If you’re considering taking out a merchant cash advance (MCA), it’s important to understand the costs involved. Most importantly, you should understand merchant cash advance rates, which don’t work like typical interest rates for traditional loans and business lending products.
MCAs are technically not loans and don’t come with traditional interest rates. Instead, MCA funders charge a factor rate (among other costs) to get funded. Want to learn more? Read on to understand how merchant cash interest rates — AKA factor rates — work and how they can impact your business.
Understanding the Structure of a Merchant Cash Advance
A merchant cash advance is a type of short-term financing that provides businesses with a lump sum of cash in exchange for a portion of their future credit incoming cash flow or sales. In other words, an MCA is not a loan. Rather, it’s an advance on future receivables.
MCAs are common among businesses with a high volume of credit card transactions, as well as small businesses that don’t qualify for traditional financing and those that do not want to wait for traditional funding. Here’s a closer look at how an MCA is structured and how it differs from a conventional business loan.
Merchant Cash Advance vs. Traditional Loan
When you take out a merchant cash advance, the MCA funder provides your business with a lump sum of cash upfront. You must then repay that amount over time, plus fees.
Repayment Structure
- MCA: Payments are made daily or weekly from your business bank account and are a percentage of credit card sales. The amount of sales that are withheld as payment is known as the holdback rate. Payments can fluctuate based on the business’s sales volume.
- Business Loan: Payments are typically made in monthly installments at a fixed amount.
Cost
- MCA: These are typically more expensive than traditional loans. The equivalent annual percentage rate (APR) can be very high, sometimes over 100%.
- Business Loan: Traditional loans typically come with considerably lower interest rates.
Repayment Period
- MCA: Since repayment is based on sales volume, there is no fixed repayment timeline. However, most advances are expected to be paid in less than two years.
- Business Loan: Most business loans have a fixed term, often ranging from a few months to several years.
Approval Process
- MCA: This usually has a quicker approval process, sometimes within 24 hours.
- Business Loan: May take longer, as it involves more comprehensive credit checks and financial analysis.
Eligibility
- MCA: Eligibility for an MCA usually centers around a business’s track record, bank statements, and projected revenue and requires that it has a steady volume of credit card transactions.
- Business Loan: Eligibility is based on various factors, including credit score, business financials, and history as a company.
How Merchant Cash Advance Factor Rates Work
Merchant cash advances don’t operate with traditional interest rates in the same way that standard loans do. Instead of charging interest on the principal amount over time, MCAs use a factor rate to determine the total repayment amount.
The factor rate is a decimal number, typically ranging from 1.1 to 1.5 or higher. To determine the total amount you’ll need to repay, multiply the cash advance amount by the factor rate. For example, if you get an advance of $10,000 and the factor rate is 1.4, you would repay $14,000 ($10,000 x 1.4). Or, put another way, the $10,000 advance would cost you an additional $4,000 in fees.
The true cost of borrowing through an MCA can be quite high when translated into an APR, especially since repayments often occur daily and within a short period.
Key Factors that Influence Merchant Cash Advance Interest Rates
When applying for a merchant cash advance, the MCA factor rate will depend on several aspects of your business and finances. The riskier your business is as a borrower, the higher the factor rate will be. Here are some of the most common factors that merchant cash advance companies consider:
- Financial health of the business: Just as with traditional loans, merchant cash advance providers will assess the risk associated with providing an advance to a business. A business with strong financials and a consistent track record of credit card sales and receivables might receive a more favorable factor rate than a business seen as higher risk.
- How long the business has been operating: Established companies with a longer track record are often seen as less risky compared to startups or newer businesses. A longer operational history can result in a more favorable factor rate.
- Volume of credit card sales: MCAs are primarily repaid through a percentage of daily credit card sales and/or directly withdrawn from the business’s bank account. A business with high credit card transaction volumes or incoming receivables is attractive to MCA providers, as it suggests the advance can be repaid quickly.
- Frequency of deposits: MCA providers view businesses with regular and frequent credit card deposits as more stable and may offer them better terms.
