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Merchant Cash Advance: A Different Financing Solution

There are all sorts of business financing options available from banks and other lenders, such as term loansmortgages, credit cards, SBA loans and business lines of credit. However, these standard financing methods aren’t always ideal for every business and situation. If your company can’t qualify for traditional financing or needs a quick injection of cash for a specific purpose, a merchant cash advance (MCA) is an alternative that may be worth considering.

To help you decide if an MCA is the right financing tool to help your business grow, we’ve put together this guide to give you the answers to important questions, including:

What Is a Merchant Cash Advance?

The concept of a merchant advance, or business cash advance, isn’t complicated. With this type of funding, you receive an upfront, lump sum payment in exchange for a predetermined amount of your business’s future credit and debit card sales. So instead of borrowing money at a certain interest rate, you’re selling a percentage of advance sales revenue. Because of this, MCAs aren’t classified as loans, so there are no merchant cash advance regulations like there are with other types of business financing.

The Nuts and Bolts of How an MCA Works

How an MCA works is also pretty straightforward. After you apply and get approved, the provider sends you an offer that lists all the terms of your advance. These include the lump-sum amount you’ll receive, the provider’s fee and the percentage they’ll deduct from your daily credit and debit sales.

The offer also includes a repayment time frame that can range between 90 days and 18 months depending on the amount of the advance, your business cash flow and monthly sales volume. Unlike most business loans, an MCA doesn’t have a specific payoff date. This is because the repayment is being made as a percentage of individual credit card transactions, so the amount collected can increase and decrease on a daily and monthly basis.

When you sign and return the offer, you agree to the terms and give your credit card processor authorization to send part of each sale to your MCA provider. Within hours or a day or two of signing, the advance is deposited into your business bank account, and the provider’s cut starts being held back by your card processor.

What Types of Businesses Qualify for Merchant Cash Advances?

Merchant cash advances are easier to qualify for than any other type of business financing. Because the requirements are mainly focused on credit card sales volume and relatively recent cash flow, even business owners with limited operating history, low personal credit scores or little or no collateral can be approved.

Businesses that need cash quickly to meet different needs are also good candidates for merchant cash advances since there are no restrictions from a lender on how the funds have to be used. The cash can go toward day-to-day operating costs, unexpected equipment repairs, inventory purchases and any other expenses a business has to meet.

These advances are ideal for businesses that get a high percentage of their sales revenue through credit and debit card transactions deposited directly into their bank account, such as restaurants or brick and mortar or online retailers. However, having most sales via card transactions isn’t a strict approval requirement of most merchant cash advance companies, so businesses with a mix of cash and credit sales can still qualify as long as there’s a high enough volume.

Some providers don’t advance cash to certain types of businesses and industries, though, such as nonprofits, firearm dealers and those in the financial, construction and energy industries.

The Requirements to Qualify for a Merchant Cash Advance

The process of getting approved for a merchant cash advance isn’t as in-depth as applying for a traditional business loan. However, a provider still has to judge whether you’re a worthwhile risk, so you’ll need to provide certain information and documents. The requirements can vary between providers but will likely include:

  • Your driver’s license or passport to prove your identity
  • Three or more months of credit card processing statements
  • One or two years of business tax returns
  • Recent business bank account statements
  • A voided business check

Merchant cash advance companies look at your credit score, how long you’ve been in business and the amount of cash flow the business produces to weigh its stability and determine whether you can afford to pay back an advance. Providers also take a close look at your credit card processing statements to see if there’s enough volume to justify a cash advance. As a general guideline, you’re more likely to get approved if you have a credit score above 525, two years of business history and an annual cash flow of around $180,000.

The Costs of Getting a Merchant Cash Advance

Merchant cash advances are one of the most expensive business funding options available largely because providers approve applicants with less-than-perfect credit who don’t have a long track record in business, which increases the likelihood they’ll default on an agreement.

Another reason why MCA costs are so high is that most small business cash advance companies don’t ask for personal guarantees or collateral, which are requirements to get approved for most other merchant loans. With no collateral or guarantee, the provider is taking a greater risk because if you go out of business before the funds are paid back, they have no claim against anything you own, such as company equipment and inventory or your home or other personal assets.

MCA providers also don’t charge interest like banks and other lenders. Instead, their fees are based on a factor rate that can range from 1.1 to 1.48.

To calculate the upfront cost of an advance, you just multiply the amount you need by the factor rate. For instance, if you’re borrowing $10,000 at a factor rate of 1.15, you’d pay back a total of $11,500; the $10,000 advance plus a fee of $1,500.

In addition to the factor rate, some merchant cash advance companies tack on an origination or closing fee of 1 to 2% of the amount borrowed. This would add $100 to $200 to the overall cost of a $10,000 advance.

The holdback percentage of daily sales you agree to also has an impact on the cost of a merchant cash advance. A provider sets the holdback percentage based on:

  • The amount of advance money your business receives
  • Your average monthly credit card sales
  • The length of time it’s going to take to pay back the funds

Holdback percentages typically range from 10 to 20% of a business’s daily card processing volume. The higher the percentage, the faster the advance gets paid off. However, paying it off faster means you have the funds for a shorter period of time, which increases the overall cost of the advance. A higher holdback rate can also cut into your cash flow and leave you scraping the bottom of your bank account to cover payroll, utility bills, taxes and other everyday business expenses.

