Last Updated on April 3, 2024
Shield Funding Team
If you’re a small business owner who’s ever typed “get cash fast” into a search bar, you’ve probably seen an ad for a merchant cash advance pop up. The offer could look like a good deal – one that gets you the cash you need quickly. But be careful! The cost of that quick cash could quickly outweigh its benefits. A merchant cash advance or MCA is a risky financial product that can be a good fit for a business owner if that individual understands how to manage higher costing financial products.
Some MCAs can have an annual percentage rate — the total cost of a loan, including all fees — in the triple digits. The repayment cost and daily repayment schedule can cause serious cash-flow problems. If you don’t handle the debt well, MCAs can lead to a debt trap, where it’s virtually impossible to repay the advance and you must refinance into rolling MCAs or file for bankruptcy.
It is important when opting for an MCA that you work with a lender that is established and trustworthy. There are good lenders that offer merchant cash advances at a very competitive rate. Most trusted lenders will be in business for more than a decade and there will be reviews easily found on the company. Good financial experiences are often determined by the lender chosen.
Many finance professionals only consider MCAs a reasonable financing option if you have already exhausted other avenues. Borrowers should know what they’re getting into – and the pros and cons of merchant cash advances – before accepting the lender’s cash.
A merchant cash advance is a way to get fast working capital for your business without going through a traditional business loan process. It is an advance of money against future credit card sales. It is typically offered as an alternative to a small business loan because it’s not technically a loan. When you take out an MCA, you’re pledging the lender a percentage of your future credit card sales as repayment until the balance of advance and any fees are paid back.
A merchant cash advance is great for businesses whose revenue comes primarily from credit and debit card sales, such as restaurants or retail shops. Any business that processes credit cards can take out a MCA, but if you do a low volume of credit card sales another loan product might be a better fit for your business.
Merchant cash advance repayments typically take one of two forms.
With the first option, you receive a sum of cash upfront in exchange for a slice of your future credit and debit card sales. The lender takes their repayment every time you swipe a credit card from the date of the loan until it’s paid off.
Or, you can get upfront cash that is repaid by remitting fixed daily or weekly debits from your bank account. This option is best for businesses with variable credit card sales, because it allows providers to extend credit to businesses that aren’t primarily tied to credit and debit card sales.
Unlike a traditional loan – where you make one monthly fixed payment from a bank account over a set repayment period – with a merchant cash advance you make daily or weekly payments, plus fees, until the advance is paid in full. This payment is referred to as a “holdback,” and it’s the percent of your sales that are held back by the lender to repay the advance. Some providers offer the option of a fixed daily payment, but this can cause more difficulties managing cash flow.
The lender calculates how much you’ll pay in fees is determined by your ability to repay the merchant cash advance. They’ll perform a risk assessment, including analyzing past credit card sales, pulling your credit score, and looking at how long you’ve been in business, to determine a factor rate. Typical factor rates for MCAs range from 1.2 to 1.5 (a higher rate equals higher fees).
To see how much you’ll pay for the advance, multiply the cash advance by the factor rate to get your total repayment amount. For example, an advance of $60,000 that carries a factor rate of 1.4 represents a total repayment of $84,000. MCAs have a high cost of borrowing, as you’ll pay $24,000 for that loan.
With such a high cost of borrowing you’re probably wondering why anyone would take out a merchant cash advance. Despite their costs, however, there are reasons why a small business owner would choose a MCA to fill their capital needs.
1. They’re quick to fund.
Forget months of submitting documentation to a bank and waiting on underwriting for approval – you can often get an MCA within a few days to a week. Providers don’t demand the same level of documentation as a bank, they’ll look at your business’s daily credit card receipts and a few other factors to determine if the you can repay the advance.
2. MCAs don’t require physical collateral.
Some small business lenders require collateral to fund a loan. You might be asked to pledge business assets upfront to back the loan – risking those assets if you can’t afford to repay it. MCAs are unsecured, though you will likely have to sign a personal guarantee. A personal guarantee is a written agreement that makes you personally responsible for repaying the advance. In the event you can’t repay, the MCA provider can recoup any losses from personal assets.
3. When sales are down, your payment may be too.
MCA repayments align with your cash flows. Because the repayment schedule is based on a fixed percentage of your sales, repayments adjust based on sales. In a slow week you don’t have to worry about coming up with a larger, lump sum loan payment.
4. Easy repayment schedule.
Juggling multiple loan payments and the daily bookkeeping and budget of a small business can get to be a lot. Many small business owners like the ease of repaying a MCA.
5. Use the funds at your discretion.
If you take out an equipment financing loan you have to purchase a piece of equipment with the funds. Many loan products can only be used for specific purchases, like a mortgage to buy a building. When you take out a MCA how you use the money is entirely up to you. For more information check out the pros and cons of an mca.
