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Updated: November 11th, 2020
When speed is your number one priority, a merchant cash advance (MCA) could be a lifesaver. Many small business owners finance their business with merchant cash advances when time is short and money is shorter. Since MCAs aren’t technically loans, they don’t require the same strict eligibility standards that loans do—so you can score capital with low credit and zero collateral in no time.
A merchant cash advance empowers your business to trade tomorrow’s earnings for cash today. You receive a lump sum of cash upfront, and then you pay back the advance with a percentage of your daily sales. You’re essentially selling your future sales at a discount.
When time is money, it’s sometimes worth it to swap value for speed. You can use a merchant cash advance on pretty much any business expense: seasonal costs, business expansion, equipment repairs, cash flow gaps—you name it!
New businesses and those struggling with their credit score love MCAs for their lenient approval criteria and blistering-fast speed. You can receive cash advances for anywhere from $5k to $400k, making them versatile financing options.
Yes, it’s debt, but the structure of a merchant cash advance offers a bit of protection for your business: since your payments are dependent on your daily sales volume when sales slow down, your payments do, too.
Traditional banks don’t usually offer merchant cash advances, so you’ll need to take your search online to find alternative lenders. Loan marketplaces, like Funding Circle’s, can expedite your financing process by finding the lender for you—you just submit a single application.
Submitting your application is quicker than taking a shower, and then you can sit back and wait for the offers to start rolling in. Once you receive an offer you like, it’s time to begin the financing process.
Once approved, you’ll receive a lump sum of cash in as little as 3 days. You’ll pay off the upfront capital with a portion of your daily credit card sales (plus interest)—and this repayment period usually begins immediately after you receive funds in your account. Payment period length can vary, but generally, they last between 90 days and 18 months.
Your merchant cash advance’s total costs are determined by the amount of the advance and your factor rate (which usually ranges between 1.1 and 1.5). Your factor rate is dependent on your business’s credit and financial strength—better credit means a lower factor rate. For example, if you received a $50,000 MCA with a 1.15 factor rate, you’d owe a total of $57,500.
Your holdback rate is the percentage of daily sales the lender will collect until you’ve repaid the MCA in full. This percentage is usually between 10% and 20%. Lenders will automatically take these “payments” out of your account each day. More sales mean higher payments and a faster payback period—fewer sales mean lower payments and a slower payback period.
Factor rate: A calculation that helps you determine how much money you will pay back in total.
Holdback rate: The percentage of your daily credit card sales that an MCA provider will take until you pay back what you borrowed (plus fees).
ACH MCAs: Like a normal MCA, except your lender withdraws a fixed daily or weekly amount from your business bank account—not a percentage of your sales.
Before you take on any new business financing, it’s important you understand the advantages and disadvantages. While merchant cash advances offer new and struggling businesses an incredible financial lifeline, they’re not flawless (like with any financing). Below, we’ll help you understand the pros and cons of an MCA so you’ll have realistic expectations.
1. Fast application, processing, and funding
MCAs are all about speed. Everything from application to money in your account is lightning fast. Approval can take less than 24 hours, and funds can be in your account in less than 3 days.
This speed comes because alternative lenders aren’t held to the same intensive regulations, allowing them to expedite the underwriting process (decreasing prices for them and hopefully for you, too).
2. Lenient qualifications
MCA providers are less concerned with your credit score and more interested in your credit card processing statements. After all, this provides more insight into how much you’ll be paying back each day. This allows startups, young businesses, and those with credit score issues to access small business financing.
However, a good credit score coupled with strong sales will score you a lower factor rate. This can substantially lower the total cost of your merchant cash advance.
3. Flexible payment schedule
The payback method associated with an MCA makes your payment schedule fluid. If you’re going through a seasonal lull or a few hard weeks, you can rest easy knowing your MCA only requires minimal payments.
That same flexibility isn’t afforded by other loans, like a short term loan or credit card payment. In those situations, your payments are due regardless of your current sales volume.
Sometimes, merchant cash providers will require a minimum monthly payment or maximum repayment period, so make sure you check the fine print to avoid unwelcome fees during slow months.
4. High borrowing limits
With advances ranging from $5k to $400k, MCAs give you a wide array of spending power. The amount providers will lend to you will be dependent on your sales. More revenue means larger borrowing limits.
5. No collateral required
MCAs are unsecured, meaning you won’t need to put your house, truck, or personal savings account on the line. However, some MCA providers may require a personal guarantee—so read your contract before signing the dotted line.
6. Adaptable to any business use case
You can use your merchant cash advance funds for practically any business expense. They’re best used to finance short-term operating costs (like restocking inventory or making payroll). But, that’s not to say you can adapt them to other uses cases, too. An MCA’s speed also empowers you to use it for emergency expenses, like equipment repairs, cash flow gaps, and more.
