SMALL BUSINESS financing can help you cover short-term expenses or invest in a project to grow your venture. But options can differ greatly, and some may be better than others for meeting your needs.
A merchant cash advance, or MCA, is a type of short-term financing designed to deliver cash to small businesses quickly. An MCA is often easy to access, but it doesn’t work like a traditional business loan.
In fact, merchant cash advances aren’t loans and aren’t held to the same regulatory standards as business loans. That means you could pay sky-high fees and end up with multiple advances at the same time.
Borrowers should proceed with caution. Before you are tempted by this fast cash fix, make sure you know the pros and cons.
How Does a Merchant Cash Advance Work?
A merchant cash advance is an advance on your firm’s future credit card and debit card sales. In other words, you’re borrowing against your future revenue.
An MCA is a lump sum of cash, and the amount you can borrow varies. Some lenders may allow you to borrow up to 250% of your firm’s typical credit and debit card sales. Others offer a fixed dollar amount that could range from $2,500 to $250,000, though some could be in the millions.
Most often, a merchant cash advance is repaid as a percentage of your daily credit and debit card receipts. You might have to commit anywhere from 8% to 30% of your card sales to repayment. The lender sets the percentage, and payments are automatically taken from your business bank account daily, weekly or monthly.
Some lenders may deduct a set dollar amount instead. Either way, repayment is simple because you only have to give the lender your bank account details.
A factor rate or factor fee determines the cost of a merchant cash advance rather than an annual percentage rate, which is common with business loans, lines of credit or credit cards. The factor rate ranges from 1.1 to 1.5, although some lenders may set it lower or higher.
Simply multiply the factor rate by the advance amount to figure out how much you will owe. If you borrow $100,000 with a factor rate of 1.2, you will repay $120,000.
Repayment terms are often eight to nine months, but you could find some as short as three months or as long as 18 months. MCAs, in this way, are more like short-term business loans than other loans, which could give you five years or longer to repay them.
Merchant Cash Advance Benefits
MCAs offer several advantages over other types of small business funding. One key benefit is how quickly you can receive the money. You could be approved for your advance and get cash in one to five business days, depending on the lender.
“Merchant cash advances are engineered for speed,” says Brock Blake, CEO and founder of Lendio, a small-business lending platform. “If your business has an urgent need, such as a crucial piece of equipment breaking or a lucrative opportunity to seize, an MCA will give you quick access to funds.”
Still, other features make merchant cash advances attractive for small businesses. Unlike small-business loans, no collateral is needed to secure an MCA, but lenders require a cut of your future card sales.
That makes them an extremely flexible funding option, says Solomon Berkoff, principal at Charleston Capital Management, an asset management firm focused on small business finance.
“They don’t require extensive due diligence. They’re underwritten based on bank statements,” Berkoff says.
Also, he says the percentage-based repayment plan many lenders use makes MCAs a good choice for small firms with fluctuating revenue. This model allows repayment to be proportionate to daily credit and debit card sales.
You don’t need perfect credit to get a merchant cash advance, either. If you have late payments or a bankruptcy on your credit report, this may not count against you, as with a traditional business loan. You could get an MCA with a credit score as low as 550, and some lenders may dip to 500.
Why a Merchant Cash Advance Might Not Work
Before you commit to a merchant cash advance, consider the cost.
At first glance, it may not seem that high. But you have to look at the effective APR for the entire repayment period. Effective APR accounts for compound interest and fees.
Going back to the example of a $100,000 advance with a 1.2 factor rate, you will need about 360 days for repayment if you project $50,000 in monthly card sales and withhold 20%. The daily payment would come out to about $333, and the effective APR would be 38.06%.
The higher your monthly credit card sales and the faster you pay off your advance, the higher the effective APR can go. Using the previous scenario, if your card sales reached $60,000 monthly, you would repay the advance in 300 days, but the effective APR would climb to 45.68%. Effective APRs can even hit the triple digits. There’s no benefit to paying off your advance faster because payments are fixed, based on a percentage of card sales.
When you’re looking solely at the effective APR, a merchant cash advance can lose some of its luster compared with other financing options.
Refinancing small business debt could improve your bottom line.
Rebecca LakeApril 29, 2019
How to Qualify for a Merchant Cash Advance
Spotless credit isn’t a must, but your business has to meet other criteria. You often need:
- An operating history that includes accepting and processing credit and debit card payments.
- A record of credit and debit card sales.
- A minimum monthly volume of card sales.
- A minimum annual revenue.
Do lenders strictly follow the criteria? Not necessarily. They assess applications on a case-by-case basis and look at your full financial picture. Say, if you haven’t been in business long but have a strong personal credit score, that could work in your favor.
Strong credit card sales are key overall for lenders. This factor, more than anything else, shows how likely your business is to repay an advance.
Merchant Cash Advance Alternatives
Anytime you’re making a decision about business financing, compare all the options first. With that in mind, you could follow three other short-term financing paths than the merchant cash advance:
- Short-term business loans. A short-term loan can give your firm a lump sum of cash to meet working capital needs or to cover day-to-day expenses. It may have a fixed or variable APR. These loans may require a personal guarantee but not collateral. Short-term loans are suited to established businesses with strong credit scores and solid financials.
- Business lines of credit. Instead of a lump sum of cash, you receive access to a revolving credit line you can tap as needed. You only pay interest on the amount you borrow. A business line of credit is flexible enough to cover just about any funding need. But as with short-term loans, good credit and an established operating history are musts.
- Business credit cards. Another source of revolving credit, these cards give you some flexibility in spending and earn points, miles or cash back on purchases. A business credit card may be easier to get than a short-term loan or line of credit, especially if you have a newer business. Just remember to compare the fees and the APR if you plan to carry a balance on your card.