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What is a Merchant Cash Advance?

Cash advances are a useful financial option for businesses when cash gets tight. If a business has their cash flow interrupted but wants to expand its operations, a merchant cash advance can be a great option. Unlike most other kinds of business financing, a cash advance is not a loan. A merchant cash advance gives a company access to funds based on their future sales or receivables.


Originally, a merchant cash advance was a small business finance strategy that provided a lump-sum payment (cash advance) to a business owner which was to be paid back using a percentage of the proceeds from future credit card or debit card sales. The term is now commonly used to describe various merchant financing structures that do not have a fixed repayment term and that are repaid through smaller, regular (daily, weekly or bi-monthly) payments, versus monthly payments and a fixed repayment term, often longer than 2 or 3 years, for a traditional bank loan.

A merchant cash advance (MCA) is not a loan. It's a commercial agreement where the business owner sells their future credit card sales or other business receipts to the MCA funding provider.



Merchant Cash Advance Quick Facts

  • Which Business Owners Typically Use a Merchant Cash Advance?

    Merchant cash advances are suitable for a wide range of business owners who have a steady credit card/debit card business. Retail stores and restaurants are some of the most common types of businesses that use a merchant cash advance.

  • Qualifications for a merchant cash advance

    A merchant cash advance will generally cost more than other types of business financing and should be used only in times of urgent cash need and when the business owner has a reasonable expectation steady business income.

    One of the benefits of this type of funding is that many funding providers have more liberal standards to qualify, compared to loans. That means if you have less than good credit rating, a limited business operating history and little or no collateral, you can still qualify.

    Typical business owners who qualify have:
    • A minimum credit score of 525-550
    • $150,000-$200,000 in annual revenue
    • Been in Business 18-24 months

  • Applying for a Merchant Cash Advance

    In addition to the lesser requirements to qualify, the application process and documentation to apply for a merchant cash advance are relatively simple. The following documents are what you will need to complete your application:

    • Credit Card Processing Statements
    • Driver's License
    • Voided Business Check
    • Bank Statements
    • Credit Score
    • Business Tax Returns

Merchant Cash Advance The Pros and the Cons

Like most financing arrangements, there are advantages and disadvantages to a merchant cash advance. An MCA is generally used by business owners who have been rejected by their bank or other traditional lenders for a business loan.

Advantages

  • They are fast

    An MCA is one of the fastest kinds of business financing available. Average turnaround for most business-owners is just a few days. Because the decision is weighted most heavily upon the revenue and sales records of the company, there is a limited amount of paperwork, which accelerates the decision-making process.

  • Poor Credit is often accepted

    Once again, because MCA providers get paid directly from credit card receipts or business receipts via ACH periodic payment, credit ratings are relatively less important than historical business performance as an approval criterion. This can be a real benefit to business owners who may have very strong business performance but do not have perfect personal credit scores.

  • Payments Are Correlated to Health of Business

    Because you pay a percentage of sales, you pay less when sales are slower (less revenue-smaller payment) and more when business is good (more revenue-higher payment). This means that if your sales dip, you are not stuck paying a fixed payment that is higher than you can afford.

    Also, if your deal is structured with periodic fixed ACH payments first, you have the right to request reduced payments if your actual business receipts percentage is less.

    In other words, the MCA provider’s right to repayment is in all cases subject to your receipt of "future receivables", namely business receipts and income. That is, if business receipts slow down despite your attempt to operate then your payments can also be reduced in tandem.

Disadvantages

  • MCA's can be expensive

    Because an MCA is not a loan, there is no fixed payment schedule, term, interest rate or APR. Rather, your total repayment amount is based on a 'factor rate' that is applied to the amount paid for your business receipts, taking your business revenue history into account. This can be more expensive than other alternative business funding methods.

    Because MCA is not a loan, it does not have an interest or annual percentage rate (APR).  However, to help evaluate total annual  financing costs including fees,  you should understand that an MCA deal might have an “equivalent” approximate APR range between 40% to 350%, depending on the funding provider, the size of the advance, any extra fees, how long it takes to repay the advance in full and the strength of the business's credit card sales. This is far more expensive than other alternative business funding methods. An MCA is generally known as the most expensive form of business financing. The above estimate is for illustrative purposes only.

