As a small business owner, you’re likely familiar with the financial struggles of trying to grow a business while keeping up with operational expenses. In fact, you’ve likely come across a popular financing option known as a merchant cash advance (MCA). But you might be wondering: How does a merchant cash advance work, exactly?
Read on to learn more about this alternative financing option — including the benefits and costs — so you can make an informed decision about whether or not an MCA could work for your company.
What Is a Merchant Cash Advance?
A merchant cash advance is a type of financing that allows businesses to borrow money against their future sales. It’s an alternative to traditional bank loans. An MCA can be used for any business purpose, such as covering payroll, purchasing inventory or equipment, or expanding operations.
This type of financing is typically used by businesses that need quick access to working capital and do not have the credit history or collateral required to obtain a traditional loan from a bank or other lender.
Definition of a Merchant Cash Advance
A merchant cash advance is exactly that: a lump sum advance on future receivables. The MCA provider purchases a portion of your future sales, which you pay in daily installments.
The payment amount is based on the holdback rate. This is the percentage of your sales that are deducted and paid to the MCA provider. That means as your sales increase or decrease, so do your MCA payments.
How Does a Merchant Cash Advance Work?
The amount of your MCA is based on your company’s average monthly credit card sales volume over several months. The lender will determine how much you qualify for based on this information and then provide you with funds. Payments are then taken from your daily sales until the advance is repaid.
Businesses must also meet certain criteria set by lenders before being approved for funding. For example, they may need to meet a minimum monthly revenue or number of years in business. Additionally, they must demonstrate consistent growth potential and have been in operation long enough to build up reliable revenue streams.
Key Takeaway: A merchant cash advance is an alternative to small business loans that allows businesses to borrow money against their future credit card sales. To qualify, businesses must meet certain criteria such as minimum monthly revenue and time in business, as well as demonstrate consistent growth potential.
Benefits of a Merchant Cash Advance
A merchant cash advance can be one option for small business owners who need easy access to cash. However, keep in mind that there are several major risks and drawbacks to MCAs, which may outweigh the benefits (we’ll get to that shortly).
Fast Access to Funds
One of the biggest advantages of taking out a merchant cash advance is that you can get your money fast. Most MCAs are approved within 24 hours. So you won’t have to wait weeks for a loan to get approved and funded. This makes it ideal for businesses who need immediate financing in order to cover expenses or take advantage of business growth opportunities.
Flexible Repayment Options
Another benefit is that payments fluctuate in line with your earnings. With most MCAs, you pay back the amount borrowed (plus fees) as a percentage of your daily credit card sales or daily receivables until the balance is paid off completely. This means that if business slows down, theoretically, so should your payments — giving you more financial breathing room when times get tough.
Good Credit Not Required
Since MCAs aren’t technically considered loans, they usually don’t appear on personal credit reports. In fact, most MCA providers don’t heavily consider credit scores during the approval process. (An MCA broker or purchaser will often tell you that the MCA will help improve your credit, which likely isn’t true.) Instead, much of the decision is based on the business’s growth potential and has little to no impact on personal credit or credit reporting. There may be a minimum credit score to be approved, but having less-than-great credit usually isn’t a deal breaker in the application process.
Key Takeaway: Merchant cash advances allow companies to access fast business funding and flexible repayment terms. Often, there is no collateral required, and it’s not necessary to have excellent credit to be approved.
Risks of a Merchant Cash Advance
While an MCA can be an effective method for getting the funds you need, there are some risks associated with taking out an MCA that should be taken into consideration before signing on the dotted line.
High Fees
MCAs are notorious for charging high fees, which make them one of the most expensive financing options for businesses. In fact, when expressed as an annual percentage rate, the APR on a merchant cash advance can be 300% or more. You will pay back much more than what you were originally funded.
Reduced Cash Flow
Your business’s cash flow will be negatively impacted by daily payments, as a portion of revenue is used to pay back the advance. Since the repayment process is based on a percentage of sales, the more you earn in a day, the more that will go toward repaying the MCA. That could mean other bills don’t get paid or go to the bottom of the pile.
Confusing Contracts and Few Regulations
MCAs are not considered loans, so they’re not subject to the same laws as traditional business loans. In fact, there are not many regulations surrounding the MCA industry at all. You can be told anything to entice you to take one with little to no repercussions. That’s how MCA companies can get away with charging such high fees and making their contracts difficult to understand. You may sign for an MCA online, only to find out you are personally liable for the debt and have agreed to other provisions beyond just the high payback costs.
Risk of Legal Action
If payments are not made as agreed upon, MCA providers can (and usually do) take legal action against you and your business, either through UCC liens or even a lawsuit. A lawsuit could result in additional costs such as court fees or attorney’s fees, especially since they’re often filed in another state other than where you live and work. If you lose the case, the MCA company can take additional actions to collect the debt, including freezing bank accounts, seizing assets, and more.
Key Takeaway: A merchant cash advance comes with high fees, as well as the potential to negatively impact cash flow. And if payments aren’t made in full or on time, you could face a number of consequences to your business and personal finances. It’s important to read all terms and conditions carefully before agreeing to any MCA contract.
Get MCA Debt Help From Tayne Law Group
If you’re struggling with MCA debt or any other type of business debt, it’s important to find reputable MCA lawyers to provide you with actual legal advice. The Tayne Law Group has been advising business clients and helping them resolve MCA debt and MCA lawsuits for over 20 years. We offer a free, no-obligation phone consultation to learn more about how we might be able to help you. So give us a call today, toll-free at (866) 890-7337 or fill out our short contact form. Your information is confidential and never shared.
Frequently Asked Questions About How a Merchant Cash Advance Works
Is merchant cash advance a good idea?
On the surface, a merchant cash advance might seem like a convenient way to get fast business financing. However, that initial convenience comes at a high cost and the potential for expensive problems down the road. It’s important to consider the high cost of these advances, as well as the potential consequences for your business and personal finances, if you’re unable to make payments. Ultimately, it’s up to each individual business owner to decide whether a merchant cash advance is right for them.
How do merchant cash advances make money?
Merchant cash advances are a type of financing that provide businesses with an upfront lump sum payment in exchange for a percentage of their future credit card sales or receivables. The MCA provider will collect a percentage of daily sales until the loan is paid off, plus fees.
MCA companies don’t charge typical interest rates. The cost of borrowing is represented by the factor rate, which is a percentage of the total amount borrowed, expressed as a decimal. Factor rates typically range from 1.1 to 1.5. For example, if a business receives a $50,000 cash advance with a factor rate of 1.3, the total amount the business would be required to repay would be $65,000 ($50,000 x 1.3).
Can a merchant cash advance hurt your credit?
Merchant cash advances are not reported to credit bureaus, so they will not directly affect your credit score. However, if you fail to make payments on the advance, it could lead to a lawsuit or UCC liens. If the lawsuit results in a judgment, it could be noted on your credit reports and negatively affect your ability to borrow in the future.
