Small businesses that receive payments via card terminals like credit and debit cards can opt for a merchant cash advance (MCA) instead of traditional bank loans. An MCA is an advance on credit card receipts where small business owners receive an upfront lump sum.
What Is a Merchant Cash Advance?
A merchant cash advance is an alternative to traditional bank loans, only available to businesses that take credit card payments. It can benefit small businesses that mainly receive payment via credit card sales and do not qualify for traditional loans or require a quick cash advance to manage their cash flow.
The hallmark perk of an MCA is that the lender provides an upfront lump sum amount processed in one to three days. You don’t need to have collateral or excellent business credit, and there are no stipulations as to how you should use the advance. As long as you make credit card sales, you need to commit to repaying the advance plus the service fee with a predetermined percentage of your daily turnover.
Applying for an MCA is convenient, especially for businesses requiring a quick cash flow boost to streamline their operations. The catch is that the advance attracts a higher interest rate than traditional bank loans.
- Fast funding typically approved in 24 to 72 hours
- Easy to qualify (good credit or collateral are not a requirement)
- Flexible repayment terms based on your sales
- Freedom to use the advance as you deem fit
- Expensive (APR could be triple digits)
- Only businesses that accept credit cards qualify for MCAs
- You must make daily payments which can affect your cash flow
- MCAs are not subject to federal regulations (it’s easy to fall victim to predatory loans)
Who Is a Merchant Cash Advance Best For?
Merchant cash advances are ideal for small businesses that receive high volumes of credit card payments. Because of the extreme flexibility in the repayment plan and how you can use the money, an MCA can offer reliable short-term financing solutions if you need:
- Quick working capital to boost a short-term cash flow crisis
- Money for unexpected business expenses (like fixing broken equipment)
- Money to fund a short-term opportunity and generate a higher ROI (like taking advantage of an inventory sale deal at discounted rates)
- Settling pressing business debts where nonpayment attracts higher interests rates
Who Should Not Consider Taking a Merchant Cash Advance?
Generally, an MCA is not ideal for reviving the operations of a struggling business. Remember that you must make daily payments from your credit card sales, meaning the advance could throw you deeper into debt. If you are not borrowing to boost an ROI-generating project, an MCA can quickly become a toxic loan.
How Does a Merchant Cash Advance Work?
MCAs lack a stringent approval process. It’s easy to qualify for an advance even if you lack a business line of credit or valuable assets that attract deals from traditional lenders. The fast cash advance can allow you to manage any limitations in your cash flow and streamline your operations.
The MCA lender will provide an upfront sum of money for a percentage of your business’s credit card revenue. It is crucial to understand the three main components of a merchant cash advance for you to acquaint yourself with the strings attached to a deal. These include the following.
Cash Advance
The cash advance is the primary subject of interest that links small business owners and MCA lenders. The lender needs transparency into a business’s average monthly turnover before agreeing to the advance amount and the repayment plan. Also, the business owner must stipulate the required amount.
The lender can offer the requested amount or reduce it depending on the risks presented. Generally, MCAs are short-term loans, although the lender has the discretion of offering money that is less than, equivalent to, or greater than your monthly credit card turnover.
Repayment Amount
The MCA lender will need to recover the upfront advance and a profit typically known as a “factor.” Most lenders set the factor rate at 1.1 to 1.5. To figure out the estimated repayment amount, multiply it with the advanced money. Also, you should note that the transaction can attract a variety of fees that can further inflate the total repayment amount.
Because merchant cash advances are not typical loans, they have higher interest rates and lack a true APR (annual percentage rate). Depending on the advance given and the length of the repayment plan, the “APR” can fall anywhere between 80% and 200%. Often, the repayment period ranges between three and 18 months and depends on the amount of money you generate from sales.
Example of an MCA Repayment
If you apply for a $50,000 merchant cash advance, and the lender sets the factor rate at 1.4, the loan will attract a $20,000 fee. The total repayment amount will be $70,000. If the contract stipulates that the lender will deduct 10% from your credit card sales each month and your business generates $100,000 monthly, $10,000 will be deducted monthly or $333 daily.
In the above example, the APR is at 125%. However, it will reduce to 87.3% if your monthly turnover drops to $70,000, and you will start making payments of $233 daily. The majority of MCAs attract triple-digit APRs.
What Affects an MCA Factor Rate?
Lenders set their factor rates depending on a borrower’s industry, business financial stability, credit card sales history, and years of operation. The repayment fees can be higher depending on the level of risk posed and how quickly you are willing to repay the MCA.