  • Higher Sales often means paying back faster

    If your deal is structured as a "credit card split" where you agree to repay your MCA as a percentage of credit card sales you may end up paying off the MCA faster than you expect. If your sales are weak, your payments will be lower and it will take you longer to repay. If credit card sales are high, you repay the MCA faster and, as a result, the effective cost of capital goes up due to the time value of money.

    However, if your deal is structured with periodic fixed ACH payments first, you will benefit from slower payments unless you choose to accelerate payments.

  • There is typically no savings if you pre-pay

    Because you are paying a fixed amount as a percentage of sales you get no savings on the total amount due to be paid if you pre-pay, unless your deal specifically provides for this. Otherwise, the full amount of future receivables purchased by the MCA provider must be repaid out of the business' future receivables.

    In other words, most loans permit a borrower to prepay without penalty. Only some MCA agreements permit merchants to prepay at reduced cost.

  • MCA Contracts are complex

    While there is relatively little paperwork, MCA contracts are complicated because repayment is often structured in terms of both a stated percentage of the business’ future receivables over a stated period and an agreed fixed repayment amount over the same period, provided the merchant in all cases has the right to reduced payments once it documents the stated percentage of receivables was less than the fixed payments for the same period.

    In all cases, we recommend that the merchant carefully review any MCA agreement with an attorney to ensure the merchant understands how the MCA agreement works and how the MCA product is different from a business loan.

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FAQs for Merchant Cash Advance

What happens if you default on a merchant cash advance?

Defaulting on a merchant cash advance (MCA) can adversely affect your finances. The lender can collect a part of your daily credit card sales or even bank deposits until the balance is paid. You can also face legal actions, or your credit score can be negatively impacted. Moreover, additional penalties will be levied for defaulting, increasing the overall amount and making it harder to repay. If you’re struggling with payment, ensure you communicate with the lender as soon as possible so that you can figure out a mutually beneficial way out of the situation.

How to get out of a merchant cash advance?

If you are struggling with payment of a merchant cash advance, you can try to renegotiate better terms with your lender or even consolidate your debt with a lower-interest business loan. Some businesses try to increase their sales efforts to accelerate their repayment. But the bottom line is to act swiftly before matters get worse.

How does a merchant cash advance work?

Unlike a traditional loan, a merchant cash advance is a flexible financing option that provides a lump sum capital upfront in exchange for a percentage of your daily credit card sales or bank deposits. The repayments adjust according to your business’s revenue is very handy because you pay less on lean revenue days. The debt is repaid over time, with the lender collecting a daily cut until the overall cost of the advance is paid off. But, keep in mind that the flexibility comes with higher costs and only businesses that can handle the daily payments should opt for this type of financing.

Are merchant cash advances a good idea?

A merchant cash advance is a good option for businesses looking for urgent capital without the hassle of traditional loan bureaucracy. But it comes with higher fees, as compared to other business loans. So, it can become very expensive if your business doesn’t generate enough revenue to handle the repayment. Only businesses with steady credit card sales should opt for it to avoid any further financial burden.

How does an MCA work?

With an MCA or a merchant cash advance, lenders provide a large sum of money upfront for a percentage of your daily credit card sales. As the repayment is linked to your sales/revenue, it gets adjusted based on your business’s revenue. So, on slow days, you pay less and on high sales days, you pay more. This aspect of an MCA comes in handy if your business has fluctuating revenue. But the flexibility comes at a cost—in the form of high interest, as compared to traditional loans.

What is the difference between a loan and a merchant cash advance?

A loan and a merchant cash advance can both be different types of debts. The only difference between the two is how they are repaid. While a loan (persona or business) usually has a fixed monthly installment that is paid for a fixed duration, a merchant cash advance takes a portion of your daily credit card sales. This means that payments fluctuate with your daily sales revenue. Loans can take time to process and disburse, whereas MCAs are faster to obtain and don’t require stringent qualifications to get approved. But a merchant cash advance has a higher cost than traditional loans.

Can a merchant cash advance hurt your credit?

Like any business financing, a merchant cash advance can negatively impact your credit if you fail to make the payments or meet agreed-upon payments. Your lenders can report defaults to business credit bureaus, which might hurt your chances of taking loans in the future. You can also face legal action in case of default.

Term Loans are made by Itria Ventures LLC or Cross River Bank, Member FDIC.