While MCAs provide plenty of benefits, there are a few cons you should keep in mind.
1. Doesn’t help build credit
Not all merchant cash providers pull your credit score or report your payments to credit bureaus. This means your MCA won’t help build your credit score, allowing you to qualify for bigger, better loans down the road. Relying on MCAs and other more expensive financing options can be costly long-term, so you must find other ways to build your business credit score meaningfully.
2. No prepayment incentives
Many loans require to pay back your loan and interest in a certain period. The faster you pay back the loan, the less you pay in interest. However, merchant cash advances use a factor rate to establish a fixed amount you must back. This means that you’ll pay the same amount for your MCA, regardless of how quickly you pay it off.
3. Difficult to budget
The constant variance in MCA costs makes it difficult to budget week-to-week and month-to-month. Normally, when your sales go up, you’ll have additional revenue to invest in other parts of the business. However, with an MCA, more sales lead to more correlated expenses—which can be a challenge to plan for in your budget.
4. Potential for super high APRs
MCAs are accessible by businesses of all shapes and sizes in a variety of industries. However, they can be expensive for companies with very poor credit scores and weak financials.
No form of business financing is perfect, which is why you must weigh all the pros and cons. A merchant cash advance is a robust capital tool for your business, but you’ll need to learn how to use it—and use it responsibly when you do.
Merchant cash advances can sometimes have incredibly high APRs—but there’s a reason for this. MCA providers lend to riskier ventures, and these businesses are more likely to default on their advance. To recoup the costs, lenders must compensate by charging a higher APR.
In addition, your APR is impacted by the speed of repayment. The more sales you earn, the higher your payments will be—driving up your APR.
The true cost of your merchant cash advance is dependent on the following:
The equation would be the amount advanced x factor rate (usually in a decimal form like 1.15 or 1.25) x administrative costs (usually in percentage form of amount advanced).
Let’s say Melissa gets a $50,000 cash advance with a 1.2 factor rate and 3% administrative fee:
50,000 x 1.2 + (50,000 x 3%) = Total payback amount
Melissa would pay $61,500 for her merchant cash advance.
If an MCA loan isn’t right for you, consider these alternatives.
A business line of credit expands your working capital for short-term projects or everyday expenses. Your line of credit is revolving, meaning once you’ve repaid the borrowed portion, you’ll get access to the full amount of the loan again.
Plus, you only pay interest on the funds you use—not the full amount of your credit line. A business line of credit isn’t as easy to qualify for as a merchant cash advance, but it’s a great financing alternative if you do.
If your cash flow is hurting because of your unpaid IOUs, turn to invoice factoring. Invoice factoring (or accounts receivable financing) lets you sell your outstanding invoices for cash now. The cost of invoice factoring means you won’t get all the money owed to you, but sometimes speed is worth a discount.
Every business has a story, and some are filled with more challenges than others. If you’re a small business with fluctuating revenue and need capital to get your business (and credit score) back in tip-top shape, let us help.
Apply for a merchant cash advance with Funding Circle, and we’ll help you navigate the entire process. We’ll be the first to admit the whole MCA world can be a bit tricky—that’s why we’ll hold your hand through the entire process. Here’s what you can expect:
What is a factor rate?
Your merchant cash advance’s factor rate will determine how much you repay for your advance. For example, with a 1.3 factor rate, for every $1,000 you receive, you’ll need to repay $1,300. Factor rates generally range from about 1.1 to 1.6, depending on your business’s creditworthiness and finances.
How does repayment work?
Repaying a merchant cash advance can be set up in several ways and you may need to change your credit card processor or terminal if the merchant cash advance company doesn’t work with your current provider. Your MCA will have a “holdback” amount, which is often around 10% to 20%. At the end of each day or week, your processor will automatically send that percentage of sales to the merchant cash advance company and the rest to your account. Alternatively, there are ACH MCAs, which can work even if you don’t have debit or credit card sales. With this arrangement, the merchant cash advance company withdraws a fixed amount from your business bank account daily or weekly.
Can I prepay and is there a prepayment penalty?
Merchant cash advances don’t have a prepayment penalty, but you also won’t necessarily save money by prepaying your MCA. Unlike a loan that accrues interest over time, your factor rate and repayment amount are determined upfront. Prepaying may save you money on monthly administration fees, but it won’t save you money on the cost of factor rate charges.
Louis DeNicola is the president of LD Money Media LLC and an experienced finance writer who specializes in credit, personal finance, and small business finance. Within the small business sphere, he helps business owners understand their financing options, cash flow management, business credit, and taxes. In addition to Funding Circle, you can find his work on BlueVine, Credit Karma, Experian, Wirecutter, and Lending Tree.