Merchant cash advances are a short-term form of business financing. In this merchant cash advance FAQ, you’ll learn about how they work, the repayment terms you’ll want to watch out for and how to protect yourself and your business from predatory practices.
How Do Merchant Cash Advances Work?
A merchant cash advance, MCA for short, allows business owners to get an advance on their future sales or revenue. Traditionally, it’s based on your debit and credit card sales. However, some MCA providers also offer ACH merchant cash advances.
ACH MCAs are based on your bank account activity. When you receive an MCA, it’ll be in a lump sum. Once it’s been disbursed, the provider will collect payments (typically daily) via your payment processor or business bank account. If it’s based on debit and credit card sales, payments will be based on a percentage of your daily sales. If it’s an ACH merchant cash advance, your payments will be fixed.
How Much Do Merchant Cash Advances Cost?
MCAs are among the most expensive forms of financing, with APRs as high as 350% in some cases. Instead of charging interest, though, you’ll be assessed a factor rate, which can range from 1.1 to 1.5. Some providers may charge additional administrative fees, so watch out for that.
You’ll multiply your advance amount by your factor rate to determine how much you’ll ultimately pay back. For example, if you’re taking an advance of $20,000 and you have a factor rate of 1.2, you’ll end up paying $24,000.
That might not seem like a lot, but MCAs are generally paid off in the short term, which increases the APR.
How Are Payments Determined?
If you’re using a traditional MCA, your daily payments will be based on a percentage of your debit and credit card transactions. This percentage, often called the holdback, can range from 5% to 20% of your daily sales. This means that if your sales go down, so does your payment, but the opposite is also true. If you’re using an ACH merchant cash advance, the provider will determine the fixed daily or weekly payments. Keep in mind that while you can repay an MCA early, there’s no financial incentive to do so. Since you’re not being charged a standard interest rate, the fees generated by the factor rate are fixed, so you’ll pay the same amount whether you’re on time or early.
Is it Easy to Get Approved for a Merchant Cash Advance?
MCAs typically have less stringent credit requirements than other forms of business financing. This makes them appealing to new business owners and businesses with less-than-stellar track records with finances and credit scores. That said, if you’re looking to get a traditional MCA, your credit and debit card sales must be solid enough to meet the MCA provider’s eligibility requirements. The same goes with an ACH MCA, but it’ll be about your overall income and expenses.
How Long Does it Take to Get a Merchant Cash Advance?
The application process can be pretty quick– you can typically get approved by a merchant cash advance provider within 24 hours. After that, it may only take a few days for the funds to be deposited into your bank account.
In contrast, some small business financing options can take several weeks or even months to fund. This makes merchant cash advances more attractive to small business owners with immediate cash flow problems.
How Much Can I Borrow With a Merchant Cash Advance?
MCA amounts can vary based on the provider and your sales (and expenses, if applicable). That said, you may be able to get an advance ranging anywhere between $5,000 and $500,000, depending on which provider you choose. If you’re thinking about getting an MCA, make sure you understand the payback terms run the numbers to avoid borrowing too much.
Do I Need Collateral to Secure a Merchant Cash Advance?
No, merchant cash advances are a form of unsecured credit, so you don’t need to worry about using an asset to secure one. However, many MCA’s require a power of attorney signed and vendor information, along with bank statements that can later be used for UCC filings.
What Can I Use a Merchant Cash Advance For?
You can use an MCA for just about any business expense. That said, it generally doesn’t make sense to use one for major equipment purchases, big investments, and other long-term needs. Rather, because they’re so expensive, merchant cash advances are best suited for short-term capital needs that cannot be managed with your current cash flow situation.
Is a Merchant Cash Advance a Small Business Loan?
Technically, no. A merchant cash advance is considered a commercial transaction and not a loan. This means that they’re not regulated the same way other forms of business financing are. They’re not covered by the Truth in Lending Act, which means you may run into some predatory practices.
Can I Use a Merchant Cash Advance to Build Credit?
Merchant cash advances may require a credit check when you initially apply. But over time, don’t expect the MCA provider to report any of your payments to the commercial credit reporting agencies. In other words, if you’re considering an MCA to build credit history, you’ll likely end up disappointed.
What Happens if I Can’t Pay My Merchant Cash Advance?
It’s crucial to take out an MCA only if you’re confident that you’ll be able to pay it back. Because there’s less regulation in the merchant cash advance industry, defaulting could spell trouble. More specifically, many MCA contracts include a clause called a confession of judgment.
A confession of judgment allows the creditor to obtain a judgment against the debtor if they stop making payments. Note, too, that the MCA provider can often sue you without notifying you in advance and obtain a judgment from the court. This could result in bank account freeze, liens, and other legal complications. On top of all of that, you won’t have the right to legally defend yourself because you signed the contract agreeing to the confession of judgment.
What Are Some Alternatives to Merchant Cash Advances?
MCAs are generally regarded as a last-resort financing option, even for small businesses with bad credit. If you’re thinking about using an MCA because you don’t feel like you have any other options, here are some alternatives to at least consider:
- Business credit card: Business credit cards typically don’t require that you meet revenue and operating history benchmarks, and they can provide ongoing access to credit for working capital needs. You’ll typically need to provide a personal guarantee, though.
- Online loan or line of credit: It can be difficult to get approved for a traditional loan or line of credit from a commercial lender. But there are several online lenders that offer them with less stringent creditworthiness requirements. Approval isn’t guaranteed, but it’s worth a shot. Note that you may need to provide collateral or a personal guarantee.
- Personal loan: If you’re just starting out, many personal loan companies allow you to use your funds for business purposes. It’ll still cost you money to borrow, but it’ll be at a much lower rate than what MCAs charge.
- Invoice factoring or financing: Invoice factoring involves selling unpaid invoices from customers to a third party, which offers a percentage of the invoice upfront. The factoring company takes over collection and gives you the remaining balance minus fees once it’s been paid. Invoice financing works similarly, but instead of selling your accounts receivable to a third party, you use it as collateral.
Carefully consider all of your options before committing to a merchant cash advance. If you’re finding it challenging to keep up with a merchant cash advance, Tayne Law Group can help. Call us at (866) 890-7337, or fill out our short contact form, and we’ll respond as soon as possible. We provide a free consultation to anyone who thinks they might benefit from our services.