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.