Merchant cash advances can provide quick and easy cash for small businesses that have ongoing sales but need cash right now. But like any other financing option for your small business, there are both benefits and drawbacks to using a merchant cash advance (MCA).
Understanding merchant cash advance pros and cons can give you the information you need to determine whether it’s right to use one for your small business. Here’s everything you need to know.
How Merchant Cash Advances Work
Before we get into the benefits and drawbacks, it’s important to understand how MCAs work. MCAs are not technically loans, rather they’re advances on future credit and debit card sales.
When you apply for one, you typically need to provide information about your recent sales, which the MCA provider will use to determine how much of an advance you can get and what the factor rate is.
The factor rate, which typically ranges from 1.2 to 1.5, determines how much you pay in fees. For example, if you borrow $20,000 with a factor rate of 1.5, you’ll ultimately repay 1.5 times the MCA amount, which amounts to $30,000.
Instead of repaying the debt with a fixed monthly installment, you’ll typically pay a percentage of your credit and debit card sales on a daily basis.
MCA Pros and Cons
These MCA pros and cons are based on the experiences of other small business owners. Read through them to get an idea of what you’re getting yourself into with a merchant cash advance, and decide for yourself if it’s right for you.
Pros of a Merchant Cash Advance
- Quick funding: Merchant cash advances are relatively easy to process, and you can often get the working capital deposited into your bank account within one to two business days. In contrast, some small business loans can take weeks or even months to process. If you’re in a financial bind and you need some money right now, a merchant cash advance may be an appealing, short-term option.
- Low credit requirements: You don’t need a stellar business or personal credit score to qualify for a merchant cash advance. In fact, you can qualify even if you have bad credit. The main focus of the MCA provider is your sales record and receivables.
- Payments aren’t fixed: As previously mentioned, you don’t have fixed monthly installments with an MCA. Instead, you’ll pay a percentage of your credit and debit card sales. This means that if your sales dip, so will your payments, and because the factor rate is fixed, the amount you pay in the end doesn’t go up if your payments go down for a short period. With other loan types, if your sales go down, you still have to make the same monthly payment, which can put further strain on your business.
- No collateral requirement: Many small business lenders require collateral to secure the loan or line of credit, and that’s not the case with MCA lenders. If you can’t repay a secured loan, you may lose the asset you used as collateral, and that’s not necessarily going to happen if you default on an MCA (though there will still be consequences).
- There’s no interest: The factor rate includes all of the costs of paying back an MCA, and it’s fixed from the start. There’s technically no “interest rate”. So you don’t have to worry about dealing with your balance growing over time or added fees.
Cons of a Merchant Cash Advance
- They’re incredibly expensive: For all the appealing aspects of a merchant cash advance, the biggest drawback is that they’re one of the most expensive ways to obtain funding for your business. According to NerdWallet, APRs can range from 40% all the way up to 350%. While payments may feel less burdensome, you’ll likely be able to find cheaper credit elsewhere.
- Daily payments hurt cash flow: Unlike traditional small business loans and lines of credit, you’re paying off your MCA daily instead of monthly. Repayment comes from a percentage of your credit card sales. If you’re considering an MCA to fix some of your cash flow problems, using a product that eats up a portion of your cash flow every day may not be the best approach.
- Unsavory fine print: Merchant cash advances can sometimes border on predatory in nature. For example, some contracts may include what’s called a confession of judgment. By signing an MCA agreement with this clause, you’re effectively signing away your rights to defend yourself in court if you default on the debt. It also means the MCA provider can get a court judgment against you even without notifying you. Be sure to read the entire contract before signing.
- The market is unregulated: Merchant cash advance providers are largely unregulated, which means there aren’t a lot of legal protections for borrowers.
- It’s a temporary solution: An MCA is effectively a Band-Aid used to help resolve cash flow problems rather than to continue to grow your business. As a result, you’ll still need to take steps to address the issues you’re trying to alleviate using the high-interest advance. And remember, your daily payments are going to make it harder to achieve that goal.
Consider an Alternative to Merchant Cash Advances
The more you learn about merchant cash advance pros and cons, the less appealing the benefits might look. While you might think that you need something quick and easy, there are other options available that won’t put as much of a burden on your business.
For starters, you could consider a business credit card. For the most part, small business credit cards don’t require that you be in business for a set period of time, and many also don’t have revenue requirements. If you want ongoing access to capital without the sky-high APRs of an MCA, a business credit card could be a good fit.
Second, consider a small business loan or line of credit from an online lender. These commercial lenders don’t typically have the same stringent requirements as banks and credit unions, so while you’ll still have time-in-business and revenue requirements, you may still be able to find something if your business is relatively new.
The important thing is that you take the time to research your options and determine the best fit for you. Understanding MCA pros and cons, as well as the pros and cons of other financing options, can help you do that.
The Bottom Line
Merchant cash advances can be incredibly easy to get, even if your business is relatively new and your credit history is in bad shape. All that matters is that your future sales are strong enough to support repayment.
But while an MCA can help you resolve some immediate cash flow issues, it can also create more issues in the long run through daily payments, high annual percentage rates and borderline predatory fine print.
If you’re considering a merchant cash advance, make sure you take the time to research all of your other options before you settle on MCAs. Not only will you save money but you’ll also have a better chance of saving your business.
If you already have a merchant cash advance, look for potential options to refinance the debt with a loan that offers more favorable terms. And if your situation is dire, you may consider merchant cash advance debt relief to avoid the worst pitfalls that this business financing option brings with it.
Call Tayne Law Group today at (866) 890-7337, or fill out our short contact form, and we’ll respond as soon as possible. We’ve been in the debt relief business for over twenty years and, in that time, we have won countless awards for our service. Rest assured, our experience speaks for itself.