A merchant cash advance (MCA) is a type of financing that allows businesses that accept credit cards to borrow against their future credit card receipts. Merchant cash advances are commonly used by restaurants, retailers and other businesses to buy inventory, meet payroll and cover operational expenses, though they are typically much more expensive than other types of business financing, such as small business loans.
Learn more about merchant cash advances and whether an MCA may be right for your small business.
How does a merchant cash advance work?
A merchant cash advance is a type of financing that works like most personal cash advances — you receive a sum of money and pay it back over time. However, instead of making regular monthly payments like a conventional loan, the lender deducts a portion of your debit and credit card sales receipts until the loan is repaid in full, with interest.
For example, imagine you need some extra cash for the month. You apply for a merchant cash advance and receive enough money to pay your monthly obligations. The lender then receives a percentage of the purchase when a customer uses a credit card to pay for your goods or services. This continues until the loan is fully repaid with interest.
There are three key components of a merchant cash advance: the advance amount, the factor rate and the holdback. It’s important to understand how a merchant cash advance works before using one to help finance your business.
Before receiving a merchant cash advance, you’ll sign a contract that spells out the advance amount, or how much you’ll receive upfront from the lender. The lender will calculate your advance amount based on your monthly sales over the last few months of business. Some lenders use the previous three months of credit sales, while others use more.
When a lender approves an advance, it determines a factor rate. The factor rate of an MCA is the multiplier for the total amount you’ll need to pay back in fees. This number is usually between 1.1 and 1.5.
For instance, if you apply for and receive a $20,000 advance with a factor rate of 1.2, you’ll owe a total of $24,000. This is calculated by multiplying the $20,000 advance by the factor of 1.2. Depending on the lender, you may also have to pay an upfront administrative fee.
Your holdback rate is the percentage of daily credit and debit card sales that lenders deduct from your merchant account. This percentage is typically between 5% and 20% of your debit and credit card sales.
To go back to our example, imagine that the holdback rate from your MCA lender is 20% of your credit and debit card sales. If your business has $5,000 in credit card sales each month, you’ll pay just over $33 per day for a little less than two years to pay back the full $24,000. With an MCA, there typically aren’t any benefits of paying off the advance early.
On average, merchant cash advance lenders have holdback amount rates of 5% to 20%. Depending on your industry, location and other business details, a lender may charge more. A lender may increase your holdback amount if you have a low credit score or have been in business for less time than comparable businesses.
The advantages and disadvantages of an MCA
A merchant cash advance can offer some benefits to your business that a traditional loan may not, but it can also come with other disadvantages. Weigh the pros and cons of a merchant cash advance before making the final decision.
- Quick access to capital
- No collateral requirements
- No credit check needed
- Much more costly than traditional loans
- Daily withdrawals from your earnings
- No reporting to credit bureaus
Merchant cash advance advantages
Quick access to capital
Merchant cash advance applications move through approval much faster than loans. This is because MCA companies base lending decisions on your monthly credit card receipt volume rather than more lengthy considerations like credit score and business history. You can usually access merchant cash advance funds as soon as they’re approved. The lender then deposits the funds in your business checking account.
No collateral requirements
Many traditional loans require collateral for approval. Merchant cash advances do not, which makes them ideal if your small business doesn’t yet have assets it can use as collateral.
No credit check required
A merchant cash advance does not require a credit check, so your business can still benefit from an MCA with bad credit or thin credit. Credit checks can hurt your business’s credit score. Plus, if your business is new, it may not have a sufficient business credit score to qualify for a traditional loan.
Merchant cash advance disadvantages
Substantially more expensive than traditional bank loans
Traditional small business loans have much lower interest rates than MCAs. Through the Small Business Administration’s (SBA) lending partner program, you can get loans with APRs as low as 6% — extraordinarily lower than most MCAs, which, under some circumstances, can go as high as 300%.
You can also find loans from online banks with much lower rates than an MCA. However, you must still meet their credit requirements.
Daily withdrawals from your earnings
Rather than making monthly payments as you would with a loan, your MCA lender will withdraw daily payments from your earnings to repay the cash advance. If you encounter low-earning days, your merchant account will still incur withdrawals.
Because the holdback amount is paid as a percentage, you won’t have to pay back as much when you earn less. However, if you have too many days of lower-than-expected earnings, you could find yourself with financial issues such as struggling to pay for operational costs. For that reason, merchant cash advances are best suited to businesses with a consistently high sales volume.
No reporting to credit bureaus
In contrast to traditional lenders, most merchant cash advance companies don’t report payments to the main credit bureaus. This means an MCA won’t help your business build credit like a loan or credit card will.
How to get a merchant cash advance
To get a merchant cash advance, first familiarize yourself with the necessary steps and considerations. This can help you avoid hiccups and misunderstandings as you choose the right lender, agree on the terms and start the repayment process.
