Best Alternatives to a Merchant
Cash Advance

Last Updated on April 2, 2024

Shield Funding Team

Table of Contents

No matter how carefully they budget or save for rainy days, small business owners can find themselves in financial difficulties. 

As a small business owner, you could be at the mercy of customers who pay late, or not at all. A machine could break unexpectedly, or a water pipe could burst and flood your storage space. Sometimes it’s not an emergency, it’s an opportunity. Such as, a rival business goes under and you can buy their equipment and inventory at a steep discount. 

The point is there are multiple reasons that small business owners might need access to cash quickly. When the need arises, a merchant cash advance is one way that you can get access to capital in a hurry. But a merchant cash advance isn’t always the best choice for your business. 

Before applying for a merchant cash advance, or MCA, determine exactly how it will impact your business and take the time to research some of the best alternatives to an MCA.

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What is a Merchant Cash Advance?

A merchant cash advance is an advance against your future credit card sales. When you apply for an MCA, the MCA provider analyzes your past few months of sales and creates a projection for future sales. Then, they advance you a percentage of those projected future sales in a lump sum of cash. 

A simple example is: your past three month’s credit card sales have averaged $22,000 a month. The MCA provider uses this to predict future sales of $22,000-$25,000 each month for the next six months. Because projections are a best estimate, instead of advancing a full $150,000 but discount it and perhaps advance $90,000. This is a simple example, and your experience and advance will vary. 

Merchant cash advance providers then set up a daily deduction from your credit card sales for their repayment. If your daily sales equal $10,000, they might deduct 10% of them before the sales revenue even hits your account. 

Reasons for Small Business Owners to Take Out an MCA

Why would a small business owner take out an MCA? One of the primary reasons is to solve a cash flow emergency. 

Merchant cash providers can fund an advance in the same day as compared to the months that it can take for a bank to complete underwriting on a small business loan. If a large vendor didn’t pay their invoice on time and payroll is on Friday, an MCA gives you the cash to cover your obligations.

Merchant cash advances are a great funding option if you need money quickly, whether it’s for working capital or an emergency equipment repair. Because the lender advances funds based on credit card sales small business owners can qualify with a lower credit score, and lenders require much less documentation to apply than when you apply for a loan at a bank.

Why Avoid an MCA?

Merchant cash advances provide small business owners with fast access to capital. They’re best used to solve a cash flow emergency. However, that speed and convenience comes with a price.

Providers of merchant cash advances take on a lot of risk when they extend credit. They’re lending money quickly – without time for the extensive underwriting that a bank would perform on a traditional loan. With less underwriting, and a quick loan approval turnaround time, lenders face more risk that you could default.

To compensate for this risk, MCA providers charge a high factor rate on the loan, which is basically what the actual costs are to borrow the funds. Rather than charging an interest rate, they multiply the cash that they’re advancing by a factor rate and take that as their flat fee. Even if you pay off the MCA early, with most lenders you’ll pay the full fee.

Multiply the factor rates, expressed as 1.0 to 1.5, by the total capital you’re borrowing to find out what you’ll pay. For example, if you’re taking out an advance of $100,000 with a 1.5 factor rate, you’ll pay $50,000 for the advance. In simple interest terms, that’s 50%.

In addition, since the MCA provider takes their repayment from daily credit card sales, a merchant cash advance can affect your cash flows and business operations. Successfully borrowing under an MCA requires careful budgeting, and some borrowers prefer a cheaper loan product with a different repayment plan.

If you prefer paying less to borrow, you’ll need an alternative to an MCA and the credit history to make other borrowing options possible. 

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Alternatives to a Merchant Cash Advance

If you’re wary of the high rates and cash flow implications of a merchant cash advance, you have options. While MCA’s can be a good option, the best loan product will align with your business’ needs. One of the following alternatives to an MCA may be a better fit for your business. 

Small Business Loans or SBA Loans

Since the pandemic the government has been a lot more involved with financing small businesses. This option should always be exhausted before all other attempts at borrowing for your business. The Small Business Administration (“SBA”) sponsors low cost, government-backed loans through approved lenders. Most larger traditional banks offer SBA loans. Because the federal government guarantees a percentage of the loan lenders charge qualified borrowers lower interest rates on these loans. The SBA has several types of loans that they back – from larger loans up to $5 million to micro loans for only $50,000. You can also take out a real estate loan, a loan if you operate in an underserved community, or a loan for current or former service members. However, most SBA loans require a higher credit score. Typically, you’ll need a credit score over 600 to qualify for a SBA loan. And it can take a few months to get approved. Also, with an SBA loan you lose the speed of an MCA.