Despite the benefits a MCA could bring to your business, it has some drawbacks. You should take these into account when deciding whether or not to borrow.
1. Your APR could be in the triple digits.
The annual percentage rate represents the total annual borrowing cost with all fees and interest included. The APR for a MCA typically ranges from about 30% to 99%, far more expensive than traditional bank loans, with APRs of 10% or less, or business credit cards with APRs from 12.9% to 29.9%.
The APR depends on the lender, the size of the advance, any extra fees, how long it takes you to repay the advance in full, and the strength of your business’s credit card sales as well as your history of repayment.
2. Higher sales mean a higher APR.
For MCAs repaid with a percentage of your credit card sales, the APR depends both on the total fees paid and on how fast you repay the funding. If you have weak sales it spreads your payments out over a greater length of time and your APR drops. If you’re pulling in strong credit card sales, you repay the MCA faster — and, subsequently, APR goes up.
For example, the lender might offer you a $100,000 advance with a factor rate of 1.4, for a total repayment of $140,000. If you repay it in just six months, the APR would be a minimum of 60%. If you repay it in 12 months, the APR would be a minimum of 30%.
3. There’s no benefit to repaying early.
No matter what, you have to repay a fixed amount of fees to the lender. There are no interest savings from early repayment. This is different from a traditional “amortizing” small-business loan, in which early repayment would reduce the amount of interest paid. If you decide to refinance, you’ll still have to pay all of the agreed-upon fees, and you may also get hit with an early repayment penalty.
4. Your credit score may be pulled.
Although MCAs can be an option for business owners with bad credit, the MCA provider may check your credit score during the application process. If the provider’s credit inquiry results in a hard credit check, it can hurt your credit score.
A MCA also doesn’t help your credit score. Repaying a loan builds credit, but MCA providers don’t report loan repayments to credit bureaus. Taking out and repaying a MCA won’t give your score a boost.
5. You run the risk of falling into a cycle of debt.
It’s almost too easy to take out a MCA. MCAs can put you into a debt cycle if you don’t qualify for other types of financing. Borrowers may need to take out another advance soon after taking on their first one due to the extremely high costs and frequency of repayments of MCAs, which can cause cash-flow problems. A daily payment of hundreds of dollars, for example, could strain your cash flow and put you at risk of default.
6. Contracts can be confusing.
Contracts for MCAs aren’t easy bedtime reading. They’re often loaded with unfamiliar terms, such as specified percentage (the percent you repay out of credit card sales), purchase price (the amount the lender advances) and receipts purchased amount (total payback amount). MCA providers do not provide APRs, making it difficult to compare them to other financing products. The provider may also require that you sign a legal document called a confession of judgment, which forfeits your right to defend yourself if the company takes you to court.
While a merchant cash advance can help business owners solve liquidity problems by providing capital when the business needs it most, it is not for everyone. Before applying for a merchant cash advance, the following steps must be considered carefully:
The obvious and most important questions is can you afford an MCA? Evaluate the repayment schedules in view of your business strategies. A merchant cash advance has a unique repayment schedule. With a merchant cash advance, business owners don’t have fixed payment schedules. Merchant cash advance lets the borrowers pay the advance by subtracting a fixed percentage on the credit or debit card sales until the advance amount plus the fee is fully paid. Does this repayment strategy coincide with your business strategies in the long run?
Also important to consider is your return on investment or ROI. Will you make more money over the life of the advance after you invest it in your business. This may involve making tricky projections, but it is imperative the you consider how much return you will get on your investment into the business.
Often the merchant cash company will ask you to switch to another credit card transaction company? Some merchant cash advance providers are partnered with a specific credit card transaction company to ensure you receive better rates. Switching a credit card transaction provider involves costs that must be taken into consideration. Can you justify the cost of switching your credit card transactions provider?
Can you obtain the amount you need from other sources that are less expensive? While a merchant cash advance is a great alternative to regular loans, it is also a more expensive source of funding due to the fact that it is a riskier loan product.
Ready to borrow? Here are the best uses for merchant cash advances funds:
For an extensive list of how previous clients have utilized their mca check out the best uses for a merchant cash advance.
How do you qualify for a merchant cash advance? Your business must generate minimum monthly revenues of $8,000 and you need a credit score above 500. You only need two months in business although six months is ideal, unlike a traditional bank loan, which makes a MCA a good borrowing option for newer businesses.
Before applying, make sure that you have a clear plan to repay the advance. Put together a budget and plan for how daily repayments will impact your cash flow and, thus, your working capital. While a merchant cash advance is not the cheapest way to access capital, it can be a good choice for your business if you know how to manage it.
