Friday, December 4, 2009

Comparing “Good” and “Bad” Uses of a Merchant Cash Advance

The ability to compare and contrast “good” and “bad” uses of a Merchant Cash Advance (sometimes called a Business Cash Advance) is an added benefit of our recent White Paper entitled: Merchant Cash Advance: Not for Every Business. Is it Right for Yours? If you have not yet had the chance to read this Merchant Cash Advance White Paper, we encourage you to do so.

Better Decisions = Better Business
As a business owner, you do everything possible to ensure the longevity and success of your business. If you are answering a working capital need for your business, one solution worth considering is raising capital with a Merchant Cash Advance (MCA).

Depending on the circumstances, this could be a smart choice for your business. However, depending on the circumstances, this could also be the wrong choice for your business.

To ensure that you continue making the best choices for your business’ strength and longevity, you’ll want to know the difference between “good” and “bad” uses of an MCA. While these points are made clearly on pages 4 and 5 of the White Paper, we will use this post to dig a little deeper.

Evaluate and Compare
An MCA is not going to be the best answer for every situation, but it is going to be a great answer in many situations. One way to determine on which side of the fence your situation falls is to do a careful evaluation of the situation, and measure each potential solution against the same set of criteria.

In many instances, some of the criteria evaluated to determine if an MCA makes a good fit or not would include:
  • The business’ specific working capital need(s)
  • Available assets to secure a solution (collateral, etc.)
  • How fast the money is needed
  • The time required by the business to complete the obligation
  • The cost (in dollars) of the solution
  • The cost (in effort) of the solution

While these are not all of the points your business should consider, they do illustrate that you can use a simple method of initial evaluation to start to “rule out” or include different working capital solutions among the options for your business.

Good Uses of a Merchant Cash Advance
The White Paper states: “…business owners must make sure that an MCA is being used for the right purpose and under the correct conditions.”

The document goes on to identify the following purposes and conditions as good ones for MCA consideration:

  • To take advantage of an unexpected opportunity that can make the business money at a favorable return on investment (ROI).
  • To manage fast growth.
  • To avoid the “negatives” of other forms of capital which may outweigh the relative costs of an MCA.
  • To cover an unforeseen event that could severely impact the business if it is not dealt with immediately.

Bad Uses of a Merchant Cash Advance
The White Paper also identifies certain uses of an MCA as “bad,” based primarily on an inability to prove an ROI. If your intentions for using the proceeds of a Merchant Cash Advance are among any of the following examples, you should very carefully consider your options:

  • Setting up a “rainy day” fund.
  • Making a purchase or investment for which you can’t project a favorable ROI.
  • Taking money out of the business to support a personal lifestyle that is unwarranted given the health of the business.
  • Purchasing something without investigating other alternative sources of capital first.
  • Using the money to “float” an otherwise sinking enterprise.

(For more detail and some examples of these uses, please refer to the Merchant Cash Advance White Paper).

Bringing it All Together
The White Paper makes one point about raising business capital very clear: “Return on Investment, or ‘ROI,’ is a concept every business manager should apply to every investment they make. Whether it’s new inventory, a new location, a new employee, or a new sign or menu, the business manager must begin with a clear picture of how much the action will cost, and how much they expect to earn because of that action.”

You can see how this idea works through the examples of both the “good” and the “bad” uses of an MCA. If you have a project that shows a very positive potential ROI, chances are much greater that an MCA is worth evaluating as a viable option.

The White Paper offers this guidance:
“No business owner should seek new capital without careful consideration and education. At a minimum, the business owner must (i) investigate all available alternatives and decide which form of capital suits their unique business best; (ii) develop a clear picture of the business’ cash flows to ensure the business can comfortably comply with the agreements associated with the new capital; and (iii) prepare and plan to maximize the benefits the new capital will bring to the business.”

As with any important business decision, you should always refer to trusted advisors, legal counsel, and industry experts before making a commitment.

What Do You Think? Has education and research played an important role in how you make most business decisions?