1. Find a suitable lender
When choosing an MCA lender, look for a reputable company that has low fees and holding amounts. Also compare the maximum funding available from each option. Many lenders model themselves to appeal to larger businesses with more market power, while others specialize in smaller businesses. Choose an MCA lender that provides the advance amount that’s right for your business.
Also consider the costs of borrowing when choosing a lender. Factor rates and holdback amounts can increase your overall payment, so compute your overall payback amount before determining which lender best fits your needs and budget.
Many MCA merchant cash advance brokers impose flexible borrower qualifications or avoid a credit check entirely. If your business is creditworthy, it may qualify for a lower factor ratio and a smaller holdback amount. However, if your business has a low credit score — or no credit score at all — look for a lender that relies solely on sales receipts or other indicators of financial stability.
Likewise, find a transparent lender that clearly states its costs, transaction fees and payment schedules. If you have questions, reach out to the lender and ask them. If you can’t get the answers to your questions, choose a different lender.
Merchant cash advances aren’t regulated under federal law, so do your due diligence when choosing a lender, perhaps looking for companies that are accredited by the Better Business Bureau (BBB) or have trustworthy online reviews.
One of the most significant issues with MCA companies involves confusing and misleading sales tactics. The Federal Trade Commission (FTC) has brought charges against companies for using deceptive methods towards small business owners. This doesn’t mean all lenders use predatory practices. However, you should thoroughly read all contracts and paperwork before you sign an MCA agreement.
Some reputable merchant cash advance companies include:
- Credibly, with factor rates starting at 1.09
- Expansion Capital Group, with factor rates of 1.26 to 1.50
- Rapid Finance, with factor rates starting at 1.22
- Libertas Funding, with factor rates that vary on qualifications
- National Funding, which has factors of 1.17 to 1.36
- PayPal Working Capital, with factors of 10% to 30% of your daily PayPal sales
2. Submit your application with the necessary documents
Depending on your chosen lender, the application process may not take long — some may even approve you in less than one business day. To qualify for an MCA, you may need documentation showing the last three to six months of credit card sales and total revenues. The top factors that influence MCA approval are whether you accept credit and debit card sales and your monthly income.
The lender may also ask about your industry and your business cycle. If your business hasn’t been around for more than six months, the lender may use industry averages to determine your qualifications. Whether your business experiences seasonal sales fluctuations can also influence your approval odds.
3. Get funded
Once a lender approves your MCA request, it will typically deposit the funds into your merchant account immediately. The advance amount depends on what you request in your application and what your business qualifies for. Some lenders approve up to $500,000 or more in cash advances for businesses with enough debit and credit card sales to warrant that amount.
Depending on the conditions of your advance, you’ll likely receive the entire amount in a single deposit. Once the merchant cash advance company transfers the cash to your account, it will start making daily withdrawals for repayment. Always keep enough funds in the account to cover payment during the entire repayment period.
Merchant cash advance alternatives
There are several alternatives to choose from if you don’t want to commit to a merchant cash advance or can’t afford to make daily payments.
- Business line of credit: A small business line of credit is an open credit account with a limit that lets you access cash for your business on an as-needed basis. Interest only accrues on the outstanding balance — not the entire line. To qualify, you’ll need a credit score of at least 620 and annual revenue between $25,000 and $250,000, depending on the lender.
- Traditional business loan: Business loans are available from traditional financial institutions like banks and credit unions and come with more competitive interest rates — and longer repayment terms — than MCAs. Your business may also qualify for a loan from the Small Business Administration (SBA), which offers more accessible qualification requirements than some lenders. If you don’t need a large loan, you may qualify for an SBA microloan of up to $50,000.
- Online business loan: Online lenders typically have less stringent eligibility criteria than banks and credit unions, so an online business loan may be easier to qualify for. Interest rates are typically higher than for traditional loans, but you’ll pay less than you would for an MCA and funding speeds are fast. Several reputable online small business lenders include OnDeck, Funding Circle and SmartBiz.
- Business credit card: Business credit cards usually come with APRs anywhere between 11% and 30%, which is higher than traditional business loans. However, these rates make credit cards cheaper than many MCAs. Plus, business credit card applications are typically streamlined and you may get instant access with a virtual card number.
- Crowdfunding: Equity crowdfunding involves selling equity in your business to investors. Along with private investor equity, crowdfunding presents a lucrative way to raise funds. It pays to be cautious with equity, however, as some private equity investors may demand more involvement in your business than you want to give them.
Is a merchant cash advance the way to go?
If your business doesn’t have assets to use as collateral for a loan, a merchant cash advance may be a good option. And, if you need cash immediately, a merchant cash advance with same-day funding could mean the difference between staying afloat and closing the doors for those just getting started.
On the other hand, if you have enough working capital to get you through a few months, apply for a small business loan or other alternative that will cost less over the life of the loan. Also consider a business credit card, which will likely come with lower fees than a merchant cash advance.