Learn about the pros and cons of merchant financing and how to assess an offer. Discover what to consider when using payment processing providers for business loans and whether you should opt for other financing options.
Questions Answered in this Article
- What is merchant financing, and how does it work? Merchant financing is a loan provided by payment processing providers, such as Stripe, Square, and Shopify, to selected merchants using their platforms. These loans are usually based on the merchant’s sales history or an invitation to apply. The loans are repaid by taking a percentage of the merchant’s revenue until the debt is fully repaid, along with a fee.
- What should you consider when assessing a merchant financing offer? When assessing a merchant financing offer, you should consider the following questions: what will you use the cash for? How will you repay the loan? How much will the loan cost? Do you qualify for other products? Are you in an emergency?
- How is the repayment structure for merchant financing different from traditional loans? The repayment structure for merchant financing is different from traditional loans. With cash advances and revenue-based loans, the repayment structure is based on a percentage of the merchant’s sales until the balance is fully paid off, rather than a fixed monthly payment. The merchant must generate sufficient revenue to cover the loan payments while managing other expenses.
- Are there other financing options available for businesses besides merchant financing? Yes, there are other financing options available for businesses besides merchant financing. For instance, businesses with at least six months of steady sales, strong credit, or specific collateral can look for more affordable financing. Online lenders may be a good starting point since they usually have more flexible requirements than banks or community development financial institutions.
- What should you do if you are facing an emergency with your business and need financing? If you are facing an emergency with your business and need financing, it’s crucial to exercise caution before taking on any additional debt. Instead, you should look closer at your business and identify ways to reduce expenses. It’s also essential to seek advice from someone knowledgeable about finances before making a final decision.
Financing Your Business Through Your Payment Processor: What You Need to Consider
Nonbank lenders have offered business loans for several years now. Your payment processing provider might be the next one to provide you with a loan.
Several companies, such as Stripe, Square, and Shopify, finance selected merchants using their platforms. Usually, they offer you a loan based on your sales history or invite you to apply for one. These loans are repaid by taking a percentage of your revenue until the debt is fully repaid, along with a fee.
These loans can be helpful for smaller, newer businesses that still need to be eligible for traditional loans. However, merchant financing typically comes at a higher cost than other alternatives.
To assess an offer, consider the following questions.
Understanding the Use of Funds in Merchant Financing Offers
When seeking a business bank loan, it is typically required to provide a comprehensive explanation of how the loan funds will be utilized. Similarly, it is advisable to follow the same protocol when presented with a merchant financing offer, according to Mike Luebbers, the Chief Credit Officer at Novel Capital.
Luebbers suggests that when obtaining capital, whether through debt or equity, you should understand precisely how the funds will be used, the anticipated return on investment, and the timeframe for the return.
Generally, merchant financing is most appropriate for investments that will enhance future revenue, such as purchasing inventory to stock up for a bustling holiday season.
For instance, Lewis Weil, the founder and investment advisor at a financial planning firm called Money Positive in Austin, Texas, has turned to this financing method to help defray the expenses of recruiting and onboarding new employees.
He explains that the company needs money while an employee is being trained, acknowledging that the individual undergoing training will generate revenue in the future.
Repayment Plan for Merchant Financing: What You Need to Know
What is your plan for repaying the loan? With cash advances and revenue-based loans, the repayment structure is based on a percentage of your sales until the balance is fully paid off rather than a fixed monthly payment. You must generate sufficient revenue to cover the loan payments while managing your other expenses. Your profit margins must be substantial enough or have the potential for future growth to cover the loan expenses. According to Luebbers, if the cost of the loan exceeds the expected benefits, you may have better loans. It’s essential to be cautious and make realistic projections since one potential risk of cash advances is taking on more debt than you can handle and accumulating additional debt to keep up.
The Cost of Merchant Financing: How to Evaluate the Total Loan Cost
What is the cost of the loan? Unlike traditional loans, cash advance lenders charge flat fees instead of annual percentage rates. This means the higher the revenue you generate, the faster you can pay off the loan. However, technically, the interest rate on your loan will also increase. According to Manasa Gopal, an assistant professor of finance at Georgia Tech’s Scheller College of Business, it can be challenging to compare the APR of one loan with the factor rate of another.
When converted to APRs, merchant cash advances are more expensive than other financing options. You can use an online merchant cash advance calculator to understand your loan’s total cost better. Gopal warns that since these products are relatively new, business owners may need help understanding the terminology and could potentially make uninformed decisions.
Merchant Financing vs. Other Financing Options: What You Qualify For
Are you eligible for other financing options? Merchant financing may be attractive to newer businesses, with some lenders, such as PayPal Working Capital, offering loans to merchants with as little as 90 days of history on their platform. In contrast, traditional banks generally require borrowers to have at least two years of business experience.
According to Gopal, “This is where some of these new products have made headway— giving access to borrowers that would potentially not be able to get alternative sources of financing.” However, she emphasizes that “these are still very expensive at the end of the day.”
You should consider looking for more affordable financing if you have at least six months of steady sales, strong credit, or specific collateral. Online lenders may be a good starting point since they usually have more flexible requirements than banks or community development financial institutions and are often more willing to work with newer, smaller businesses.
Emergency Financing: What to Consider Before Taking on Additional Debt
Are you facing an emergency with your business? If so, it’s crucial to exercise caution before taking on any additional debt. Instead, look closer at your business and identify ways to reduce expenses.
It’s essential to be aware that if you opt for merchant financing and cannot make timely repayments, your lender may increase the percentage of your sales taken as repayment and even withdraw funds directly from your linked bank account.
Weil advises speaking with your bookkeeper or financial planner before accepting any financing offer, especially if your business is struggling. She also cautions against making hasty decisions when in a state of panic. It’s best to step away from the situation, reflect, and seek advice from someone knowledgeable about finances before making a final decision.
Summary
- Payment processing providers like Stripe, Square, and Shopify offer loans to selected merchants using their platforms.
- These loans are repaid by taking a percentage of the revenue until the debt is fully repaid, along with a fee.
- Merchant financing is most appropriate for investments that will enhance future revenue, such as purchasing inventory to stock up for a busy season.
- Repayment structure of merchant financing is based on a percentage of sales until the balance is fully paid off rather than a fixed monthly payment.
- The cost of merchant financing is more expensive than other financing options when converted to APRs.
- Merchant financing may be attractive to newer businesses, but it’s essential to look for more affordable financing if you have at least six months of steady sales, strong credit, or specific collateral.
- It’s crucial to exercise caution before taking on any additional debt in case of an emergency.
- It’s best to seek advice from someone knowledgeable about finances before making a final decision.
