A merchant cash advance (MCA) is a form of financing where lenders provide businesses with capital in exchange for a percentage of their future credit card transactions. While MCAs have their advantages, like providing fast access to capital, they can be expensive and confusing to understand. This article explains what merchant cash advances are, how they work, and the pros and cons of getting one.
What Are Merchant Cash Advances?
A merchant cash advance is one financing option that businesses seek out when capital is running low. The major difference between an MCA and other lending options is that an MCA is not technically a loan. A small business loan — also called a term loan — is a lump-sum payment that small business owners qualify for based on credit, collateral, and other factors.
An MCA is an advance on future credit and debit card sales. In essence, the lender buys your future credit card transactions. You receive a cash payment upfront and repay the amount — plus a fee — with future transactions.
How MCAs Work
When you apply for an MCA, the lender will typically assess your credit and debit sales and determine your eligible advance limit. Since the transactions act as collateral, lenders typically don’t factor in your credit score. Thus, the higher and more consistent your credit and debit card transactions, the higher your advance amount could be.
After determining your MCA amount, your lender will calculate your factor rate or the fees associated with your MCA. Other types of business financing — like loans or lines of credit — calculate fees using APR (interest rate plus associated fees). For an MCA, if you multiply your advance by the factor rate, you’ll get an estimate of the total amount you will pay for the advance.
For example, let’s say that you are approved for a $10,000 cash advance with a factor rate of 1.3. That means it will cost you roughly $13,000 to repay the advance ($10,000 x 1.3 = $13,000).
How to Repay an MCA
Repayment terms vary, but generally, you will repay the advance with a percentage of credit/debit card sales or with fixed withdrawals.
- Percentage of Credit/Debit Card Sales: This is the traditional way of repaying an MCA. Your lender will automatically deduct a percent of your daily (or weekly) credit/debit card sales until you pay off the advance. This daily amount is also called the holdback amount.
- Fixed Withdrawals: Your lender can also withdraw a fixed amount from your business bank account like a traditional loan — based on your monthly revenue.
Why Do Businesses Use Merchant Cash Advances?
One of the main reasons businesses apply for merchant cash advances is because they are much easier to get than other loans. For new businesses or business owners that have less than ideal credit, getting a business cash advance may be the only viable option.
Additionally, merchant cash advances are processed quickly, normally within one to two days. For businesses that find themselves in an unforeseen financial predicament, an MCA is a much faster way to access capital than applying for a loan or line of credit.
What Are the Pros and Cons of Merchant Cash Advances?
Before pursuing a merchant cash advance, consider the pros and cons.
- Easier to Qualify For: Some lenders will work with businesses with low cash flow or bad credit because the decision is based on the amount of credit and debit card transactions. Collateral is not required for MCAs.
- Quick Funding: MCAs are generally approved much faster than other financing options. Many lenders make decisions within one to two business days and offer funding within 24 hours following approval.
- Versatile: Some loans have specific requirements on how they can be used and what purchases are allowed. With an MCA, you can use the capital for practically anything business-related.
- Very Expensive: Although they provide fast access to cash, MCAs tend to have higher fees, sometimes with factor rates equivalent to 300%+ APR. You may pay twice or three times your advance amount in fees.
- Frequent Payments: Since you will make daily (sometimes weekly) payments on your MCA, it can negatively affect your cash flow during slow periods.
- Confusing Contracts: Since MCAs use factor rates instead of APRs, and many lenders do not make direct comparisons between the two, MCA contracts can be confusing, especially when determining the repayment period and the total cost of the advance.
- Doesn’t Build Credit: Unlike other financing options, MCAs do not build your credit.
What Are Alternatives to Merchant Cash Advances?
While some businesses may need to resort to merchant cash advances, there are alternatives that may be more beneficial and less burdensome to your business. Here are a few options to consider:
- Equipment Financing: Equipment financing is ideal if you need to purchase new or used equipment for your business.
- Lines of Credit: Lines of credit offer you a consistent pool of capital, and you only pay interest on the amount you use.
- Quick Capital Loan: These short-term loans are based on monthly cash flow and future sales and provide quick access to capital with terms from 1 month to 1 year.
If you’re interested in learning more about our flexible financing programs, you can reach us at (317) 408-4364 or contact us here. We’d love to help you understand your options and create a plan that is best for your business!