Merchant Financing: What It Is and How to Find It

Will merchant financing work for your business? Understand the costs, compare options and discover alternatives.
Sep 8, 2020

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If you’re on the hunt for a small business loan, you’ve likely come across the concept of merchant financing along the way.

What does it mean? And can it fund your business quickly and affordably?

With this guide, we’ll tackle the concept of merchant financing and all the information you need to know in order to decide if merchant financing is the right move for you.

What is merchant financing?

Merchant financing is exactly what it sounds like—financing for merchants. It’s a blanket term that refers to any business funding that any business with a merchant storefront—and the credit card processing system a merchant storefront typically requires—can fund with.

"Merchant financing" is most often used to refer to merchant cash advances, though this umbrella term can refer to any funding type that collects repayment automatically through your credit card processing system.

How does merchant financing work?

Basically, any merchant financing lender will set up a system for intercepting the money that your business takes in through credit card transactions; and through that system, they’ll take a daily percentage of your transactions as a form of repayment. This will go on until your merchant financing—plus interest—is paid off.

This repayment structure means that on a day when business is good, you’ll be paying more toward your financing. On the other hand, on a day when business is slow, you’ll be paying less toward your financing. Plus, on holidays or any other day when your credit card transactions are a solid $0, you won’t pay any at all.

How will you know how expensive your merchant financing will be if there’s no set repayment length?

Well, because there’s no way to know how long it will take for you to pay off your merchant financing, the cost of merchant financing typically isn’t expressed using the same, time-based APR as other types of business funding. Instead, merchant financing involves factor rates, which are decimal values that express how much your merchant financing will cost overall.

For instance, if you secure merchant financing of $1,000 at a 1.15 factor rate, then you’ll just multiply 1000 by 1.15 to find out that you’ll ultimately have to pay your lender $1,150 for your merchant financing. Though factor rates on merchant financing products might seem daunting at first, they’re actually a pretty straightforward way to see how much your business funding will ultimately cost you.

Merchant financing terms

If the features that merchant financing can offer your business sound like a fit, then it’s time to dive into the logistics before you decide to apply.

Let’s take a look at the terms that merchant financing products typically come with.

Merchant financing loan amounts

Generally speaking, merchant financing can range anywhere from $2,500 to $250,000. However, they can certainly reach past this general range.

By and large, if you’re willing to pay extremely high rates, you can find merchant financing for as much as you need. However, if you’re looking for large loan amounts, we’d suggest looking for funding sources with longer terms and lower rates.

Merchant financing rates

As mentioned, merchant financing rates won’t be expressed with your typical interest rate or APR. Because merchant financing doesn’t come with a predetermined term length, it will come with a factor rate that tells you how much your loan will end up costing regardless of how much time it takes you to pay it off.

Generally speaking, a typical merchant financing product should come with a factor rate from 1.14 to 1.18. However, many sources of merchant financing come with factor rates that are much higher than this. In fact, if translated to a traditional APR, many merchant cash advances’ costs can turn out to be APRs in the triple digits.

What you need to secure merchant financing

Having covered the details on what merchant financing can offer, the next step is to take a look at what you and your business need to offer in order to secure merchant financing.

Let’s take a look at the minimum qualifications typically required in the application process, along with the documents needed to verify them:

  • A personal credit score of at least 500.

  • At least 1 year in business.

  • At least $50,000 in annual revenue.

  • Driver's license.

  • Voided business check.

  • Bank statements.

  • Credit score.

  • Business tax returns.

  • Credit card processing statements.

The advantages and disadvantages of merchant financing

The advantages of merchant financing

Now that the logistics have been described, let’s take a step back to evaluate what all of these details actually mean for you and your business. In order to answer that question, we’ll separate all of the stand-out details about merchant financing into the good and the bad.

To start, we’ll go over what exactly makes merchant financing a good solution for some small businesses’ financing needs.

Here are the 3 main advantages of merchant financing:

Easy to qualify for

First and foremost, one of the main draws of merchant financing is that it is one of the easiest types of business funding for which to qualify. As you saw in the minimum requirements, compared to what the best types of merchant financing generally require of borrowers, this is a pretty accessible funding option.

And that’s just the top tier of merchant financing.

In fact, many merchant financing lenders won’t even consider your—or your business’s—credit history. Because merchant financing repayment will be deducted automatically from your credit card processing system, most merchant financing lenders simply want to see that you’re performing a high amount of credit card transactions.

Automatic repayment

Another big draw of merchant financing is its repayment structure—you’ll never have to worry about missing a payment or having an automatic payment bounce. Your repayment will be credit card revenues that you won’t ever touch—it’s basically intercepted by your lender before it reaches your accounts. As such, you won’t have to worry about late fees or rejected payment fees.

Additionally, this automatic repayment structure that’s simply a daily percentage allows you to repay at your own pace. When business is good, you’ll pay more. When business is slow, you’ll pay less. Simple as that.

Low total cost of capital

Finally, merchant financing, as a short-term form of financing, has one last fundamental advantage it offers small businesses—its low cost of capital.

Because you’re making daily payments toward paying off your merchant financing, you’re more than likely going to pay it off quickly. And lenders know that, so they aren’t charging you large amounts of interest, as your loan will probably reach maturity within the year, if not much quicker.

Long-term financing, on the other hand, will have less frequent, often monthly, payments, and will take much longer to reach maturity as a result. As such, long-term loans will accumulate much more interest and will end up costing you much more in the long run.

With merchant financing, you might be making high daily payments in order to pay off your financing quickly, but you’re ultimately paying less for the financing because of that.

