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Is a Merchant Cash Advance Right for My Business?

Joan PabonJun 28, 2017

If you’re a business owner in need of quick access to capital, you may be wondering if a Merchant Cash Advance (MCA) is right for your business. As opposed to a regular term loan the approval process for an MCA is short, and credit requirements are rather flexible, yet this option may also have considerable drawbacks.

What is a Merchant Cash Advance?

A merchant cash advance, also known as credit card receivable funding, is a viable alternative for small businesses that accept credit cards, have compromised credit, and need short-term financing to cover business-related expenses. An MCA is not an actual loan, but rather the sale of a percentage of a business’ future debit and credit card sales. That means a merchant cash advance can be obtained in a relatively short amount of time in comparison to a conventional loan, but will likely carry very high interest rates. This type of financing is an option for restaurants and retailers that have a steady volume of credit and debit card sales, but have bad credit or no collateral and therefore don’t qualify for conventional bank loans.

How Merchant Cash Advances Work

Typically, MCA providers will offer businesses a lump sum payment or cash advance in exchange for a percentage of their future credit card sales. Providers first determine a factor rate that ranges from 1.2 to 1.5 based on a risk assessment that takes into account the businesses’ credit card processing statements, bank statements, years in business, and business tax return. The amount of the advance you request multiplied by the factor rate will equal your total repayment amount. For example, if you borrow $25,000 with a factor rate of 1.3, you would be paying $7,500 for those $25,000. Higher factor rates mean higher fees, so understanding how that will affect the actual cost of your loan or annual percentage rate (APR) could be useful knowledge when repaying your advance.

MCA Loan Cost and Repayment

MCA lump sums can range from $2,500 to $250,000 and can be received in as little as one week. Once the advance is paid out, your credit card processor will deduct a portion of your business’ daily debit or credit card sales – also called holdback – until the provider receives the total amount of future sales they purchased. Some providers may ask for a percentage of your daily credit card sales, while others may require you to pay a fixed daily or weekly amount. Regardless of the repayment option, the more credit card transactions you have, the faster the advance will be paid off – usually in less than a year. Something to keep in mind is the speed at which you estimate you’ll be able to pay back the advance. Before committing to this type of financing, consider how a drop in your credit card sales could affect your APR or dangerously restrict your businesses’ cash flow.

Merchant Cash Advance vs. Factoring

Business owners considering different financing options may have wondered about the difference between merchant cash advances and invoice factoring. Both options may seem similar at first glance, but cash advances work as short-term loans would, while invoice factoring is more akin to a risk transfer from a business to a third party – called a factor. Factoring, also known as accounts receivable financing, is when a business sells its accounts receivables or outstanding invoices to a factoring company at a discounted price. Factoring companies buy invoices from businesses’ and pay them an initial advance of 85% of their total value, once they collect from the business’ clients, they pay the business the remaining advance. Factoring fees usually range from 1% to 5% and companies often pay out between 50% to 90% of the total value of the unpaid invoices. Factoring can be an excellent option for businesses whose clients owe them money and need cash quickly, but rates can also be higher than those of other financing options, and factoring companies may charge additional fees for canceling the service.

Is a Merchant Cash Advance Right for Your Business?

The biggest drawback of merchant cash advances is that, since they’re not considered loans, providers are not bound by usury laws that regulate and set a limit to interest rates, which can be quite steep. Ask yourself the following questions and get informed about other financing options before you take the plunge:

• Does your business have a constant volume of monthly credit card sales?

• If so, do you foresee that remaining true for the next 12 months?

• How does your business make the most of its income?

• Do you qualify for a regular loan or have enough recent unpaid invoices to opt for other alternatives such term loans or factoring?

The primary requirement for a business to qualify for a merchant cash advance is to have a stable volume of monthly credit card sales. The application process itself tends to be relatively straightforward. Businesses are typically required to provide documentation such as bank statements and evidence of credit card processing for previous months, among other essential documents. Although some providers may check your credit, having compromised credit or no collateral –or both– should not be a problem. Approval could take place within days, yet some providers may ask businesses to switch credit card processors before paying out the first advance.

What to Watch out For

When choosing an MCA watch out for the following:

• A High APR – If you’re repaying your MCA through a portion of your credit card sales your APR will be affected by how long you take to pay off the advance. If your card sales drop, you may end up paying for a longer term than originally expected and your APR will drop. If your credit card sales are up, your APR will increase accordingly.

• No Regulation – Because advances are not considered loans, MCA providers are not regulated by usury laws designed to protect consumers.

• Defaulting and Debt – You could find yourself trapped in a cycle of debt if you don’t qualify for other financing options and a fixed repayment puts your business’ cash flow in a chokehold.

In a nutshell, look out for interests, fees, and repayment methods that could adversely affect your credit or restrict your business’ cash flow. If you already know the lump sum of your MCA and how much you’re expected to pay back, use an online merchant cash advance APR calculator to help you keep track of how much your advance will cost you in the long run.