What is a Merchant Cash Advance?
Merchant cash advance (MCA) is an alternative lending product. It’s not a loan but an advance against your future credit card sales. In other words, your business sells a portion of your future revenue in exchange for the advance of capital you receive.
A hallmark of a merchant cash advance is speed. Businesses can often get funded within 72 hours. The entire process requires minimal paperwork, no collateral, and bad credit is not an obstacle.
This funding product is best used by businesses that need an infusion of cash quickly. For example, if you’re a business that needs to do an immediate expensive repair, but don’t have the funds at the moment. A merchant cash advance might be able to help you because it’s a very fast funding option.
MCAs also have the highest approval rates compared to conventional business loans. According to the Federal Reserve Banks’ 2023 Report on Employer Finds:
Pros and Cons of a Merchant Cash Advance
Pros
Cons
How does a Merchant Cash Advance Work?
A merchant cash advance is very different from traditional business loans. Because of this, there are some things you need to be aware of.
Advance amount.
This is the agreed-upon amount the MCA company will provide you with. Most merchant cash advances fall in the range of $5,000 – $500,000. What your business gets approved for is usually around your average monthly revenue.
Borrowing costs.
Instead of paying an APR as you do with most business loans, you pay a factor rate.
The factor rate is usually in the range of 1.10 – 1.50. In interest terms, the factor rate is the dollar amount you pay back for every dollar you borrow. In other words, you pay back somewhere around 10 – 50 cents in interest for every dollar you borrow. (e.g. if you borrowed $30,000 at a 1.20 factor rate, you’ll need to repay $36,000.)
Your MCA factor rate is based on an assessment of how likely you are to pay it back, industry, state, merchant cash advance company, and other factors.
Term.
Unlike traditional business loans that typically have a set term. Merchant cash advances don’t have a typical repayment term.
Repayment is based on a certain percentage of your future credit card sales. This means that if your sales go down, your payment gets reduced and your “term” elongated. However, merchant cash advances must usually be repaid within 3 – 24 months.
This difference gives merchant cash advances an advantage over conventional business loans. They provide a flexible repayment solution for small businesses that might have fluctuating revenue.
Payment frequency.
With merchant cash advances there are no monthly payments.
Instead, payments are automatically deducted from your merchant processing account or business bank account on a daily or weekly basis until the advance is repaid.
Holdback.
Holdback is the term that applies to the repayment method of a merchant cash advance.
It refers to the percentage that’s held back until your advance is repaid in full. It’s typically around 10 – 20% of your daily or weekly credit card sales.
MCA vs Loan
MCAs are not Loans.
As mentioned in the first section of this article, merchant cash advances are not loans. The reason is because of the technicality that the funder is purchasing a portion of your future credit card sales. This means that the borrower doesn’t owe anything to the MCA provider until they have generated a sale. This allows an MCA to not be treated as a loan.
This type of flexibility can provide relief in comparison to other funding options. Since the merchant cash advance providers are repaid on a percentage of your revenue, if your sales slow down, you can pay less. If your sales increase, you can pay down your advance quicker. Compare this to a fixed monthly payment that happens regardless of slower sales periods.
MCAs evaluate creditworthiness differently.
What makes merchant cash advances different than traditional business loans is how it evaluates the creditworthiness of the borrower. It’s primarily based on the business cash flow. That carries the biggest weight. Other factors such as credit, time in business, and industry are taken into consideration but have small weights.
On the other hand, traditional lenders are very risk-averse. They have a mountain of requirements. They might require applicants to have great credit, many years in business, a business plan, physical collateral, etc.
Why are MCAs expensive?
A merchant cash advance is more expensive than other business loan options because of its speed.
An MCA can fund your business in as little as 24 hours and has almost no requirements. This means there’s a high chance that some businesses might not pay back their advance. This higher risk equals higher borrowing costs to make up for those businesses who unfortunately default on their MCA.
How to get a Merchant Cash Advance?
Qualifying for a merchant cash advance is the easiest part.
Most MCA lenders provide an online 3 – 5 minute application that gathers all they need. Which usually includes:
After you have submitted these items to the alternative lender. They will do a soft pull on your personal and business credit. Keep in mind that your credit score has a small weight on your qualification. What matters most to merchant cash advance lenders is your business revenue. A good credit score can however get you better terms.
Is a Merchant Cash Advance right for my Business?
A merchant cash advance is all about speed and ease. That said, if you have identified how to use the funds to strengthen your business, then it’s a good option if you meet one of the following conditions.
We recommend traditional business loans first as repayment terms and borrowing costs are more favorable.
But we understand that the traditional route is very inconvenient. Especially for small business owners who wear many hats and don’t have the time or energy to navigate the overwhelming requirements.