The disadvantages of merchant financing

Now that you know what merchant financing has going for it, let’s round out its review by taking some time to consider its downfalls.

Let’s take a look at some of the reasons that you might hesitate on funding your business with merchant financing.

Payment frequency

Though your payments will ebb and flow with how much business you do each day, they will still happen every single day that you do business.

This means that every single day, a percentage of your business’s revenue will go toward repaying your merchant financing, which can really stifle your small business’s cash flow.

If daily repayments are daunting, try looking into loan options that are repaid through weekly, or even monthly, repayments.

At the end of the day, you’ll need to decide whether you want to prioritize the less frequent payments that long-term financing offers or the lower cost of capital that merchant financing can offer.

Short repayment terms

Though there won’t be a specific repayment term length for your merchant financing, your lender will expect it to be repaid quickly. And the daily percentage of your business’s credit card revenues will be accordingly large.

All in all, if you’re worried about being able to manage large, frequent payments, look into a form of business financing that has a longer term, like a business line of credit or a term loan.

Yet again, you’ll have to make a decision between the lower payments that long-term financing provides versus the lower cost of capital—but much higher payments—that merchant financing often comes with.

Which lenders offer merchant financing

With all the ins and outs of merchant financing laid out at your fingertips, you have all of the necessary information to decide if it’s the right funding fit for your business.

If you like what you see so far, the next move is to consider where you’ll find your merchant financing. While some purely lending-based companies can provide merchant financing, many credit card issuers and processing companies have moved into the market of merchant financing as well. As such, you’ll probably see a lot of familiar names in your search for merchant financing companies. Who knows, you might have come across the term “merchant financing" through a pre-approved deal from a company you already work with in some other capacity.

Here are some of the top companies on the market offering merchant financing:

  • Rapid Advance.

  • American Express.

  • Square.

  • PayPal.

  • Amazon.

And those are just a few of the many companies vying to provide your business an advance for a future percentage of its daily credit card revenues.

Next steps if merchant financing isn’t the right fit

On the other hand, if you’ve gotten all of the information on merchant financing and have decided it’s not the right fit, you’re going to need to think next steps.

Based on merchant financing’s downfalls—like high rates and short terms— we’ve narrowed down some alternative funding sources that address these disadvantages.

Let’s take a look at two types of funding that are often much more affordable than merchant financing.

A low-rate alternative to merchant financing: Short-term loans

First, look into a go-to alternative to merchant financing, the short-term loan.

Just like merchant financing, the short-term loan is relatively easy to qualify for and comes with a pretty low cost of capital.

That said, short-term loans often come with lower rates, along with weekly—instead of daily—payments.

Here are the details on this merchant financing alternative:

Terms for short-term loans

Generally speaking, short-term loans come with the following ranges of terms:

  • Loan amounts from $2,500 to $250,000.

  • Repayment term lengths as short as 3 months and as long as 18 months.

  • Interest rates that start as low as 10%.

Requirements for short-term loans

In order to access short-term loans, borrowers will generally need to fulfill the following minimum requirements:

  • A personal credit score of at least 550.

  • A minimum of 1 year in business.

  • At least $50,000 in annual revenue.

Additionally, you’ll likely need to provide the following paperwork during the application process for a short-term loan:

  • Driver's license.

  • Voided business check.

  • Proof of ownership.

  • Bank statements.

  • Credit score.

  • Personal tax returns.

Funding speed for short-term loans

Finally, one definite leg up that short-term loans have on merchant financing is the speed at which they tend to be funded. Whereas merchant cash advances tend to take more than a week to fund, your business can get funded with a short-term loan in as little as a single day.

A long-term alternative to merchant financing: Term loans

If you’re looking for less frequent, more affordable payments, then we suggest looking into a long-term form of funding—the term loan.

With lengthy repayment terms, low APRs and large loan amounts, term loans offer some of the very best terms that a small business can secure.

Let’s take a look at the numbers.

Terms for term loans

Looked at generally, term loans are able to offer small businesses the following ranges of terms:

  • Loan amounts from $25,000 to $500,000.

  • Repayment term lengths from 1 to 5 years.

  • Interest rates that start as low as 7%.

Requirements for term loans

As far as qualifying goes, term loans are unfortunately some of the hardest business loans for which to qualify. That said, with a market full of alternative lenders looking to work specifically with small businesses, you shouldn’t rule this option out as a possibility.

By and large, if you fulfill the following minimum qualifications, then you have a chance at qualifying for a term loan:

  • A personal credit score of at least 600.

  • A minimum of 1 year in business.

  • At least $90,000 in annual revenue.

If you plan on entering into the application process for a term loan, then it will be prudent to gather the following paperwork ahead of time:

  • Driver's license.

  • Voided business check.

  • Bank statements.

  • Balance sheet.

  • Profit & loss statements.

  • Credit score.

  • Business tax returns.

  • Personal tax returns.

Funding speed for term loans

Last but not least, even these long-term loans can fund faster than merchant financing. That’s right. If you qualify, you’ll be able to get a term loan in your business’s account in as little as 2 days.

The bottom line on merchant financing

There you have it—all you need to know, and then some, on merchant financing.

If you decided that this is the right funding source for your business, congratulations! The next step forward is to apply to your chosen merchant financing provider and go from there.

If merchant financing doesn’t seem like the right fit, that’s okay. At the end of the day, merchant financing can really choke up a small business’s cash flow. Looking into long-term, low-rate funding before taking on merchant financing is probably a smart idea. For you, the next step forward is to explore your more affordable options before committing to anything.

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with Fundera by NerdWallet

This article originally appeared on Fundera, a subsidiary of NerdWallet.