How Merchant Financing Fosters Growth for Franchise Systems
Like most independent small-business owners in the United States, franchisors and franchisees are up against tight credit restrictions and high loan eligibility requirements when seeking crucial financing needed for growth. While franchisee demand for capital has remained unchanged, current traditional loan products and credit line requirements have stiffened significantly. Whether capital is needed for renovations, equipment upgrades or development of new franchise locations, the ability to secure financing is crucial for franchises to grow and prosper. But with limited, if any, access to traditional bank lending, what options are franchisors left with? Looking beyond bank loans, franchisors and franchisees are increasingly turning to business cash advance services to acquire the fast capital they need.
Also known as merchant cash advances, the rapidly growing popularity of these financing services is being driven by relatively low personal credit requirements and the simple and quick process of obtaining the financing. Business cash advances offer a short-term working capital solution for franchisors and franchisees and fits a unique financing gap that banks don’t service (usually in the range of $10,000 to $250,000).
Prior to the economic downturn, there were only about 10 firms in the United States providing business cash advance services, and today the industry has grown to more than 40 firms nationwide. In 2011, the nation’s largest providers of advance services issued up to $8 million in business cash advances each month, which is up from $5 million per month in 2008, according to First Annapolis, a Linthium, Md., electronic-payments consulting firm. Merchant Cash and Capital specializes in providing capital to franchises through MCC Franchise Capital, its franchise division, and has provided more than $400 million in small business/franchise funding during the seven years the firm has been in operation.
How Do Business Cash Advances Work?
But how exactly do franchisees use business cash advances to their advantage? Here’s how it works: similar to a bank, a business cash advance firm provides working capital to franchisees, but unlike traditional loan options, these firms work by purchasing future revenues from franchisees at a discount. The amount of funding the franchisee receives is based on his average monthly credit and debit card processing volumes, and most franchisees can typically qualify to receive 200 percent of their average monthly processing volume, up to $250,000.
Most franchisees can typically qualify to receive 200 percent of their average monthly processing volume, up to $250,000.
Before the franchisee receives the advance, he agrees to pay it back with a percentage of future credit card processing volumes taken over an estimated monthly period of nine to 12 months until the full purchased amount has been collected. The payments fluctuate in accordance with processing volumes. After the agreement is signed, the money is transferred to the business owner in three to five days, allowing the franchisee access to the needed capital. Most commonly, a franchisee uses the financing to purchase equipment, remodel a location, assist with seasonality or to finance a new location, but the capital can be used for any purpose.
Unlike bank loans, most franchisees easily qualify for a business cash advance. To be approved, the business must be open for at least six months, accept credit cards and process an average of at least $5,000 per month in credit card sales. Here’s how the approval process works: the cash advance firm reviews a franchisee’s recent credit card processing and bank statements to see how much they can qualify for, and then a reasonable cash flow deduction is established that the franchisee will be able to manage without negatively impacting the cash flow of their business.
The risks associated with this type of financing are minimal because many merchant cash advance firms that specialize in financing to both individual and multi-unit franchise operators offer customized financing programs to best suit an individual’s cash flow demands. Consultants work one on one with franchisees to help them understand their margins and profitability to ensure that the franchisee can manage the reduced cash flow during the payback period.
Examples of Cash Advances
An East Coast-based women’s clothing chain with 11 stores recently consulted a merchant cash advance firm for help securing the capital needed to purchase inventory for a new store they were planning to open in New Hampshire. Having only been in operation for just over a year, the owner was still focused on increasing profits and did not have the extra revenue needed to purchase enough goods to open the new location. The clothing store was able to secure a $75,000 advance that enabled it to stock enough inventory to open the new store on time.
A franchise chain of 24 tuxedo stores in business for 19 years, typically experiences a lull in business during the winter when weddings and formal events slow down. The owner usually would use his personal capital to cover rent expenses during the off-season months, but this year he had taken out an SBA loan and would be unable to pull his personal capital out until the loan terms were fully satisfied. To secure fast working capital, the owner obtained a $400,000 merchant cash advance to cover rent expenses during the slow season rather than injecting his own capital.
Franchisors also benefit from merchant cash advance services. By using the working capital received through a merchant cash advance to assist strong operators with their expansion strategy, franchisors can stimulate growth among franchisees.
Even as the economic outlook gets brighter, banks haven’t shown signs of letting up on their tight lending and credit policies, and even franchise owners with solid credit ratings are being denied loans that are crucial to the success of their business. Seeking such alternative lending options as merchant cash advances is a viable option for franchisees searching for working capital needed to help their business grow.
Seth Broman is vice president of business development for New York City-based Merchant Cash and Capital, a privately held company. He can be reached at 866-413-3646.