- Average ticket size: Businesses with a higher average transaction amount might be seen as having a more stable revenue stream, influencing the MCA terms provided.
- Industry type: Certain industries might be riskier than others based on volatility, seasonality, or other factors. Businesses in stable industries might get better rates than those in industries with more inherent risks.
Merchant Cash Advance Interest Rates vs. Other Financing Options
When comparing different business financing options, it’s important to consider the interest rate and how the total cost of borrowing will impact your overall finances. Here’s a look at the typical rates on other types of business loans and funding options.
Traditional Bank Loans
Offered by traditional banks and credit unions, these business loans typically have lower interest rates and longer repayment terms. However, they often require a solid credit history, collateral, and a lengthy approval process. According to Federal Reserve data, as of the second quarter of 2023, the average small business bank loan rate ranged from 5.75% to 11.91%.
SBA Loans
The Small Business Administration (SBA) provides guarantees on small business loans made by its partner lenders, which can lead to favorable terms and lower interest rates. SBA loans come with some of the lowest rates available to businesses. The maximum rate you’ll pay ranges from 11.5% to 15%, depending on the amount you borrow. However, you may qualify for a much lower rate with excellent credit.
Business Line of Credit
Instead of a lump sum, a business line of credit provides access to a credit line you can draw from as needed. You only pay interest on the amount you use, and it offers flexibility for businesses with fluctuating capital needs. Business line of credit interest rates can vary a lot, depending on your creditworthiness — anywhere from 8% up to 60% or higher.
Business Credit Cards
Useful for managing cash flow and smaller expenses, business credit cards can also provide rewards or cash back. However, they can come with higher APRs than consumer credit cards. Currently, a business card’s average interest rate is just under 29% APR.
Tips for Managing a Merchant Cash Advance
An MCA can be a convenient source of fast cash. However, they can also be quite expensive and deplete your cash flow, putting your business at risk of failing. If you aren’t careful, agreeing to an MCA can result in a cycle of debt that’s tough to break out of, and you could lose your business.
So, if you are thinking about taking out an MCA, be sure you consider the following tips:
Understand the Terms
Before taking out an MCA, understand the factor rate, the holdback percentage, and the estimated repayment time frame. This will help you anticipate the daily cash flow impact. Always review and read the agreement. Do not rely on statements made by a broker or provider of MCAs.
Monitor Daily Sales
Since MCAs deduct a portion of your daily credit card sales and bank balances, keeping a close eye on these sales will help you understand how quickly you’re repaying the advance and its impact on daily cash flow.
Maintain Adequate Cash Reserves
Given the daily deductions from sales, it’s essential to have a cash cushion for other operating expenses, especially during slow sales periods.
Plan for Seasonal Fluctuations
If your business has seasonal ups and downs, account for this in your cash flow projections. Consider how slower sales periods might affect your ability to manage other expenses alongside MCA repayments.
Limit the Number of MCAs
Some businesses take out a second MCA to repay the first, leading to a cycle of debt that can spiral out of control. This can be risky and exacerbate the financial strain on the business’s finances, so proceed cautiously.
Refinance if Necessary
If managing the MCA becomes challenging, consider other financing options that might allow you to refinance or consolidate your MCA debt at a lower cost.
Consult a Professional
Before taking out an MCA, consult with an experienced MCA attorney who works regularly with MCA agreements, lawsuits, and other challenges that can come from an MCA. Only an attorney who knows the MCA industry can provide insight into whether an MCA contract is favorable for your business, how the terms will impact your business, and walk you through your options if your MCA debt becomes unmanageable and is challenging your business’s cash flow.
Tayne Law Group Can Help With MCA Debt
Whether you’re comparing MCA offers or struggling to manage existing MCA debt, we may be able to help. Tayne Law has worked with business owners to resolve MCA and other business debt for over 20 years. We focus on resolving MCA debt-related matters. Call our law firm today for a free, no-obligation phone consultation at (866) 890-7337, or fill out our short contact form. We’ll respond as soon as possible to discuss your options. All conversations are confidential, and we never share or sell your information.