Lines of Credit

When you apply for and receive approval for a business line of credit it stays open, similar to a credit card. The lender approves you up to a limit and you can draw against the line as needed. While you may pay a fee to keep the line open, you only pay interest and regular payments when you’ve drawn against the line of credit. 

A line of credit offers more flexibility than an SBA loan. Just like a credit card, you can borrow against it when needed. Small business owners will likely pay less in interest with this option in comparison to a credit card. 

Due to the attractive flexibility and costs associated with this type of borrowing, many small business owners apply for, and keep open a line of credit “just in case.” 

The main issue with taking a line of credit is it requires good credit to obtain. It will also require tax returns and a lot more documentation than an MCA. You will also lose some time with the approval process as it will likely take several weeks or more to secure a line of credit.

Equipment Loans

Equipment financing loans cover the purchase of equipment for your small business. Like a car loan, an equipment financing loan’s funds go straight to the seller. 

If a key piece of equipment has broken down, or you want to invest in new equipment to grow your business, an equipment financing loan might better meet your needs than an MCA. 

Because the equipment secures the loan as collateral, lenders charge a lower interest rate. They could seize the collateral if you defaulted, and this lowers their risk. Most charge a flat monthly loan payment, so it can be easier to budget for than the daily deductions of an MCA. This is definitely a more suitable option if you are attempting to acquire a piece of equipment for your business. 

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Invoice Factoring or Financing

Do you have a large volume of accounts receivable, and are you having a hard time collecting on them? Sometimes a cash flow crunch happens when your bills arrive before your customers have paid. You can turn these invoices into cash faster than you can collect on them if you utilize invoice factoring.

With factoring, lenders advance a portion of your outstanding invoices. Effectively getting you the money customers owe you; less the cost to them for giving you the money up front.

There is a key difference between invoice factoring and financing. With factoring, you sell the invoices directly and have no further contact with your customers. Lenders discount your invoices for the risk of non-payment. With financing, you retain ownership of the invoices and remain responsible for collection.

Some small business owners opt to finance rather than factor their invoices because they worry that a factoring company could alienate or upset their customers during collection efforts. The trade-off with that is that you will receive less money for your invoices because there is more risk to the lender. 

Again, this is another business funding option that will take more time than an MCA. Often factoring companies will want to do credit checks and look into the creditworthiness of the customers that owe for the invoices, and this process can be time consuming.

Business Term Loan

A business term loan has a set repayment term and schedule. These are the most traditional loans, where a borrower receives a lump sum, and then repays the funds with a once a month payment. A business term loan has an established repayment schedule and you will know exactly what you owe monthly and when it will be paid off. Unlike a line of credit, once you’ve repaid the loan you can’t borrow against it again. If you anticipate ongoing credit needs a business term loan wouldn’t be a good fit, but if you’re funding a one-time expansion plan or remodel they’re a good choice. The negative with this type of funding is that the process is long and drawn out and it often ends in rejection. The main issue, especially today after recent bank failures throughout the country the underwriting regulations at a bank requires everything from background checks all the way to several years of tax returns, all bank activity, and many other documents. Also required is excellent credit and strong guarantees that you will pay. It is because of this process that merchant cash advances became so popular.

Personal Loans

Small business owners willing to put their personal credit on the line could take out a personal loan. With a personal loan you could potentially risk personal assets such as investment retirement accounts or your home as you will be personally liable on this type of loan.

While a personal loan gives you access to capital, ultimately your small business should generate enough revenues to cover its expenses. Otherwise, you’re putting your personal finances at risk to sustain your business.

Additionally, personal loans require excellent credit and excellent debt-to-income ratios, 2 factors that often are not a reality for a business owner that needs money. This is another reason why an MCA loan can be attractive, although you pay more, MCA lenders offer bad credit business funding.

Business Credit Card

A business credit card functions as a revolving line of credit that business owners can borrow against as needed. Some business credit cards allow you to take out a cash advance – though you’ll pay extremely high interest rates. If you experience periodic cash flow issues, or just want to earn points from regular business purchases, consider opening a business credit card.

Business credit cards typically charge rates of 20% and higher, so they will cost more than a small business loan. But, unlike a loan, you only make payments if you’ve charged something to the card. Since business credit cards have lower limits than lines of credit or loans they’re not the best choice to fund a large business expansion or expense. Also, not having the available credit in cash makes it difficult to fund business operations. Remember, cash is king.

Merchant Cash Advance or an Alternative?

With multiple funding options you can research and find the best for your business. Depending on why you need the funds, a merchant cash advance could work, or there are sever business loan alternatives that could be a better fit. If you still need help deciding, reach out to the lending specialists at Shield Funding. The professional there will walk you through the pros and cons and help you make the best decision.