What Is A Merchant Cash Advance?

What Is A Merchant Cash Advance?

If you’re wondering what is a merchant cash advance, you’re in the right place. Most businesses need to borrow additional funds to maintain operations from time to time. This may be to purchase inventory or pay employee salaries.

Wondering what is a merchant cash advance? Learn about merchant cash advances & discover about how they work, the pros, the cons, & more.

While searching for financing for your business, you’ll come across various financial solutions. One of these is a merchant cash advance (MCA). An MCA is a non-loan form of capital that involves selling your future credit sales to a lender for cash.

The approval rate and turnaround time for an MCA are higher than for a traditional loan. However, the fees are more significant.

If your business needs immediate financing, an MCA may be worth considering. We’ll explain what is a merchant cash advance. In addition, we’ll walk you through everything you need to know about getting an MCA. Let’s dive right in.

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What is a Merchant Cash Advance (MCA)?

A merchant cash advance, or MCA, is a non-loan form of financing. An MCA involves leveraging your company’s future credit sales to access capital from an external lender. Think of it as discounting your company’s future credit sales. A percentage of your future receivables will pay back the money you borrowed.

Small and medium-sized businesses opt for an MCA because you don’t need collateral. Also, your personal and business credit score doesn’t affect your chances of being approved for an MCA. It’s the best way to access immediate funds for your business to maintain cash flow and growth.

Now that you know what is a merchant cash advance let’s look at how it stacks up against a business loan.

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Merchant Cash Advances Vs Business Loans

When looking into what is a merchant cash advance, you should know off the bat that it’s unlike a business loan. An MCA doesn’t have a fixed payment. The terms are also different from a business loan.

An MCA is a safe way to access capital for your business. Since it’s an unsecured source of financing, you don’t have to put up an asset as collateral. However, this kind of financing carries higher rates because it’s a greater risk to a lender.

Much like applying for a business loan, a lender will run a credit check. However, your credit rating won’t play a significant role in your chances of approval. A lender will look at records of your company’s performance and future credit sales, and consider your years in business instead.

Uses of a Merchant Cash Advance

If you consider a merchant cash advance, you’ll also need to know its use. Merchant cash advances can be used for various purposes to grow a business. This includes:

  • Purchasing inventory
  • Expanding to new locations
  • Additional cash flow
  • Paying salaries
  • Advertising and marketing campaigns
  • Employee hiring or training
  • Covering seasonal costs

With so many uses for an MCA, you must have a plan before getting one. Put the money you receive to work in an area that will quickly recoup the investment. That way, you can pay off what you owe fast. Now that you know what is a merchant cash advance used for let’s look at how it works.

How Merchant Cash Advance Works

An MCA provider will lend you a certain amount of money based on your past sales records. They will look at invoices from previous financial periods and other records to assess your business’s financial performance. Once they approve the MCA, you’ll sign an agreement with the lender. This contract details:

  • Advance amount – The agreed-upon amount a lender gives you. It can be higher, equal to, or less than your monthly sales.
  • Holdback percentage – The portion of your daily sales will pay back the merchant cash advance. It’s derived from your monthly receivables, the time it’ll take to repay the advance amount, and the funds granted.
  • Payback amount – The total amount you’ll pay for financing. It includes the factor, which is a fee charged by an MCA lender. The factor rate varies by lender and business, based on the MCA provider’s risk assessment. A higher factor rate translates to higher fees.

Paying off an MCA is tied to the daily balance in your merchant account. Therefore, the more business your company does every day, the faster you’ll repay the funds. If you experience periods with fewer transactions, the deductions from the merchant account will be lower. This means it’ll take longer to repay the advance.

