How Can Your Business Benefit From a Merchant Cash Advance?
By: Kate Samano January 17, 2022Merchant cash advances are viable alternatives to traditional loans for new businesses and operators with a low credit rating. It's a short-term solution with no collateral and minimal paperwork, and lenders usually approve the contract and pay a lump sum of cash within a day or two.
While merchant cash advance loans can be excellent for businesses that have exhausted other avenues, the fees might stack up quickly. Continue reading to find out more about the pros and cons of this type of small business loan and discover if it could help your company move forward.
What Is a Merchant Cash Advance?
A merchant cash advance is a sales agreement, rather than a traditional loan. It’s a means of exchanging future earnings for an upfront lump sum. A merchant cash advance lender usually pays out the cash very quickly, and you pay them back a predetermined percentage of your daily sales until the debt is repaid.Â
They can be a lifeline for a company that’s in a stitch and needs funding quickly. In particular, they can help businesses that experience a seasonal lull, startups that haven’t yet built a credit rating and organizations that haven’t amassed sufficient collateral to apply for a traditional business loan. Â
However, there are caveats. Because they’re sales agreements, the laws and regulations that govern loans don’t apply. As such, lenders can charge whatever they choose in fees, often sending APRs far beyond what you’d pay for a term loan.Â
Fees
It’s true that an MCA is interest-free. Lenders charge a one-off fixed fee that’s worked out by multiplying the borrowing amount by a factor rate. This one-time fixed fee or buy rate tends to range between 1.1 and 1.7, and levies, such as origination fees and closing fees, might also apply.
Repayments are made according to a holdback percentage, which is usually around 10-20% of your sales. This means the amount you repay on a given day is entirely conditional on your earnings, with larger payments made on good days and smaller ones on slower days.Â
Lenders collect money directly from your credit and debit cards sales, usually on a daily basis. Repayment amounts depend entirely on your cash flow, so there’s no fixed term or repayment date. Â
Eligibility
One of the most appealing features of a merchant cash advance loan is how easy it is to be approved. Whether you’re a startup, have a low credit rating or lack collateral to get approved for a traditional loan, an MCA can be a knight in shining armor. That said, the rates and fees you’re expected to pay are likely to be more if a lender perceives your business to be a higher risk.Â
The most important qualification requirement is solid evidence of sufficient annual income. Expectations can vary between providers, but $50,000 in card sales and at least two years of evidence is a general benchmark. MCAs are usually approved quickly, often within 48 hours, and you can complete the process online. Â
MCAs are best-suited to businesses that make most of their money from credit and debit card sales. Hospitality, retail and the service industry can arguably benefit the most from this type of small business financing. Â
How to Use a Merchant Cash Advance
Once you’re approved and receive your merchant cash advance loan, you should get a direct deposit within a week. The moment the funds land in your account, your lender starts collecting a percentage of credit card and debit card sales, usually on a daily or weekly basis. Despite the fact it’s not a term loan, repayment tends to be made within 18 months.
MCAs can be unpredictable because you can’t accurately guess how much you’re going to earn on a given day or week. Generally speaking, during a slow season you’ll make smaller repayments, but it will take longer to repay the lender. In busy times, you’ll make larger repayments but can expect to pay the lump sum back faster.
Factors to Take Into Account
- Holdback percentage:Â The holdback percentage determines how much your lender takes from your credit card and debit card sales. The higher the percentage, the more they take.
- Factor rate:Â This incorporates the entire cost of lending, taking into account the money you need to repay and the cost of lending.
- Fees:Â Set up fees, advance fees and closing fees might also apply, so it’s important to be thorough when doing research into an MCA.
Merchant Cash Advance Cost Example
The total cost of your merchant cash advance loan is mostly determined by the factor rate, with the holdback determining how much is deducted. The factor rate is conditional on your company’s financial health and the perceived risk of lending.
For example, if your business borrows $20,000 at a 1.2 factor rate, the provider has bought $24,000 (20,000 x 1.2) of your future credit and debit sales for $20,000. If fees are an additional $6,000, this brings the total cost to $30,000.Â
| MCA Amount | Factor Rate | Fees | Total Cost of MCA (including fees) |
|---|---|---|---|
| $20,000 | 1.2 | $6,000 | $30,000 |
If the holdback percentage on your MCA is 10%, this determines the amount you pay back each day. So on Thursday, your sales are $2,000, your lender recovers 10% x $2,000 = $200. On Friday, your sales are $4,000, so you pay your provider 10% x $4,000 = $400.Â
Fees are usually charged on top, and due to the lack of regulation, they can be sky-high. Working with an expert to find the best MCA option for your business might be necessary to get the best deal. Â
MCA Benefits
There’s a lot to think about when applying for financing to fund your small business. Let’s look at the advantages of merchant cash advances.Â
Easy to Apply and Qualify
You don’t need a complicated business plan or obscure documents to apply. In most cases, all that’s required is your business tax ID, the owner’s social security number and basic business information. This could include evidence of at least two years of credit card transactions and two months’ worth of bank statements and credit and debit card processing information.
