An agreement is made between the small business and the MCA provider regarding the advance amount, payback amount, and holdback percentage. Once an agreement is made, the advance is transferred to the business’ bank account in exchange for a future percentage of receivables or credit card receipts.
Each day, an agreed upon percentage of the daily revenues or credit card receipts are withheld to pay back the MCA. This is called a “holdback” and will continue until the advance is paid in full. Access to a business owner’s merchant account eliminates the collateral required for a traditional small business loan.
Because repayment is based upon a percentage of the daily balance in the merchant account, the more transactions a business does, the faster they’re able to repay the advance. And, should transactions be lower on any given day, the draw from the merchant account will also be less. This means during times of slow business, the business’ payback is relative to their incoming merchant account deposits.
Repayment and Loan Costs
A business that uses a merchant cash advance, according to several MCA provides, may pay back 20%-40% (or more) of the amount borrowed. This percentage is frequently displayed as a factor rate, which would equivalently be 1.20 – 1.40.
NOTE: There’s a difference between the holdback amount a small business pays every day (as a percentage of their receivables) and the repayment amount for the entire advance. There could, for instance, be a holdback of 15%, and a repayment of 30%, so it’s important for the business owner to understand the distinction.
The holdback percentage is typically based on:
The amount of funds a business receives
How long it will take to repay the advance
How big the monthly receivables are
For example, a business is advanced $10,000 and agrees to pay back $13,000. This means the payback, or factor rate, is 1.30 or 30% of the advance amount. Moving forward, the business agrees to have 15% of its credit card transactions withheld by the advance company (the holdback) until the $13,000 is collected. If the business is averaging $14,500 a month in credit card sales, approximately $2,160 would be withheld each month and the advance would be paid back in roughly six months.
Typical holdback rates may range from 10%-20%, though this can vary widely based upon the business and the provider’s evaluation of the borrower’s risk.