Anyone lumbering under a bad credit score knows the obstacles it puts up. You might be able to get a small business loan, but the terms will be harsh. For some, a business loan may not be an option at all. And frankly, it just doesn't feel good to have a bad credit rating. It's like a bad report card for grown-ups.
While some bad choices or circumstances may have gotten you the bad credit rating, you're not powerless to change it. There are a number of ways you can start repairing your credit rating, and using a merchant cash advance (MCA) is one of them. You can use the merchant advance you get to do a little financial house cleaning and improve your position. Before I get into the details how, let's take a quick look at MCAs.
The Skinny on Merchant Cash Advances
A merchant cash advance offers you cash based on the strength of your business's credit card sales. If your business doesn't have a good amount of its revenue coming through credit cards, you might not be a good candidate for an MCA. But with today's habits, most businesses – from cafes to dentists' offices – typically have a strong, regular credit card volume.
A business owner's bad credit isn't an obstacle to getting an MCA because the lender is more concerned about the credit-worthiness of the business's customers. The lender will look at the average dollar amount of credit card sales for the last six months to a year. The amount of cash the owner can get in his MCA deal is based, in part, on this average volume.
The other two key terms on the MCA deal are the factor rate and retrieval rate. The factor rate determines how much the business owner is paying for the advance. So a factor rate of 1.3 on a $20,000 cash advance means the business owner will pay $6,000 for this cash advance.
An MCA doesn't have a set end date because it's paid off using the deal's retrieval rate, which is the percentage taken out from each day's credit card sales. So a retrieval rate of 10% means the business owner will pay $200 of today's $2,000 in credit card receipts to the MCA funder. The dollar amount paid back ebbs and flows with his daily credit card sales, so the paid in full date can't be fixed.
The big take away here is that an MCA isn't a loan. It's an advance against future credit card sales. This on its own has a couple of advantages.
First, unlike small business loans or a business credit line, a merchant cash advance doesn't get reported to credit agencies. Even if it did, you can't really fall behind on MCA payments because they're made automatically from your credit card processer to your MCA lender as a percentage of actual sales.
Of course, this also means that the MCA can't directly improve your credit rating. You have to get a bit more creative than that. But that's what an MCA offers – some cash and space to get a bit creative to improve your financial situation.
There are three main ways an MCA can help with bad credit:
- Pay off or get current with your outstanding small business loan(s)
- Pay down your utilized business credit on your line of business credit
- Get current with any unpaid vendor invoices
Using an MCA to Help with Outstanding Small Business Loans
For some, bad credit isn't keeping them from getting a business loan. It's trying to keep up with their outstanding business loans that's pulling down their credit score. They may even be business loan junkies.
Late payment history is a large factor in determining both a business owner's personal and business credit score. If you're carrying a lot debt and falling behind on a business loan, a merchant cash advance may be used in different ways to help. If you're late on any loan, you can use the MCA cash to get current. Avoiding default on a loan is a great way to protect your credit score. If you have any loans with lower payoff amounts, it might make sense to use the MCA cash to just pay those off and get those reported as paid to the credit agencies.
Now that you don't have to spread your sales revenue across multiple business loans, you can focus on using your own revenue to stay current on the outstanding business loan. Moving the remaining, outstanding business loan from the late payment pile will also improve your score as late payment history great affects your credit score. According to FICO, which is the standard personal credit rating used by nearly everyone, payment history accounts for 35% of your credit score, the single largest factor.
Keep in mind, this isn't just happening. You'll have the MCA to pay off. However, one of the MCA's best advantages is that your payments stay level to your actual sales. So unlike the risks a business loans presents to your credit score, you don't have any risk of failing behind or defaulting on your MCA.
Clearing Up your Business Line of Credit
Credit utilization is the amount of credit you're actually using relative to what you have available. Say you have a business line of credit of $50,000, and you're consistently using around $40,000 of that line every month. You keep paying a little bit each month, just to clear enough room to use more credit. It's one payment forward, two vendor steps back. This is high credit utilization and it scares lenders.
Let's say instead, you average using around $10,000 of your $50,000 business line of credit each month. You pay most of it off. In some cases, it jumps up for a one-off expense, but you keep paying it down regularly. That's low (= good) credit utilization. Lenders like that.
In this scenario, it's your high credit utilization that's scaring away business loan lenders and leaving you room on your credit line to make any investment in your business. You want to improve your credit score so you can get a business loan on good terms. Here's where an MCA can help.
Now typically, an MCA will be more expensive than a business loan on good terms. So if you have some time before you need/want to make that investment you're thinking about, it will probably make more sense to use the MCA to improve your credit than to use it for that investment directly.
Use the MCA to pay down the percentage of your business credit you're tying up. You should also take that time to look closely at why you were relying so heavily on credit to run your business. You may have financial management or operational gaps to fix so the MCA doesn't just become a temporary fix.
Keeping Your Relationship with Your Vendors
Now the first two ways a merchant cash advance helps with bad credit can impact both your personal and business scores. Vendors with unpaid invoices report only into your business credit score. Business loan lenders, particularly banks, will look at both a small business owner's personal and business credit score. So staying current (or getting current) with your vendors improves your business credit score.
Of course, there's also the benefit of maintaining good relationships with your vendors. They like to get paid as much as you do. They have their own financial management needs. And your credit score isn't just a number – it's also professional reputation. So keep them paid.
Understanding What Impacts Your Credit Score
The basic premise is this: use your merchant cash advance, which can't directly affect your credit score, to cleanup those things that are dirtying up your credit score.
Credit agencies determine your credit score by looking at things like the overall amount you owe, payment history, credit utilization, and length of credit history, and if there are any legal filings against you or your business, say a loan default or lien on property. The degree to which you can use an MCA to reverse any of these factors that exist for you, will help improve your credit score as well.
This method is about getting your financial house in order. As your credit score improves, you'll become more attractive to lenders, which will give you access to cash on better terms that you can invest in growing your business, not just doing clean up.
Consider an MCA your investment in an improved credit score for less expensive cash and more financial options in the future.