To get a better idea of what you’re really paying for a merchant cash advance, you can use an MCA calculator to convert the factor rate into an interest rate over different repayment periods. Using the same example of a $10,000 advance and 1.15 factor rate, the interest rate over a 12-month payback period is 15%. If the repayment time frame is only six months, the interest rate more than doubles to a hefty 30.42%.

The interest rate conversions for a 1.48 factor rate are even more shocking. With a 12-month repayment period, the interest is 48%. Drop the time frame to six months and you’d be paying 97.33% interest.

Some providers do include an early repayment discount in their agreement terms, which can help lower your overall cost a bit if you’re able to pay off the entire advance balance before it’s due.

General Industry RequirementsNational FundingReliant FundingOnDeck
Amount Available$5,000 - $500,000$5,000 - $300,000$5,000 - $500,000$5,000 - $100,000
Speed of FundingAs little as 2 daysWithin 2 hours of accepting the termsNext day after offer acceptedAs soon as 24 hours after approval
Required DocumentsDriver’s License Voided Business Check Bank Statements Credit Score Business Tax Returns Credit Card Processing Statements3 months of business bank statements Your most recent business tax return A voided business checkBusiness bank statements Copy of your driver’s license Voided business check3 months of business bank statements A voided business check
Personal Credit Score550525600
Time in BusinessOver 2 years1 yearN/A1 year
Cash Flow RequiredOver $180,000$150,000$10,000/month$100,000
Cost of Funding1.14 - 1.18 factor rate2% origination fee plus 1.17 - 1.36 factor rateN/A2.5% for first loan 1.25% for second loan no fees after that 13.99 - 36%
Payback Terms Personal Guarantee?Yes
ProsQuick access to funds Easy approval process Bad credit is accepted Suitable for a wide range of business purposePrepayment discount up to 7% Easy application process Offers funding to people with low credit scoreLow qualifications for approvalEasy application and fast funding
ConsHigher fees than with traditional loans Less flexibility to change merchant service providers Daily deduction of credit card receipts reduces cash flowHigh origination fee High factor rates Required to make more frequent paymentsFar less transparent than industry standards Does not disclose the minimum and maximum factor rates Not BBB accreditedCan get expensive if you don’t qualify for lower rates Will file lien against your business and personal finances if you can’t payback loan
Best ForBusinesses that are unable or unwilling to offer a valuable piece of collateral in exchange for the loan and need cash fastBusinesses that need quick accessible financing and can’t gain access to more affordable business financingBusiness that have no other choice because they can’t quality for other loansBorrowers who need fast access to funding

How Much Can a Business Get with an MCA and How Quickly?

The amount of cash a business can get through a merchant advance spans can range from $5,000 up to $500,000 or more. The exact amount a provider offers you largely depends on your company’s credit card sales volume, cash flow and business history.

Most MCA applications are just one or two pages long and can be completed online and submitted with the click of a mouse. There aren’t a lot of supporting documents to send in with an application either, which helps make the approval process less complicated and faster.

Compared to applications for other types of financing that drag on for weeks or even months, a merchant advance can get cash into a business owner’s hand within hours or a couple of days of approval and signing an agreement.

The advantage of quick funding can also make an expensive cash advance attractive to established businesses with strong credit histories. There are good reasons why an owner is willing to pay this extra cost — they may not want to put up valuable collateral for a loan or need immediate cash to cover an unplanned expense. Or, they may want to take advantage of a profit-making opportunity that can’t wait the 30 days or longer it often takes to get funding approved through a traditional lender.

These types of businesses are likely to get approved for larger advances at lower factor rates because they’re seen as less of a risk by providers.

Is a Merchant Cash Advance Right for Your Business?

Merchant cash advances are a lot more expensive than regular business loans, credit cards and business lines of credit, so it’s important to weigh the high cost against your company’s needs before you sign on the dotted line. If you don’t have the collateral, good credit and cash flow to qualify for more affordable financing or your business has an unexpected need for immediate cash, an MCA may be a worthwhile, short-term solution.

Pros and Cons of a Merchant Account Cash Advance

MCAs can be valuable financing tools for some businesses and certain situations, and they have some unique advantages and disadvantages. Before you sign away a slice of your credit card sales in exchange for a lump sum, be sure to weigh all these pros and cons.

Prons
  • Exceptionally fast access to needed cash
  • Easy application and approval process
  • Complete flexibility on the use of advanced funds
  • Low qualification requirements
  • Those with poor credit can qualify
  • Early repayment discounts may be available
Cons
  • Higher costs than traditional loans
  • May involve switching to a provider's preferred card processor
  • Reduced cash flow due to daily receipt deductions
  • Less transparency and no regulation of rates and fees
  • No credit-building benefit since providers don't report to credit bureaus

Getting Started

When you’re searching for affordable business financing, you don’t have to go it alone. Contact us at Lendzi, and let our experience and industry insight help you find the best business funding solution for your unique needs. To get started, complete our convenient application or just give us a call.

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