A Merchant Cash Advance (MCA) can provide your business with a quick injection of working capital. However MCAs don’t have the best reputation. The high interest rates mean it might not be the first line of alternative funding you want to pursue, but in some scenarios it might be the only viable option. Before you consider a merchant cash advance financing product you should know the facts.
Before you sign off, be aware:
- An MCA is not a loan – it is a cash advance against your future earnings
- Because those earnings can fluctuate, you will pay a much higher rate of interest than with a loan
MCA providers evaluate risk and weigh credit criteria differently than lenders. Instead of using a FICO score or similar credit algorithm, they look at daily credit card receipts to determine if your business can repay the advance in a timely manner.
Because the advance is based on future income, the provider takes more risk. Which translates into higher fees.
Merchant cash advance repayments can be structured in two ways:
- Withdrawals of a slice of your future credit and debit card sales.
- Fixed ACH (Automated Clearing House) withdrawals on a daily or weekly basis directly from your bank account.
Most MCA providers charge what’s called a “factor” rate. Unlike a traditional term loan, the rate isn’t amortized over the course of the advance. The provider determines the factor rate based on the risk. Typical factor rates range between 1.2 and 1.6.
How Much Will I Pay?
To determine the cost of the repayment, multiply the amount of the advance by the factor rate.
For example, the total payment for a $50,000 advance that carries a factor rate of 1.4. will be $70,000, which includes fees of $20,000.
If the advance is based on your future credit/debit card sales, the MCA provider automatically deducts a percentage of your credit or debit card sales until the agreed-upon amount has been repaid in full.
Repayment periods typically run from three to 12 months. The higher your credit card sales, the faster you’ll repay the MCA.
According to NerdWallet, MCA payback takes longer than the purchaser thought it would 80% of the time.
Fixed ACH Withdrawals
Alternatively, you can sign an agreement for a daily or weekly payment to be withdrawn, based on an estimate of your monthly revenue. For example, a business with $100,000 in monthly revenue would owe $333 per day or $2,331 per week based on a percentage of sales of 10%.
Using this structure, your payment does not fluctuate. However, you’ll pay the same amount whether sales are down or up.
An MCA may be a good choice for you because:
- They’re quick. You can often get an MCA within a week or so with no heavy paperwork. Providers look at a business’s daily credit card receipts to determine if the owner can repay.
- You won’t lose your home. MCAs are unsecured, so you don’t need collateral. This means you won’t lose your personal or business assets if your sales plunge and you fail to repay.
- When sales are down, your payment may fall. That could make repayment more manageable, but it will take longer.
On the other hand:
- Your APR could be in the triple digits.
- Higher sales mean a higher APR. Unlike a conventional loan, the faster you repay your credit card sales-based advance, the higher your APR.
- There’s no benefit to repaying early.
- There’s no federal oversight. This is a big one, be cautious of predatory lenders.
- Your credit score may be pulled. Background credit checks are a common requirement. If the provider’s credit inquiry results in a hard credit check, it can hurt your credit score.
- A personal guarantee may be required. While the MCA is unsecured, the provider may require a written agreement that makes you personally responsible for repaying the advance.
MCAs get a bad rap in the finance industry but there are some situations where it could be the best option. Before jumping into any type of agreement, always do your research! For other types of alternative funding check out our guide to altfi options.
The merchant cash advance financing product is relatively new, which creates an opportunity for customer confusion, as well as deceptive practices. Because lending laws do not apply to merchant cash advances, business owners don’t have much legal standing if they want to get out of a bad agreement.
However, if you’ve read the fine print and feel comfortable with the level of risk involved, a merchant cash advance may be a workable option to cover your immediate business needs.