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- A merchant cash advance forwards cash against future sales.
- MCAs have aggressive repayments that disrupt profitability until it’s repaid.
- Borrowing fees are high with rates of 50 percent to 100 percent or more.
If your business sells products via credit or debit card payments but sees a dip in sales, a merchant cash advance (MCA) could help you make ends meet temporarily. Most applications are accepted as long as you have enough sales history to show that you can repay. But since MCAs aren’t business loans, they’re not limited by lending laws and can charge top-dollar in borrowing fees.
Let’s dive into the ins and outs of getting a merchant cash advance.
What is a merchant cash advance?
A merchant cash advance is an alternative type of business financing that advances a lump-sum payment based on future credit or debit card sales. You’re essentially guaranteeing the advance with future revenue. This type of financing is typically for businesses that get revenue through credit card sales.
But the advance isn’t technically a business loan, and MCAs don’t report your payment history to the credit bureaus. So you won’t build credit through this financing. Eligibility guidelines for MCAs are loose, making it easy for businesses with bad credit to get approved.
- MCAs: 90%
- Equipment loans: 87%
- Business line of credit: 76%
- Business loan: 66%
- SBA loan or line of credit: 64%
How does a merchant cash advance work?
A merchant cash advance loan forwards payment to your business against future credit or debit card sales. It’s typically used to increase working capital for businesses and cover cash flow gaps. The advance works like this:
- Your business receives the cash. You and the financing company agree to the amount your business needs. The funds are dropped in your business bank account.
- The financing company charges fees. Instead of an interest rate, MCAs typically charge a factor rate that gets multiplied by the entire loan amount. For example, a $100,000 advance with a factor rate of 1.4 would cost a total of $140,000.
- Your business repays based on future sales. Repayments are often daily, though some MCAs offer weekly payments. The advance is repaid once you pay the borrowed amount plus the factor rate and any other fees.
Refinancing merchant cash advances
Some MCAs allow you to refinance your cash advance if you need to extend the repayments. The trouble with refinancing is that most MCAs still require you to repay the total borrowing cost from the first advance.
If you refinance, the new advance may calculate interest on the first advance’s borrowed amount plus fees. You’ll then be paying interest on interest, which can trap you in a cycle of debt until you repay the advance in full.
Merchant cash advance repayment terms
Merchant cash advances come with two options for repayment terms: a percentage of your credit card sales or a fixed payment. Most MCAs also keep repayment periods short, typically 18 months or less, depending on the lender.
Percentage of credit and debit card sales
Most MCAs structure repayments as a percentage of your credit or debit card sales, also known as a holdback. Holdbacks range from 10 percent to 20 percent of sales revenue. Because you’re paying a percentage, the exact amount paid to the financing company varies with each repayment.
You can estimate your repayment term based on how much you make in sales. But the terms may be drawn out if sales dip at any point.
Let’s look at the example of a $100,000 cash advance with a 1.4 factor rate. The total borrowing cost would come to $140,000 ($100,000 x 1.4 = $140,000).
If you generate $50,000 in sales each week and pay 20 percent toward the advance, it would take your business 14 months to repay the advance. To calculate the repayment term:
- Calculate each repayment: $50,000 in weekly sales x .20 (20% holdback) = $10,000 repayment
- Figure out how long it will take to repay: $140,000 / $10,000 = 14 weeks
Some MCAs take fixed withdrawals directly from your business bank account each day or week, similar to a conventional business loan. The fixed amount is calculated from your estimated monthly sales, and you can figure out how long it will take to repay the advance plus borrowing fees.
But while the repayment term is predictable, you don’t have the flexibility to extend it if revenue slows down.
Merchant cash advance rates and fees
You’ll want to take note of the fees listed in the MCA agreement and ask questions if you don’t understand the borrowing costs. Merchant cash advance loans subtract these fees upfront. If the MCA charges $1,000 in fees for a $5,000 advance, your business will receive $4,000 in funding.
Typical financing fees for MCAs:
- Factor rates. MCAs may charge factor rates between 1.1 to 1.5, multiplying that rate by the amount you’re borrowing. These are typically charged on business loans for riskier borrowers.
- Origination fee. This fee is charged as a percentage of the borrowed amount and is a common fee for other business loans as well.
- Underwriting or funding fee. This fee is charged for reviewing the financing application. It may get charged as a percentage of the borrowed amount or a flat fee, depending on the financing company.
- Administrative fee. This flat fee covers the cost of processing or maintaining the MCA agreement.
Factor rates: Why MCAs are expensive
Because merchant cash advances charge a factor rate, the cost of borrowing is often higher than other types of business financing, such as a working capital loan.
Take the $100,000 cash advance with a factor rate of 1.4 and a 14-month repayment term, for example. If you convert the factor rate into an interest rate, the annual interest rate for the $100,000 advance is 34 percent.
By comparison, if you were able to take out a short-term loan for the same amount with a 34 percent APR for one year, you would have more time to pay off your loan. Monthly payments would also be smaller, and you’d pay less in borrowing costs overall. Use a business loan calculator to help you crunch the numbers and see how much more expensive factor rates can be.
Pros and cons of MCAs
- Approval rates as high as 90 percent. Merchant cash advances are an accessible type of business financing for bad credit borrowers. MCAs may take businesses with credit scores in the 500s.
