What is a Merchant Cash Advance?
A Merchant Cash Advance, or MCA, can work great for businesses that need quick access to funds they can use to cover payroll, purchase inventory or address other immediate expenses.
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What is a Merchant Cash Advance, or MCA?
A merchant cash advance (MCA), or business cash advance, is a form of alternative financing in which a lump sum of money is given to a business in exchange for a percentage of future sales.
Unlike a traditional small-business term loan, a merchant cash advance is typically a lesser amount of money, with smaller payments, repaid in a shorter period of time. For example, many MCAs are between $5,000 and $100,000 and repaid over 3 to 12 months.
Also, instead of a bank loan simple interest rate, the cost of a merchant cash advance is stated using a factor rate, and the repayment amount is typically a percentage of the business’s sales.
How Does a Merchant Cash Advance Work?
While merchant cash advances can range from $5K to $500K or more, the amount (the advance) you can borrow depends on your monthly business sales. Most cash advance providers will look at either your prior three months or six months average monthly collected revenue.
The repayment of the advance is structured in one of two ways. In the first repayment method, the merchant cash advance company collects a percentage of your daily credit and debit card receipts. This is the most common method.
Alternatively, instead of basing the amount on card sales, repayment is structured as a predetermined fixed amount, like with SBA loans or a short-term bank loan.
In both cases, ACH payments are withdrawn directly from your business bank account. More on the two methods of repayment is detailed below.
Calculating the Cost of a Merchant Cash Advance
The overall cost of a merchant cash advance is based on the amount your business will repay. The MCA provider determines a factor rate — typically ranging from 1.15 to 1.6 — based on that risk assessment.
The higher the factor rate, the higher the fees you pay. To see your total repayment amount you multiply the cash advance by the factor rate. For more details on loan costs, see How to Calculate the True Cost of Financing for Your Small Business.
In the table below, you can see some examples using an an advance of $50,000 and different factor rates from 1.2 to 1.5. With a factor rate of 1.2, for example, the total repayment is $60,000 ($50,000 advance x 1.2), which includes fees of $10,000.
Table 1 - Examples of Cash Advances and Factor Rates
Total Cash Advance
Total Amount Repaid
How Do You Repay a Merchant Cash Advance?
There are two primary ways your business pays back a merchant cash advance: 1) paying a % of credit and debit card sales, or 2) paying a fixed amount daily or weekly.
1. Repayment Method 1: Paying a % of credit card sales
With this method – the most common - the MCA provider automatically deducts a percentage of your credit or debit card sales until the contract amount has been repaid.
The repayment period typically ranges from 3 to 12 months. Since the repayment is based on a % of sales, the higher your sales, the faster you’ll repay the merchant cash advance.
Using the $50,000 advance as an example, as shown in the table above, a factor rate of 1.2 means the total repayment will be $60,000. Let’s suppose your monthly card sales are $75,000. If your merchant cash advance provider deducts 10% of your monthly card sales, this is $7,500 per month, or $250/day using a 30-day month.
With this example, you’d pay $250/day, or $7,500/month. At that rate, you’d pay off the advance by the eighth month ($7,500 x 8 = $60,000). Be aware, though, that if card sales decline, you’ll payoff the advance at a slower rate. Many businesses take longer than they expect to payoff their MCA.
2. Repayment Method 2: Paying a fixed amount of credit card sales
With this structure, you agree to have a fixed daily or weekly payment withdrawn, and this fixed amount is based on an estimate of your monthly revenue.
Unlike the repayment structure tied to a % of your credit and debit card sales, the fixed payment does not go up or down with your sales fluctuations. That means you’ll pay the same amount regardless of whether sales are down or up.
This can be good when sales are up, but when sales are down, the fixed payments can put more pressure on your cashflow.
Merchant Cash Advance Pros and Cons
Pro 1: Merchant Cash Advance Same Day Funding
Advantage #1: Speed - The biggest benefit of a merchant cash advance is how quickly the funds can be disbursed. With an easy application process and no collateral required, merchant cash advance same-day funding is entirely possible.
