Is a Merchant Cash Advance Right for Your Small Business?

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Last updated: 12/02/2020
Is a Merchant Cash Advance Right for Your Small Business?

What's a Merchant Cash Advance?

Technically, a merchant cash advance isn’t a loan. It’s a cash advance that’s based on the credit card sales of the borrowing business. This lending method allows for small businesses to skirt around the lengthy processes of a conventional loan, accessing funds quickly for their needed expenses.

The full scope of this lending procedure involves higher rates in comparison to conventional loans. But in exchange, the small company can receive funds right away, without waiting the loan periods and dodging the strenuous and tedious application process.

In an essence, the borrowing business sells part of their future credit card sales in exchange for immediate working capital.

How Do Merchant Cash Advances Work?

If a small business is interested in a merchant cash advance, then they must seek out a MCA lender. Lenders vary, as with any type of loaning element. Some have better deals through more attractive rates and terms, but most with a merchant cash advance have sky-high rates because of the style of lending. It’s the price the borrowing company pays to receive funding up front and quickly.

Once the small business has decided on the MCA provider they want to contract with, an agreement is created regarding the advance amount, the payback amount, the holdback amount, and the term of the advance. When the contract has been created between the borrowing party and the lending provider, the advance is transferred to the business’ bank account. The advance is given to the small business in exchange for a future percentage of their credit card transaction sales.

A percentage of the borrowing business’ daily credit card transactions are withheld in order to pay back the merchant cash advance. This is called the holdback, and the amount for the holdback is previously determined in the original agreement between borrower and lender. The holdback period continues until the merchant cash advance is paid in full.

The holdback acts as collateral for the lender. In other lending processes, collateral is often a more physical asset that can be liquidated to recoup losses. For example, equipment loans feature a piece of heavy machinery or equipment a business has that the lender uses to back a loan, seizing it in the scenario of missed payments to make up for their losses. Invoice financing uses a more intangible asset, outstanding invoices, to collect upon should a borrowing company default on the loan. 

But merchant cash advances aren’t loans, exactly. MCAs are a subset lending option, an advance of funds strapped with interest. The holdback offers a guaranteed access to the borrower’s bank account, sending the money daily until the MCA is paid in full. Here, the lender is protected, just like they would be with a traditional loan with seizing property, equipment, or assets.

There are some MCAs that have an agreement centered on fixed daily withdrawals. It’s not tied to your business’ credit card sales, so your payment won’t change based on their dependence on them. Your payments back to your lender are the same, regardless of your fluctuating daily credit card sales.

MCAs are best used for businesses that experience the majority of their revenue through credit card sales. So, the more credit card payments a business runs, the faster they can repay the merchant cash advance back to their provider. 

Calculating the Fees of MCAs: Is It Worth It?

Much is to be said about the outstanding fees associated with MCAs. Fees and interest can overwhelm the entire idea of having access to immediate working capital. Before you sign on to anything, use a MCA loan calculator to determine critical factors like: the merchant cash advance amount, your estimated monthly credit card sales, factor rates, payback terms, and percentage of monthly credit card sales.

The annual percentage rate, or APR, could very well be in the triple digits. Coupled with all the fees, interest, and your total annual borrowing costs, a typical MCA APR ranges from 40%-350%, depending on the lender, size of your advance, and how long it takes you to repay, as well as the amount of your credit card sales. 

With ceiling-high APRs, it’s hard to see why anyone would opt for a merchant cash advance.It’s easier to break down the pros and cons:

The Pros

  • Ultra-fast means of accessing capital and funds are usually available within a week
  • No thick stacks of application paperwork
  • Application process is more streamlined than a traditional loan as lenders will examine just the business’ credit card history to determine credit worthiness
  • Your home isn’t used as collateral—or your property, or your assets, or your equipment—it’s your personal guarantee in a written contract
  • If your credit card sales are down, the payments are down, too

While the pros make MCAs sound like a catch of a lending option, don’t get too excited just yet. As they bait you with the upfront capital, they have their own catch. 

The Cons

Triple-digit APR means that MCAs are much more expensive than other lending solutions

  • No perk to repaying early as you’ve agreed to repay on a fixed amount of fees with no interest savings
  • There’s no federal oversight; MCAs are not loans, but commercial transactions and aren’t subject to federal regulation like conventional bank loans
  • MCA lenders often have confusing contracts to purposely make you pay more in fees
  • You could find yourself in debt quickly, in need of another advance because MCAs often cause serious cash flow problems 

What Are my Other Options as a Small Business?

As you can see, MCAs can get astoundingly pricey. But MCAs aren’t your only option as a small business owner: a traditional bank loan has an APR of 10% or less; small business loans have APRs that range from 8% to 99%; and business credit cards with APRS of 12% to 30%.

  • For small businesses struggling with bad credit, online lenders like OnDeck or Kabbage offer business loans on the higher end of the spectrum of APRs, but with better advantages than MCAs
  • For businesses with outstanding invoices, they should consider invoice financing or invoice factoring, a lending solution that uses unpaid invoices as collateral
  • Small businesses can also consider small business loans (SBA loans), asset-backed financing, or even a business credit card
It can be tempting to sign on to a merchant cash advance when you need immediate funds. Stopping to consider that this could do your business more harm than good can save you the future headaches of attempting to pay the advance back, a trap that small businesses find themselves in all too often. 
Finance Guru

Finance Guru