- Fast funding. Most MCAs are offered through online lenders, which often fund within 24 to 48 hours. You may be able to apply through a streamlined online application.
- No collateral needed. MCAs use future revenue to guarantee repayment, which means the financing company won’t require you to back the advance with other business collateral.
- Daily or weekly repayments. You’ll be on the hook with this aggressive repayment schedule until the advance is fully repaid.
- Factor rate fees often cost more than conventional loans. The fees paid on an MCA can translate into interest rates of 50 percent to 100 percent or higher.
- Doesn’t build credit. MCAs don’t report your payments to the credit bureaus, so you won’t improve your credit through this financing option.
- Not subject to loan usury laws. MCAs aren’t technically business loans, so they’re not required to abide by maximum interest rates set by each state’s usury laws.
Alternatives to merchant cash advances
Merchant cash advances work well as a last resort to cover temporary gaps in cash flow. But if your business qualifies for other small business loans, you’ll probably pay much less in interest and fees than with an MCA. Alternatives to explore include:
Like a merchant cash advance, a business term loan provides a lump-sum payment upfront. But you make repayments on a fixed schedule, no matter your current revenue, rather than tying repayments to your sales.
There are several types of term loans that you may run across, including:
- Short-term loans. Short-term business loans come with fixed repayments over a short time period, usually six to 24 months. These are often offered through online lenders with streamlined applications and quick funding speeds.
- Asset-based loans. Asset-based loans are secured business loans that determine funding primarily by the value of assets instead of cash flow. This makes it more accessible to businesses with less-than-perfect credit but significant assets. Businesses may use accounts receivable, inventory, equipment, real estate and even intellectual property as collateral.
- Bridge loans. Bridge loans are short-term loans designed to cover financial gaps temporarily until your business finds other financing. Lenders approve these loans more quickly, though interest rates may be higher than conventional term loans.
- Equipment loans. An equipment loan offers your business payment to purchase, upgrade or refinance commercial equipment. Since the loan is secured by the equipment, it may offer interest rates as low as 5 percent, compared to 8 percent starting rates for unsecured term loans.
- SBA loans. If you don’t qualify for conventional term loans, you may be able to get a loan backed by the U.S. Small Business Administration. SBA loans often come with long repayment terms and low interest rates, helping to make repayments manageable.
Business lines of credit
Business lines of credit can be one of the easiest types of conventional business loans to qualify for. Online lenders keep eligibility requirements loose, such as requiring a 600 minimum credit score and as little as six months in business.
Loan amounts can range from $1,000 to $250,000, providing your business with a moderate amount of working capital to cover day-to-day expenses.
A business line of credit works by setting a maximum credit limit that you can borrow from at any time. You have fixed repayment terms once you draw funds, but your credit limit replenishes as you repay the loan.
Business credit cards
Business credit cards are a solid option if your business doesn’t need much funding or doesn’t qualify for business loans. The card sets a credit limit, such as $50,000, and typically offers 1 percent to 5 percent rewards for purchases. APRs can range anywhere from 14.00 percent to 28.00 percent.
If you don’t have good credit, you’ll need to find credit-building business credit cards. For example, the Spark 1% Classic is designed for fair credit borrowers and doesn’t charge an annual fee. It also offers 1 percent cash back on all purchases. Its APR is higher than business credit cards reserved for good or excellent credit but much less than you’d pay in merchant cash advance fees.
Invoice factoring or invoice financing
Like merchant cash advances, invoice factoring sells your future revenue to a factoring company, except you sell outstanding invoices instead of future credit card sales. The factoring company advances a percentage of the total invoice amount to you. It then collects payment from your clients, takes out fees and pays your business the remainder.
Invoice financing also uses outstanding invoices to provide you with a cash advance. But you’re responsible for collecting the payments instead of the financing company.
If you need business financing without repayment strings attached, you can look into business grants, which provide a one-time payment of funds if you meet qualifications and win the grant. Federal, state or local governments are good places to start looking for grants, but some corporations and non-profit organizations also provide them.
Because it’s free money, grants tend to be competitive and may have specific requirements, such as being a minority-owned business. You may need to provide plenty of documentation or even presentations to win the grant.
Merchant cash advances can help when your business needs cash immediately to cover day-to-day expenses, and nearly any business with card sales can qualify even with bad credit. But its high fees and aggressive repayments may not be ideal for businesses with persistent cash flow problems.
If you don’t qualify for loans with traditional banks, consider business loans designed for bad credit borrowers, which may offer significantly lower interest rates than MCAs.
Frequently asked questions
While beneficial for cash flow gaps, merchant cash advances charge high fees and typically require aggressive daily repayments. This option works best for businesses that need funds quickly and get their revenue from card sales. It may not be a good idea for businesses that qualify for other business loans.
Merchant cash advances can help businesses having difficulty finding funding, offering the capital needed to cover day-to-day expenses. But if you miss payments and default on the advance, the MCA company can sue you. If it wins in court, it can seize business assets to repay the advance.
You can typically write off the interest portion of a business loan. While merchant cash advances aren’t a loan, you may be able to write off its fees on your annual taxes. But like a business loan write-off, you can’t use the advance to invest in business growth.