Pro 2: Easy Application for Merchant Cash Advance
Advantage #2: Simple Documentation - Any business owner who has taken out a traditional business term loan, or applied for an SBA loan, knows the process for obtaining traditional loans can be very cumbersome, requiring extensive document processing and many stages of approval. By contrast, you can get a merchant cash advances with very limited documentation.
Pro 3: Merchant Cash Advance for Bad Credit
Advantage #3: Not Dependent on Good Credit – Merchant cash advance approvals are based less on your credit score and more on your probability of repaying the advance. This makes merchant cash advances excellent options for those with average or poor credit scores.
Pro 4: Merchant Cash Advance Renewal
Advantage #4: Ease of Re-Borrowing - Most MCA lenders will allow borrowers to renew the advance once some or all of it has been repaid. This provides a great opportunity if your business has ups and downs such that you’d benefit from the ability to borrow again in the future without starting over with a loan application. If this is important to you, repeat borrowing is also a great feature of Small Business Lines of Credit.
Merchant cash advances have drawbacks too.
Con 1: Merchant Cash Advance Costs
They can be more expensive than traditional bank loans, with high APRs once the full repayment amount and time to repay is factored in.
Con 2: Variable Rates for Merchant Cash Advance
Another drawback is that the APR isn’t actually fixed for merchant cash advances when they are repaid with a % of your sales. If your sales are up and you pay the MCA back faster, your APR is actually higher (since APR is calculated as an annual interest rate). Paying over a longer period of time actually lowers the APR.
Con 3: Additional Financial Strain on Business
One other possible drawback is that the repayment process can put some stress on a business’s daily or weekly cash flow. Of course, this is true with almost any type of debt, as it adds to your monthly obligations. The fixed method of repayment – just like with fixed term loans – has the ability to impact you the most, since payments don’t drop when your sales are down.
Merchant Cash Advances for Startups
A merchant cash advance is a potential option for startup businesses that are just recently beginning to collect revenue but may not yet qualify for other types of small business financing.
Because a merchant cash advance is repaid based on the business’s daily sales, you can qualify with a fairly short time in business - often as little as three months. As long as your new business has solid daily sales, and uses a business bank account, a merchant cash advance enables you to access capital quickly.
Likewise, a merchant cash advance is a good option for small business owners with less than stellar credit. Merchant cash advance providers may pull your credit, though not all do. But even for those that do, they do not require very strong scores since the merchant cash advance is really based on the sales flow for your business.
If you want other startup loan options, visit our post on The Best Business Loans for Startups.
What to Look for in a Merchant Cash Advance Company
Once you’ve decided that a merchant cash advance is the right funding solution for your business, you’ll want to seek out a fair and reputable MCA company. To protect your business, make sure you understand what you will be required to submit and how the repayment process works.
Look for companies with repayment schedules you are comfortable with, and find out what happens if your company does not have enough sales to make a payment.
Look for a merchant cash advance lender that doesn’t require collateral or personal guarantees.
Some MCA companies may impose other restrictions. For instance, some require the business to change credit card processors as part of the agreement. Make sure you know about any specific restrictions before signing the contract and be sure to look for any hidden fees.
Exit Options for Your Merchant Cash Advance
Ask about your exit options and find out how to get out of merchant cash advance. What if your business’s sales plummet? Or, suppose sales skyrocket, and you want to pay off the advance quicker. Find out how you can either extend the repayment term, or see if there are any penalties for paying the advance off early.
The merchant cash advance can be the ideal solution for many business owners. When seeking one, it’s wise to research the best options early, before cash flow becomes an issue and your business needs cash in a hurry.
Also, take advantage of services that can connect you with multiple lenders at once. This can be a huge value to business owners who don’t otherwise have time to research, find and apply with a handful of lenders that are a great fit for their needs.
About the Author
Rieva Lesonsky is the CEO and president of GrowBiz Media and SmallBusinessCurrents.com. She is an award-winning business journalist and the former editorial director of Entrepreneur magazine. Her work has appeared in numerous business publications, including MSN Money, Forbes, Success magazine, NerdWallet, and many more.