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Why Opt for an Merchant Cash Advance

Several business owners prefer MCAs because of the following reasons:

  • Easy application. Unlike bank loans, you won’t have to deal with strict lending criteria and a complex application process. Most of the time, applying for an MCA requires completing an application online. You can upload any supporting documentation on the MCA provider’s system without hassle. The approval rates are often high, so you don’t have to worry too much about your application being rejected.
  • Quick access to funds. After applying for an MCA, you’ll typically receive your funds in two to three business days. Some MCA providers can fund you the same day you apply if it’s a small amount. Therefore, if you need immediate cash to purchase inventory, an MCA may be your best bet.
  • No collateral is required. Collateral can stand in the way of getting the funds you need for your business with a traditional lender. MCAs are an unsecured means of financing, meaning you won’t have to secure the advance with assets.
  • Flexible repayments. MCAs don’t have a fixed monthly payment. Instead, a flat rate is charged on your credit sales. This means repayments fluctuate with your business’s sales. Therefore, if you make fewer sales, the repayment will be less.
  • Ideal for bad credit. If a poor credit rating keeps you from being approved for financing, an MCA is ideal. Lenders won’t focus on your credit score as much as they will on your company’s financial performance.

Reasons to Be Cautious About an Merchant Cash Advance

While there are many advantages to an MCA, there are also several drawbacks worth considering.

  • Unregulated industry. MCA providers can charge as much as they want because the industry isn’t regulated. While they claim to self-regulate, many don’t offer fair deals to consumers.
  • Triple-digit APRs: Since MCAs aren’t regulated, they can carry an annual percentage rate (APR) up to 120%. The APR differs from lender to lender, but it’s often higher than what you’d be charged for a bank loan. This can be harmful to your business if you can’t afford to pay what you owe in the future.
  • No interest savings. Unlike a traditional loan, you won’t benefit from interest savings when you make early repayments. The reason is that you have to pay a fixed amount of interest no matter what.
  • Reduced cash flow. While you receive immediate funds to improve your business’s cash flow, it only lasts for some time. Once you make repayments against the advance, you may experience cash flow problems. This is because a percentage of your revenue will be withheld to pay off the MCA. Therefore, if you have periods with low sales, most of your income could go towards paying the advance.
  • Contract traps. MCA contracts can be confusing. They may have unfamiliar terms, and lenders can omit the APR. Therefore, read the contract thoroughly and make sure you understand all the terms before signing.
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Alternatives to an Merchant Cash Advance

When researching what is a merchant cash advance, you may come across other forms of financing. This includes secured and unsecured business loans, business lines of credit, and guarantor loans. Therefore, before settling on a merchant cash advance, assess all the financing options available to you.

You may qualify for a business loan with a strong business and personal credit rating. Several lenders provide loans to those with bad credit as well.

A merchant cash advance won’t work for you if you want to build your business’s credit. The reason is that repayments aren’t reported to the business credit bureaus and thus won’t appear on your credit report. Look into getting a secured loan instead that you can collateralize with a vehicle or your home’s equity.

A guarantor loan is another alternative to an MCA. You will often be eligible for these loans since someone with good credit co-signs the agreement. A business line of credit is also worth looking into. It’ll grant your business immediate cash flow in an emergency without the high fees associated with an MCA.

The best alternative for many is online small business loans. These provide you with immediate access to cash like an MCA, but they come at a lower rate. An online business loan can improve your business’s credit rating as well.

The Bottom Line: What is a Merchant Cash Advance?

Merchant cash advances are the most enticing of all the capital sources available to business owners. The amount of money you receive depends on your future credit sales. Your credit score or ability to attach collateral to the advance doesn’t play a significant role in your chances of approval. Given the simplicity of MCAs, it’s no wonder many people opt for them.

Despite all the good that comes with an MCA, there are also significant drawbacks. It can affect your business’s cash flow. What’s more, you may get an MCA with a three-digit APR, making it unaffordable in the long run.

Remember to weigh the benefits against the drawbacks when considering a merchant cash advance. Also, look into alternatives that may work better for your business and situation. Finding a financing solution for your business is an important decision. Therefore, take your time to ensure you make the best choice for your company’s success.

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April 16, 2022
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