What Is a Merchant Cash Advance?

Merchant Cash Advance
6
min read
May 12, 2022

When a small business needs money, small business borrowers typically look to the usual suspects for their business financing: Their own bank account, credit cards, and, depending upon their credit score, bank loans.

 

But there are also a wide variety of creative funding options too—microfinance, crowdfunding, factoring, and Merchant Cash Advances (MCAs). Today we are going to drill down into that last option and explain why, although a viable option, MCAs should not be near the top of any small business owner’s list for emergency business financing.

Merchant Cash Advance Explained

A merchant cash advance is exactly what it sounds like–it is an advance. It’s as simple (but, as you will see, also as complicated!) as that. When you were younger, you may have gotten an advance on your allowance, or, when you were a little older, an advance on a paycheck. Some people even get advances on inheritances.

 

An advance is money you get now that is owed to you later, right?

 

Well, that is all an MCA really is, except that here, the small business owner is getting the advance on future credit card sales. In other words:

A Merchant Cash Advance is money given to you by a lender—for a steep fee—that you agree to repay with future debit and credit card sales.

Is a Merchant Cash Advance Good for a Business?

Like most things in life really, MCAs have pluses and minuses. On the plus side, if your small business has consistent credit card sales and cash flow, you can get an MCA fairly quickly and easily; usually in less than a week.

Speed is a major selling point for what can almost be considered a usurious small business loan. Another benefit is that the advances can be substantial–anywhere from $5,000 to $500,000 is possible.

 

The bad news? That money and convenience doesn’t come cheap. The total cost of an MCA, considering all fees and everything, can get well into the triple digits. An advance of, say, $50k, could easily have fees and costs half that—$25K. That’s 50 percent!

Is a Merchant Cash Advance a Loan?

No, a merchant cash advance is not a loan. An MCA essentially is based on money you plan to make from future credit card transactions. Your sales pay back the advance. A loan is not tied to credit card sales like an MCA is.

Are My Personal Assets on the Hook with a Merchant Cash Advance?

Unlike a mortgage or a car loan, the merchant cash advance isn’t backed up by any collateral. If you miss a payment, they can’t come take away your home or your car. But that doesn't mean you're totally off the hook. Some lenders might ask for a personal guarantee, that is, you agree to pay the debt if your business is unable to. 

Danger Will Robinson! Why? Because a personal guarantee means that if the business cannot repay the MCA, you—the guarantor—will have to.

Merchant Cash Advance Process

Getting Started

As you have likely surmised, MCAs have been historically geared toward those businesses that get a lot of their income from credit card sales–businesses like retail shops, restaurants, gas stations, and the like. 

A service business, like a law firm for example, would not typically be an appropriate merchant for a merchant cash advance.

 

Let’s say that you need some quick cash because you need to buy a new, refrigerated delivery truck for your floral shop and a great deal that you can't pass up popped up. 

You need $50,000 pronto. Finding a lump sum like that in a hurry is no easy task and so you decide that a merchant cash advance is the way to go, given that a good percentage of your business comes from credit card sales.

You would Google ‘merchant cash advance companies,” find one, contact them, and apply. Once approved for the $50,000 advance, you would find out the extra fees and get the funds. But what are those extra fees? Let's find out:

How Much Will a Merchant Cash Advance Cost Me?

MCAs use factor rates to figure out how much you owe on top of the advance. They're like an interest rate, but typically much steeper and calculated differently.

Your factor rate is determined by your small business’ credit history, its financial stability, and the amount of money you want to borrow. 

MCA factor rates fall between 1.1 and 1.5. 

So, in this example, let’s say your factor rate is 1.5. You'd need to repay—out of upcoming credit card sales—a total of $75,000 ($50,000 x 1.5)...plus administrative fees. 

If the administrative fees are 3 percent, you'd have to pay back a total of $76,500.

Repayment timeframes in the MCA universe are usually between three and 12 months or so.

Here's a quick break down of that $76,500 number: 

So, 

Repaying with Credit Card Sales

After the application process, you and the MCA provider will agree on your holdback rate or the percentage of your daily credit card sales you’ll “holdback” to pay the lender. 

It may be something like 10 percent. If you therefore sell $60,000 a month via credit cards, that means $6,000 a month will be earmarked for repayment, and that $75,000 would be repaid in a little over a year.

 

But.

 

But what if sales drop? But what if taking 10 percent of your revenue is too big of a bite out of your operating budget? 

Here’s the deal: Sales volume fluctuates. That means that the amount you repay will likely fluctuate. If the fluctuation is downward (due, say, to a pandemic or recession), the amount of time it will take to repay the advance extends. 

Repaying with Fixed Repayments

An alternative to daily or weekly credit card withholding is called “fixed withdrawals.” If your revenue doesn’t typically come from credit card sales, then you and the lender can agree to a fixed amount automatically withdrawn from your bank account on a daily or weekly basis. The amount will be determined by your estimated monthly revenue. 

Based on our previous example of $6,000/month, the MCA company would debit your account at $1,384 a week.

 

In this scenario, the repayment term would be fixed and would not deviate due to sales. This might be advantageous as the payments would be predictable (as opposed to being unpredictably tied to fluctuating credit card sales).

The Pros and Cons of Merchant Cash Advances

Pros

Cons 

Creative Funding Alternatives to Merchant Cash Advances

There are other small business financing options available, like:

Merchant Cash Advances Cost A Lot, But Get You Funds Fast

They are easy to fall into and tough to get out of. That said, in a pinch, an MCA can indeed be a source of quick finding. Just be sure you have a plan to pay it back in a jiffy.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.