Another major boon is how easy it is to qualify for an MCA compared to a traditional term loan. Proof of earnings and your ability to pay back using credit card earnings are more important than a credit rating, and no collateral is required at all. Â
No Collateral Required
That brings us to the next reason MCAs are a great choice for some companies. Small businesses and startups might not have the assets necessary to qualify for a traditional loan, making it hard to secure funding. With merchant cash advances for startups, proof of strong card sales is the main eligibility requirement.
Flexibility
When cash flow is tight, fixed repayments can be a major cause of stress, especially for seasonal businesses. The amount you pay back with a merchant cash advance is entirely dependent on income, so you pay less during slow periods and more when you’re busy.
Quick Payout
MCAs have one of the fastest payout rates, usually approving funds within 48 hours. If you need fast cash and don’t have the time to go through the extensive processing period associated with traditional term loans for businesses, it might be the best funding option.Â
MCA Risks
Merchant cash advance loans come with risk, and it’s important to understand the potential drawbacks before you apply.Â
Potentially Expensive
Although MCRs can make bold claims about no interest, if you compare their APRs with traditional loans, they can be very expensive. It’s crucial that you shop around, do plenty of research or work with an experienced team of financial experts to avoid extortionate rates.
Impact on Cash Flow
On a busy day, you could repay a high proportion of your daily sales, placing a strain on cash flow. For businesses that face a lot of uncertainty, this can make financial planning even more challenging.Â
Don't Build Business Credit
As a small business, one of the most important things you can do is build your credit rating. Because a merchant cash advance isn’t an actual business loan, it won’t make a dent in your rating. If you’re looking for an option that improves your credit rating, an MCA might not be the best choice.
Can Be Conditional
MCA providers want to make sure they get their money as quickly as possible, so they can place restrictive rules on your company. For example, you might need to use a specific credit card processing company or be forbidden from changing processors until the funds are repaid.
What’s more, some lenders might restrict you from offering incentives for customers to pay in cash. This is to stop you from encouraging customers to pay in cash to avoid making higher repayments.Â
What Type of Business Should Use This Type of Financing?
While MCAs aren’t the right financing option for every company, they can be beneficial if:
- You have strong cash flow but haven’t been able to secure funding from other sources
- Your company requires funding very quicklyÂ
- Your operation experiences seasonal peaks and troughsÂ
- You don’t have sufficient collateral to put up against a traditional business loanÂ
How to Apply
If you’ve decided that a merchant cash advance loan is the best option for your business, applying is straightforward. It’s possible to complete the process quickly online and get approval on the same day. The only documentation you’re likely to need is:
- Proof of income
- Evidence of credit card sales for a set time period
- Future financial projections
- Information about your company structure
- Financial history
Some MCA providers might ask for a credit score, but you should be able to find one that accepts businesses with an unfavorable credit score.Â
Who Would Be Better Off Seeking Alternative Funding?
It might be better to consider a different type of small business loan if the following applies to you:
- You have a good credit rating
- Most of your business transactions are conducted in cash
- Interrupting your daily revenue flow would be problematic
- You need a clear cut repayment plan
Alternatives to Merchant Cash Advance Loans
If a merchant cash advance isn’t for you, the following financing options might be more suitable:
- SBA loans:Â SBA loans are federally guaranteed low-interest term loans that are more affordable than many other options. To qualify, your businesses’ finances need to be in good shape, as this type of loan is in high demand.
- Business line of credit:Â This is a revolving line of credit that works similarly to a company credit card. You choose what you use it for, monthly payments aren’t fixed and you only pay interest on what you use. What’s more, funds become available to you again as soon as you pay them back.
Business term loan: A traditional term loan from a bank provides a lump sum upfront and you pay it back with interest over a one to five year period. Â
Apply for a Business Loan Today
Merchant cash advance loans can be a game changer for businesses that need cash fast, have strong cash flow and operate seasonally. For a discussion about the best type of loan for your small business with an expert, get in touch with Lendzi today.
About the Author
Kate Samano
Kate Samano is a copywriter and Head of Content at Lendzi. She believes in helping small businesses grow by providing access to viable financial advice.