Traditional financing options, like bank loans, are often the cheapest ways for small businesses to acquire capital.
On the downside, these loans typically involve a strict approval process, and it can take close to six months to receive actual cash in your account. So if you need fast and flexible funding, a merchant cash advance may be the right option for your business.
What is a merchant cash advance?
A merchant cash advance, or MCA, is a popular alternative to traditional bank loans. A lender gives your business a sum of money, and you repay it with an agreed on percentage of future sales revenue. MCAs are a great way for small businesses to receive quick access to capital, but they can be risky and expensive.
It’s important to note that a merchant cash advance is not considered a loan. MCAs are commercial transactions where a provider purchases a percentage of your future sales.
This is a popular financing option for businesses like restaurants, who drive a majority of their revenue through debit and credit card sales. Although merchant cash advance providers tend to prefer these types of businesses, you can still find options for businesses that don't rely on monthly credit card sales.
How Merchant Cash Advances Work
Compared to traditional lenders, like banks, providers of merchant cash advances have a very different set of criteria when deciding whether to issue funds. MCAs tend to have a much faster turnaround than traditional loans, and are meant to be a short term financing solution.
Providers will assess your risk based on your industry, business performance, and - to a lesser extent - your credit rating, and assign a factor rate that indicates how much you will pay in fees. Factor rates can range from 1.2- 1.5, and the higher your rate, the more you pay in fees.
To calculate your full repayment amount, multiply your advance by the factor rate. For example, if you apply for a merchant cash advance of $100,000 to buy inventory at a discount and the lender assigns a factor rate of 1.3 based on your risk level and credit card sales your total repayment amount would come to $130,000, including fees of $30,000.
Who Is Eligible?
MCA providers are not nearly as strict as banks. Qualification requirements for business owners often focus more on sales numbers than credit history. Businesses with high monthly revenues are a great match for a MCA, especially if the business owners struggle to qualify for a small business loan due to their credit history or lack of securable assets.
How do you apply for one?
It’s pretty easy to apply for a merchant cash advance. You can apply for your advance easily online, and often receive a response within 24 hours. Providers don’t require lots of paperwork, you just need to have these documents ready when you apply:
- Credit card receipts and/or credit card processing statements
- Business bank account statements
- Bank routing numbers and relevant business information
Although providers may check your credit during the application process, it is not usually the factor that will decide whether you qualify for a merchant cash advance. This unique qualification process is why MCAs are considered a reliable option for business owners or founders with bad credit or a limited business credit profile.
Providers generally offer two different options for structuring your repayments. You can either repay your advance with a percentage of future credit or debit card sales or repay with daily or weekly debits withdrawn right from your bank account. Let’s take a more detailed look at both of these options for structuring your repayments.
1. Repayment via credit and debit card sales
The most common repayment structure sees providers take a daily or weekly percentage of your credit or debit card sales. The percentage they take is called a holdback, and ranges from 10%-20%.
With this method, your repayments fluctuate based on your monthly sales numbers. Repayment can take anywhere from 3 months to over a year but ultimately depends on your sales performance numbers month-to-month.
If your sales are higher than expected you can repay the advance faster, and if sales fall, so do the size of your repayments. This means it can take longer than expected to repay your advance if sales decline unexpectedly.
Imagine that you move forward with the $100,000 merchant cash advance. Let’s estimate that your business has monthly credit card sales of around $250,000, and your provider decides to take 10% daily deposits until you repay the total of $130,000. In this example, you would repay $25,000 a month and make daily repayments averaging $833. At this rate, you would pay off your MCA in a little over 5 months, but if your sales drop to $150,000 it would take closer to 8 ½ months.
If you plan to use this repayment method, make sure you have realistic forecasts for your monthly credit card sales and repayment timeline.
2. Repayment via ACH debit withdrawals
ACH cash advances are another method that providers use to give businesses access to working capital. With this method, providers withdraw a daily repayment amount directly from a business’s bank account. The repayment amount is fixed based on an estimate of your monthly sales, and does not fluctuate month to month.
For example, if your monthly revenue is $150,000 and providers still take 10%, you’ll owe $500 a day or somewhere around $3,500 a week.
These ACH transactions are not as flexible as traditional merchant cash advances, but they generate funding for businesses whose revenue is not mainly driven by credit or debit card sales.
Merchant cash advance rates: how much does it cost?
Determining your annual percentage rate, or APR, is the best way to calculate the total borrowing costs for your merchant cash advance. Your APR fluctuates based on how long it takes you to repay your advance.
