Merchant Cash Advance

Before you apply for any type of business financing, you’ll want to understand the pros and cons. Consider the following when considering a merchant cash advance:

Pros

Quick access to funds. Merchant cash advance companies typically allow for an expedited approval process and fast funding times.

Flexible repayment. Payments are generally based on a percentage of daily sales, making them more adaptable to business revenue fluctuations. You may also have the option to repay fixed amounts on a daily or weekly basis.

May be easier to qualify for. Businesses with lower credit scores or limited collateral may find it easier to qualify compared to traditional loans.

Cons

High cost. MCAs often have higher fees and factor rates, making them more expensive than conventional financing options.

Impact to cash flow. Since repayment is generally tied to daily sales, businesses may experience tighter cash flow, especially during slow periods.

Lack of regulatory protections. Unlike traditional loans, MCAs may not be subject to the same laws as traditional business loans, which may lead to less favorable terms.

No boost to business credit. Because an MCA is not a loan, it won’t affect your business credit score or help you build business credit history. However if you default on your MCA, it could be sent to a collections agency. Unpaid debt collection accounts generally get reported to major credit bureaus.

A loan and a merchant cash advance are both a form of financing for businesses, but they work differently.

Small business loan. A traditional business loan provides a lump sum of money that is repaid over a period of time with fixed payments, typically including interest. Loans often require credit checks, a form of collateral and sometimes a lengthy approval process.

Cash advance. A cash advance for a business is known as a merchant cash advance (MCA). These are not loans, but rather an advance against future sales. The lender provides upfront funding in exchange for a percentage of daily credit card or debit card sales until the full amount (plus any fees) is repaid. MCAs have more flexible repayment terms but can be more expensive than traditional loans.

MCA providers generally look at daily credit and debit card receipts to determine if you can pay back the advance in a timely manner. All lenders — including merchant cash advance providers — typically require you to meet some minimum requirements. These providers have different qualification standards than credit lenders. As a result, the cost of an MCA can be much higher than traditional credit lenders. Make sure you understand the terms you’re being offered so you can make an informed decision about whether or not a merchant cash advance makes sense.

The MCA holdback is the percentage of daily credit or debit card sales that a merchant cash advance provider deducts to repay the advance. This percentage is agreed upon during the funding process and remains consistent until the advance is repaid in full. Unlike fixed loan payments, the amount deducted fluctuates based on sales volume, making repayments more manageable during slower periods.

A holdback rate is the percentage of future credit card sales that will be taken by the merchant cash advance provider. This money will be used to pay off the total amount of your advance. But the total cost of your advance will be directly impacted by your factor rate, which is the MCA version of an interest rate.

Unlike the interest rate or annual percentage rate charged on a term loan, a factor rate doesn’t amortize over the course of repayment. Factor rates are also usually expressed as a decimal instead of a percentage.

Say you’re approved for an MCA with a factor rate of 1.5. You’re essentially paying the provider $1.50 for every dollar you’ve been advanced ($100,000 x 1.5 = $150,000). With this simple calculation, you may be able to calculate the total cost of the MCA.

A merchant cash advance is one option if you need cash quickly and aren’t able to secure other forms of credit. However, it’s critical to make sure that the costs of the MCA make financial sense for your business. Because they’re typically easy to obtain, they often come with a premium cost and can cause cash flow problems down the road.

Defaulting on an MCA can have serious financial consequences, including:

Aggressive collection efforts. MCA providers may attempt to recover funds through daily withdrawals, legal action, or placing a lien on business assets.

Higher fees and penalties. Defaulting could trigger additional fees, if authorized by the contract you signed, increasing the total amount owed.

Personal financial risk. MCA agreements may include a personal guarantee. So a business owner could be held liable for the debt if the business fails to repay.

Legal repercussions. Some MCA agreements include a confession of judgment, allowing the lender to take legal action against the business without a court trial, if allowed under the laws of the specific state.

Credit and business impact. While MCAs don’t always report to credit bureaus, defaulting could still damage your business reputation and ability to secure future small business financing.

If a business is struggling with MCA payments, it’s best to communicate with the provider early and explore restructuring your payment options.

A small business cash advance is a type of financing where a business receives an upfront sum of money in exchange for a portion of its future revenue. These advances are often structured as merchant cash advances, where repayment is based on daily sales. Small business cash advances are commonly used for:

• Covering short-term expenses.
• Managing cash flow fluctuations.
• Purchasing inventory or equipment.
• Expanding operations.

Unlike traditional loans, small business cash advances typically have faster approval processes and more flexible qualification requirements than traditional bank loans, but they can come with higher costs.