s is a hardware store located on the banks of Lake Tahoe in quiet Truckee, California. Watching the news one day, the store’s owner, Charlie, learns of a Polar Vortex heading right for Truckee with estimates of 3-4 feet of fresh powder. Tahoe Charlie’s is the only hardware store in town and Charlie anticipates a huge ramp-up in sales next week in preparation for the storm. He wants to buy more shovels, salt and snow blowers but unfortunately, Charlie doesn’t have enough money in his bank account at the moment to purchase extra supplies from his wholesaler.

Rather than turn to a bank for money (which could take months to approve a loan) he reaches out to a merchant cash advance company for an immediate source of funds.

The merchant cash advance company, Squaw Capital, analyzes a handful of financial information from Tahoe Charlie’s (recent credit card statements, bank statements, business records, etc.) as well as information on Charlie himself (number of credit lines, FICO score, public records) and determines that they can advance the $10,000 Charlie needs to purchase goods from his wholesaler.

  1. Squaw Capital will advance Tahoe Charlie’s $10,000 request at a factor rate of 1.20x, meaning that the final purchased amount Tahoe Charlie’s will pay Squaw Capital will be $12,000.
  2. The $10,000 is transferred to Tahoe Charlie’s bank account which Charlie uses to immediately purchase all the supplies he needs.
  3. Squaw Capital and Charlie agree to a holdback percentage, of 30%, meaning that 30% of Tahoe Charlie’s daily sales will go back to Squaw Capital every day until the entire $12,000 is repaid.

Where Your Money Goes in a Merchant Cash Advance Offering
When participating in a merchant cash advance offering, your money goes directly to an originator (in this case a merchant cash advance company) that typically advance money to hundreds of businesses at the same time. The different advances are diversified in cross-collateralized portfolios and categorized based on business type, risk profile and some of the terms discussed earlier, like factor rate and holdback percentage.

Why We Like Merchant Cash Advance Offerings
Merchant cash advance offerings are short in duration (typically 3-12 months), and have low stock market correlation.

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