When you know how to calculate your own APR, you can use it to evaluate the cost of your advance and even compare lenders. Here’s a step-by-step look at how to calculate your merchant cash advance rates:
- Step 1: amount of advance (X) factor rate = total cost
- Step 2: total cost - amount of advance = borrowing cost
- Step 3: Borrowing cost (/) amount of advance = percentage cost
- Step 4: percentage cost (x) 365 = x
- Step 5: x (/) pay period (in days) = Annualized Interest Rate
Let’s walk through these same steps using the example from earlier with an estimated repayment period of 9 months.
- Step 1: $100,000 x 1.3 = $130,000
- Step 2: $130,000 - $100,000 = $30,000
- Step 3: $30,000 / 100,000 = 0.3
- Step 4: 0.3 x 365 = 109.5
- Step 5: 109.5 / 270 = 0.4055 or 41%
This is considered an Annualized Interest Rate and not true APR because there are often additional fees you may need to consider.
MCAs also involve additional fees, which can make them an expensive option, depending on your lender. Use your APR to compare your advance to traditional financing options and determine if it’s the best choice for your business.
The pros and cons of a merchant cash advance
While a merchant cash advance may be a risky option for some thanks to unregulated fine print and high interest rates, many small businesses find MCAs helpful for taking on new projects or settling short-term financial issues, like seasonal declines to sales problems. However, if you’re able to effectively use the capital and make timely repayments, a merchant cash advance can be a practical option for growing your business.
Take a look at the pros and cons below to help you decide if a merchant cash advance is the best financing option for you and your business:
Not only is the application process quick and simple, but you can also receive your advance in as little as 24 hours. This is of course great for businesses who need capital ASAP and are willing to pay for that convenience with future revenues. As we mentioned, you don’t need a lot of paperwork to get started..
Don’t need physical collateral
Since merchant cash advances are unsecured, you don’t have to put your business assets at risk in order to qualify. This is yet another reason why MCAs are a popular option for business owners who haven’t had a chance to build good personal credit or even a business credit profile.
Repayment fluctuates with sales
When your sales decline or stop altogether, so do your repayments! This means that the size of your repayments reflect the success of your monthly sales, and there’s no added stress when sales are low. You may even pay your advance off faster than expected with a few months of high sales.
This is often the main reason business owners are hesitant to get started with a merchant cash advance. One of the biggest downsides to MCAs is that the APRs can range anywhere from 20% to as high as 250%.
The APR for your advance depends on the following:
- Advance size
- Repayment timeline
- Monthly revenue
Merchant cash advances are more expensive than the typical small business loan, which tend to have an APR of 10% or lower.
Additionally, there is no major benefit to repaying your advance early. Although high monthly sales will help repay the amount of your advance, you will still have to pay the same amount of interest and fees that you originally agreed to.
Impacts your credit score
Although credit isn’t the determining factor for getting a MCA, many lenders may still pull your credit score. Merchant cash advances don’t help you build credit, but if too many lenders pull your score it could have a lasting impact on your credit profile.
Contracts can be confusing
The language in contracts can be confusing for new business owners given the various terms used to explain the structure of the repayment process. Here are a few terms you should become familiar with if you think a merchant cash advance could be the right move for your business:
- Holdback/specified percentage- daily percentage of credit card sales deposited towards repayment
- Purchase Price/principal amount - the amount of the advance you receive
- Receipts purchased amount - how much you repay in total
- Factor rate - a multiplier of the purchase price used to calculate receipts purchased amount
- Payback period - The time it takes to repay the full receipts purchased amount
- Payment frequency - how often a lender withdraws repayments (daily, weekly)
Best uses for merchant cash advances
Merchant cash advances are a great way to get access to capital for timely projects or help relieve financial strain. These are some of the most common ways to use your advance to drive ROI:
- Fix temporary cash flow problems
- Purchase bulk or seasonal inventory at a discount
- Increase working capital to pay short-term debts or unplanned expenses
How to qualify for a merchant cash advance
You don’t need an extensive business history or credit profile to get started with a merchant cash advance. The volume of your credit card transactions are often more impactful than your credit, or even profit numbers. More often than not, great sales numbers make up for poor or lacking credit. Get to know the ins and outs of what you’re signing up for, and anticipate repayments to begin as soon as you receive your advance.
Is a merchant cash advance right for your business?
If your business can attain steady monthly sales numbers and timely repayments, a merchant cash advance is likely a reliable choice.
It’s up to you to evaluate the cost of your advance, and decide whether the ROI is worthwhile. Cash advances are less strict and more flexible, but you have to pay a premium for their convenience.
With a merchant cash advance, small businesses get fast access to capital and choose the repayment option that works best for them. At the same time, these businesses also take on more costs compared to traditional financing options.. If you have strong monthly revenues but don’t qualify for a small business loan, a merchant cash advance can be a great way for you to find access to capital and grow your business.