Merchant Cash Advances

Are you a proprietor of a small business with cash flow challenges? Have you received advertisements about merchant cash advances in the mail? Before considering the offer, you should be aware of the costs and other alternatives like business debt consolidation.

Starting and operating a small business can be a risky proposition. With sales being highly variable and costs fluctuating, a predictable and stable balance sheet is rare. So, when a merchant needs money fast without having to provide collateral (like their home or business property), a type of financing option called a merchant cash advance (MCA) can be pretty attractive. Companies like PayPal and Square have entered this space.

A merchant cash advance isn’t a loan. It’s a cash advance where a company lends money to a cash-strapped business in exchange for future earnings.

How Merchant Cash Advances Work

A merchant cash advance company provides a sum of money to a business. In return, the business agrees to give the company a percentage of its credit card revenue. This definition is how merchant cash advances have worked historically.

This initial structuring of the cash advance has now been surpassed in popularity by an automated clearing house or ACH withdrawal advance. In this case, the upfront cash is repaid by debits directly drawn from the merchant’s bank account.

How Merchant Cash Advances Are Calculated

A merchant cash advance uses a factor rate to determine the cost of funding. To see how much your cash advance will cost, multiply the factor rate by the loan amount. For example, a $50,000 loan with a factor rate of 1.2 equals $60,000. This means if you borrow $50,000, you’ll owe $60,000 ($50,000 x 1.2 = $60,000) total.

Merchant Cash Advances may be helpful for businesses prone to volatile sales periods or relying heavily on seasonal transactions. Historically, they’ve been popular among restaurants and retail stores.

Why Do Businesses Choose to Use MCAs?

Merchant cash advances are an alternative to traditional small business loans. Many banks have been wary of funding small business ventures since the financial crisis of 2008. When cash flow problems persist, a merchant cash advance may seem like a good solution.

Here are some reasons businesses choose to use MCAs:

They are fast – MCA applications get to the point. A few months of credit card and bank statements is all it takes for businesses to receive funding in a matter of 24-72 hours.

No physical collateral required – MCAs are unsecured. There are no business assets on the line should things go south during repayment.

Repayment typically based on a fixed percentage of sales – The higher your sales, the faster you’ll repay the MCA. On the flip side, if sales drop, the amount you owe each month will drop as well. You’re obligated to repay the total amount regardless of sales revenue.

MCAs are convenient, but they can drain your cash flow and come with incredibly high-interest rates. Depending on your needs, you may find another funding option more practical. Here are some alternatives to a merchant cash advance:

  • SBA loan
  • Business line of credit
  • Invoice factoring
  • Crowdfunding
  • Equipment leasing

Merchant Cash Advance Risk

If you intend to take advantage of an MCA, you should know what’s at stake. After reviewing the risks, you may decide it’s too much of a gamble. Even if you decide to move forward, understanding the common issues associated with MCAs will put you in better position to mitigate them.

  • APR could be triple digits: MCAs may be quick to receive, but they’re also expensive to repay.
  • Higher sales = Higher payments: MCAs are paid back using a percentage of credit card sales. This means the more money your business brings in through credit cards, the higher your monthly payments.
  • No federal oversight: Standard usury laws, such as those outlined in the Truth in Lending Act, don’t apply to MCAs because they’re considered commercial transactions, not loans.
  • No early repayment benefit: You’re on the hook for the entire cost of the advance. Paying it off early won’t save you on interest (like it could with an installment loan) because the interest price is fixed into the factor rate.
  • MCAs are so fast and easy they can lead to a dangerous debt cycle: Borrowers may be tempted to seek additional funding to pay off their MCA. This could lead to accepting sub-par terms to meet cash-flow demands. If the problem persists, they’ll need to find more funding, so on rolls the cycle of debt.
  • Credit score may be pulled: MCA providers may pull your credit to assess the risk involved in funding your business venture. This could result in a hard credit check which may lower your credit score. The drop is only temporary, but if you’re denied funding, you may have to wait a while before seeking help elsewhere.
  • MCA contracts may be confusing: Since they aren’t exactly loans and aren’t bound by the same stipulations, contract terms can confuse those unfamiliar with merchant cash advances.

Merchant Cash Advance Repayment Structure

Let’s break down the MCA repayment structure.

First, multiply the factor rate by the MCA amount. For instance, a merchant cash advance of $60,000 with a factor rate of 1.5 would cost you $90,000 total. So, the fees equal $30,000—half the amount of the initial advance!

Your holdback rate determines how much of your revenue goes toward repayment. It often ranges from 10% to 20%.

Taking the numbers from above, let’s say your business generates $2,500 in revenue per day ($75,000 per month). With a 10% holdback rate, you’d pay around $250 per day until you reached $90,000. According to these terms, you’d repay the full amount of the advance in around 12 months.

This could change, depending on your revenue: if it drops, you’ll take longer to repay. Likewise, if revenue rises, you can repay the advance quicker.

Merchant Cash Advance Relief

Merchant cash advances can result in a cash shortage to make payroll, pay for supplies, or other business expenses. When funds no longer cover the essential obligations of running a business, you’re forced to make difficult decisions. It’s wise to seek an alternative form of relief before you find yourself trapped in a corner.

You can use a term loan to consolidate your MCA debt. Even a relatively high-interest debt consolidation loan could offer relief from the triple-digit rates of some MCAs.

If you’re looking for a better rate and have adequate assets, consider a secured loan. You can use machinery or real estate as collateral to lock in a better rate.

How to Find a Nonprofit Lender

Unfortunately, nonprofit lenders do not have large budgets for advertising that can compete with for-profit lenders. Therefore, many of their borrowers come through referrals and not through direct advertising. You can be one of those referrals or avail yourself of their low-cost loan products.

The existence of community development financial institutions (CDFIs) should no longer be the best-kept secret. You can find many through the Treasury’s searchable database. Credit Builders Alliance’s “find a member” catalog is also a way to locate nonprofits in your community, as is another network organization of CDFIs, the Opportunity Finance Network (OFN). For more information on how to turn around your struggling business, speak with a nonprofit credit counselor today.


Dara Duguay

Dara Duguay is the CEO of Credit Builders Alliance. Prior to joining CBA, Duguay was the Director of Citigroup’s Office of Financial Education and founding executive director of the Jump$tart Coalition for Personal Financial Literacy.


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