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Merchant cash advances are risky, but they can be helpful if used correctly. Are they right for your business?
Running a successful business requires regular cash flow and working capital. Every business experiences periods when sales are down and money is tight. When this happens, you may look to outside sources of funding. A merchant cash advance is one of the various types of small business funding options.
A cash advance allows you to borrow against your future income — the lender is “advancing” you the cash before you are paid. Technically, you are selling your future revenue in exchange for money today, so a cash advance is different from a typical loan. Cash advances are offered by a variety of lenders, including banks and credit unions, online lenders, and alternative lenders.
Personal cash advance loans are borrowed against your next payday, when the lender debits your checking account for the amount you borrowed with additional fees. Lenders sometimes have borrowers write a check for the loan plus fees, then cash the check after the borrower receives the money.
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The fees for these loans are often very high and can leave you saddled with significant debt. Cash advance loans are sometimes considered predatory. However, they can provide vital cash flow if you don’t own a credit card.
There is a specific type of cash advance available for businesses, which is called a “merchant cash advance (MCA) loan.”
Unlike credit cards, which offer a grace period, lenders usually begin charging interest on cash advances the moment you withdraw the money.
MCA loans are a source of short-term funding if you cannot obtain financing from a bank or other source. These advances are borrowed against future credit card sales, and most are repaid — plus the associated fees — within 6 to 12 months.
To obtain an MCA, your business must have daily credit card transactions and proof of at least four months of credit sales. Many MCA companies require that your monthly credit card sales be between $2,500 and $5,000, depending on the amount of the advance. This practice allows the lender to confirm that you can repay the advance.
MCA companies will most likely work with your business if you rely primarily on debit and credit card sales, which includes retail, service shops and the restaurant industries. However, these are two structures that would allow your company to get an advance if you don’t have high debit or credit sales:
How much you pay in fees depends on how much risk the MCA firm is taking. Generally, the factor rate will be 1.1 to 1.5. The decimal indicates the repayment percentage on the loan; for example, a factor rate of 1.1 means you’ll repay the principal plus 10%.
So, if you take out a $40,000 advance with a 1.5 factor rate, your total repayment will be the principal plus 50% of the borrowed funds for a total $60,000 (your $40,000 advance with $20,000).
An MCA is considerably more costly than traditional financing. It can also create a debt cycle that would force you to take out a second advance to pay back the first — resulting in additional fees.
MCAs tend to come with rates and fees that are substantially higher than traditional loans. Here’s an overview of what you can expect to pay:
Because MCAs use factor rates instead of interest rates, the costs often appear lower than they actually are. The factor rate is multiplied by the advance amount to determine the total repayment, but, because MCAs don’t have fixed repayment terms, the effective APR can be as high as 200%.
Taking out an MCA has many advantages and risks compared to other small business loans. According to Chad Cohen, VP of sales at Credibly, a business financing company, the ease of use and lack of documentation are two of the biggest benefits.
“Merchants of all financial profiles can qualify for an MCA, and the documentation requirements are much lower,” he explained. “The speed of the transaction is another benefit — you can apply and be funded within the next day, which is faster than any other lending product.”
Cohen warned that MCAs come with significant drawbacks to consider. “The cost is higher than most financial products and the terms are shorter, which leads to larger monthly payments,” he said.
The following chart provides an overview of the biggest MCA pros and cons:
MCA Pros | MCA Cons |
|---|---|
Almost immediate access to cash | Extremely high APR, potentially as high as 200% |
Easy repayment | High payment frequency that can hinder cash flow |
Low credit score acceptable | No impact on business credit score or report |
No restrictions on loan use | Binding in ways that other loans aren’t |
No need to put up collateral | Unavailable to small businesses that don’t accept credit card payments |
Cohen said that MCAs are best for businesses that can’t qualify for traditional financing, like a bank or SBA loan. “They do require established revenue, so startups aren’t the best fit for an MCA,” he added.
If you need extra cash but are wary of a merchant cash advance, consider other financing solutions that provide working capital for your small business. There are a variety of small business loan types to choose from. Lines of credit, term loans and payment processor financing are just some of the options.
A line of credit (LOC) is similar to a credit card. You can apply for and be approved for a set amount, which you can borrow against for the term of the LOC. You can never owe more than the upper limit of your line of credit, but you can repay the amount you owe and borrow again as many times as you need. You can open an LOC for your company for any amount, often ranging from $2,000 to $500,000. Funding is generally approved in less than a week, and repayment terms are 3 to 12 months.
Fundbox is one lender that provides business LOCs. Fundbox’s fast, transparent application, pricing and approval processes can offer up to $150,000 over 3 to 6 months. Fundbox is known for its direct communication regarding how much you’ll pay per week for its services, and it will automatically withdraw these fees from your bank account. Learn more in our review of Fundbox.
A short-term loan is an unsecured business loan offered by a private lender rather than a bank. These loans have lower interest rates and more transparency than an MCA, though lenders will review your credit history. Short-term loans generally offer up to $500,000 in one-time financing, are approved in less than a week and have repayment terms of 3 months to 3 years.
Fora Financial is a top lender for short-term small business loans. With Fora, your repayment period will be at most 15 months, and you can obtain a loan of up to $500,000. You can set your payment schedule to fit whatever terms work for you, and you won’t have to put up any collateral. Plus, the approval process takes just 24 hours, with funding of the loan as quick as 72 hours. You can learn more in our review of Fora Financial.
There are a variety of lending options for your company. The best small business loans have an easy application process, transparent pricing information and flexible repayment options.
If you use a credit card processing company like Square or PayPal, you may be eligible for the financing these companies offer. You can apply for the loans, which are generally under $100,000, through your online account. They usually come with a factor rate of 1.1% to 1.16%, which is lower than an MCA.
MCAs are legal because they are not considered loans. Instead, they involve the purchase and sale of future income. Firms offering this financing don’t have to follow regulations that traditional lenders are required to follow, because the advance never lasts more than a year.
The fees paid with MCAs are not technically considered an interest rate. If compared to one, however, the rate paid for an MCA is significantly higher than it would be for a bank loan. The equivalent annual percentage rate (APR) for an MCA fee can be up to 200% of the advance, which can result in costly loan payments.
Here are some items you should look out for in the contract:
Though the steep fees of MCAs mean that many financial experts discourage them, there are good reasons to consider a cash advance for your organization, including:
MCAs are a workaround to unavailable bank lending, particularly if your company has poor credit or is otherwise unable to obtain a traditional loan.
MCAs are typically available for your business if you have poor or no credit, but that doesn’t mean the company will ignore your credit report. Your lender will complete a background credit check as part of the application.
Fortunately, this generally will not impact your business credit score. Your business credit score and report weigh far less in the MCA approval process than with other types of small business loans.
Some providers may do a hard credit check before issuing you an advance. This type of check can potentially hurt your credit score. Ask what kind of credit check companies perform before you apply for the cash advance.
There are MCA companies that accept applications both online and in person, but the information they ask for on your application will be similar in either case. A typical application is one or two pages. Here is what you will need to provide:
Applying for an MCA is quick, and you’re approved in hours or days. Once approved, you will need to sign a contract agreeing to the advance amount, payback amount, holdback and repayment period. Once this agreement is signed, the advance is transferred to your bank account.