For instance, if you apply for a merchant cash advance of $20,000, and the lender sets the factor rate at 1.5, you are obligated to repay $30,000. The lender will earn a profit of $10,000, meaning the MCA has a 50% fee.
Cash Advance
Factor Rate
Repayment Amount
Overall Fees
$20,000
1.5
$30,000
$10,000 (50%)
Note that the total repayment amount can be higher after including administrative and underwriting fees.
Holdback Rate
There are two main ways of repaying an MCA. They include:
- Credit card sales percentage: This involves automatic deductions of a predetermined percentage of your daily debit and credit card sales
- Fixed bank withdrawals: This option involves the lender withdrawing a fixed amount daily or weekly from your business bank account. Click here to learn how to open a bank account with EIN only.
The agreed-upon percentage that a lender will deduct from your daily or weekly debit and credit card sales is known as the holdback rate. It could range between 5% and 20% depending on the MCA repayment period you choose.
The holdback rate is responsible for MCAs lacking a true annual percentage rate. Lenders deduct varying amounts daily or weekly, depending on your sales volume. If your revenue increases, your effective APR increases. Fortunately, even if your lender deducts a higher amount of money during your heydays, the total repayment amount remains constant.
Steps for Applying for a Merchant Cash Advance
Most businesses are eligible for MCAs as long as they accept credit and debit card payments. A lack of good credit, years of operation, or high-value assets will often not exclude you from qualifying. It only takes a few minutes to apply for this alternative financing solution, and most providers offer relatively quick turnaround times. Here are five steps to applying for a merchant cash advance.
Step 1: Do Your Research
It is crucial to compare the fees and factor rates of different merchant cash advance providers. Some popular options include Lendio, Rapid Finance, CAN Capital, and Square Capital. Make sure you go through their eligibility requirements and ensure there is a reasonable likelihood of your application being approved.
Step 2: Set Up Credit Card Processing
Having your credit card processing approved is crucial to enhance your chances of receiving a merchant cash advance. Your lender will automatically deduct payments through your credit card processor.
If you are already working with a specific company, find out whether it has a working relationship with merchant cash advance lenders who interest you. It is also perfectly okay to jump straight to the next step and switch to a credit card processor accepted by your lender once your advance is approved.
Step 3: Apply for the Advance
MCA lenders typically operate online, and you can quickly obtain their application forms. You will be required to fill in basic information such as your Social Security Number, EIN (employer identification number), and type of business.
Step 4: Submit the Required Paperwork
The next step is to submit paperwork that supports your request for a cash advance. Apart from documents showing your business structure, you will also need to provide credit card processing statements and your bank account statements.
It’s relatively easy to obtain your financial statements if you have an online business checking account. Depending on the lender you choose, you also need documents that project your annual business income and the estimated income growth in the next 12 months. The idea is to be transparent about your sales and cash flow This allows a lender to evaluate the risk of lending to you.
Step 4: Get Your MCA Approved
MCA lenders differ in their style of operation. While some can have your advance approved in a few hours, others can take between 24 and 72 hours to deposit the money into your account. Often, businesses with online accounts can access their money faster. Click here to learn how to open a fee-free business banking account.
Step 5: Review the MCA Contract
Once a lender approves your merchant cash advance, you will receive a finalized financing contract. You must review all the details, including the penalties that apply if you default. Do not hesitate to ask questions if you find the contract confusing or need clarity on any information.
If everything checks out, it’s time to sign on the dotted line and receive an upfront lump sum. Your lender will deposit the advance into your small business bank account, where the agreed daily deductions will take place automatically.
What if You Want to Get Out of the MCA?
It is vital to make a calculated decision before applying for an MCA. In case you find yourself struggling to repay the debt, here are a few things you could do.
- Consider credit unions for business banking accounts. Apply for a loan with more favorable repayment terms and pay off the merchant cash advance
- If you don’t qualify for bad credit business loans from other lenders, negotiate with your MCA lender to settle the debt. Note: It may be imperative to work with a skilled attorney
- As a last resort, you can file for bankruptcy. An MCA is an unsecured loan that could be erased through bankruptcy (consult with an attorney before attempting this approach)
Frequently Asked Questions (FAQs) for Merchant cash Advance
It is imperative to be an informed consumer before applying for a merchant cash advance. Here are answers to some frequently asked questions.
Final Thoughts on Merchant Cash Advance
A merchant cash advance offers an excellent short-term financing alternative ideal for small business owners. The lender provides a cash advance and sets repayment terms based on how much your business makes on average each day. The arrangement generally involves buying your future sales at discounted rates. If an MCA is your best bet, beware of the recurring fees to ensure you don’t fall into a devastating cycle of debts.