Merchant Cash Advance: Benefits, Drawbacks, Alternatives

If you’re running a small business, you may have already considered a merchant cash advance (MCA) at some point. After all, it can be a quick and easy way to get funding for your business. 

However, a merchant cash advance can be a tricky move. If you don’t pay back the loan on time, you could end up paying a lot in fees. You might even find yourself drowning in debt if you’re not careful.

Before deciding on an MCA, it’s important to understand the potential benefits and drawbacks. You should also look into some alternatives to a business cash advance that may be a better fit for your business.

What Is a Merchant Cash Advance?

A merchant cash advance is a type of alternative financing that allows businesses to receive funding based on their future sales.

MCA companies will give businesses an upfront sum of money in exchange for a percentage of their future debit or credit card receipts. The amount borrowed is then repaid with interest. MCA providers typically do not require collateral, making them a good option for businesses that may not be able to qualify for traditional loans.

A cash advance for business is not technically a loan but rather a cash advance against future sales. MCAs are available to small enterprises with business revenue generated primarily from debit and credit card transactions. 

How Are Merchant Cash Advance Repayments Structured?

There are two options for repaying merchant cash advances: 

Percentage of Overall Debit/Credit Card Sales

A merchant cash advance company takes a daily or weekly percentage of your debit and credit card transactions, typically around 10% until the loan is repaid. Unlike other business loan options, merchant cash advance loans don’t require a fixed repayment structure. 

Generally, the repayment terms for your business cash advance are not determined by the time frame you must repay the advance because your repayment period is based on your sales. Merchant cash advances have varying repayment spans depending on how much money you borrowed and how rapidly you sell products or services.

Fixed Withdrawals From a Bank Account 

Another way to repay an MCA is through fixed withdrawals from your bank account. You make set daily or weekly payments to the merchant cash advance provider, regardless of your actual sales on those days. Instead of deducting money from your credit or debit card, the lender withdraws funds directly from your business bank account until your advance is paid in full.

For example, if you get a merchant cash advance loan for $10,000 with a 1.5 factor, your fixed daily repayment would be $500 a day in a 30-day month (($10,000 x 1.5) / 30).

This repayment method can be helpful if you have uneven sales patterns and want to know exactly how much you’ll need to repay each day or week.

How Do Merchant Cash Advance Costs Work?

Merchant cash advance rates are fees typically expressed as a factor rate. MCA companies usually charge a factor rate anywhere from 1.1 to 1.5. This is the number that your total advance amount will be multiplied by to determine the total cost of your loan. 

For example, if you have a factor rate of 1.5 and borrow $10,000, your total loan cost will be $15,000.

Factor rates, unlike interest rates, are expressed as a decimal number instead of as a percentage. They only apply to the original amount borrowed, making them a great short-term financing solution for your business.

Your factor rate is determined by several elements, including your business industry, years in operation, overall financial stability, personal credit score, and the MCA provider you choose.

Merchant Cash Advance Costs Example

To understand what a merchant cash advance for small businesses looks like, we’ll give you an example of an MCA repayment term. This way, you’ll get better insights into the costs you’ll need to pay.

Let’s say you decide to take an MCA of $65,000. If you get approved for an entire sum with a 1.4 factor rate, your total repayment will be $91,000. 

If you decide to use a credit card repayment structure, the merchant cash advance lender will deduct 10% of your monthly sales until you pay off $91,000. If your monthly credit card revenue is $110,000, you will repay $11,000 every month. Your daily payments will be $367 in a 30-day month. You’ll repay your debt in eight to nine months.

However, things can change if your monthly credit card sales drop to, let’s say, $80,000 per month. In this case, you’ll pay $8,000 monthly and repay the debt between eleven to twelve months. 

Unlike traditional small business loans, business cash advances don’t necessarily use an annual percentage rate when expressing their cost. However, if we calculate it for the first scenario in which you repay your debt in eight months, the APR would be ​​104.94%. On the other hand, if you end up repaying your MCA in eleven months, your APR would drop to 76.65 %.  

The merchant cash advance will thus be higher the shorter the repayment term. A merchant cash advance is an expensive financing solution when considering only the APR, especially compared to standard loan rates in 2024. 

Merchant Cash Advances: Benefits and Drawbacks

As with any other funding method, choosing an MCA has its pros and cons. Let’s look into some of them.

Benefits of Merchant Cash Advances 

Quick funding: One of the primary benefits of merchant cash advance financing is that it can provide business owners with fast access to capital. Funds can be made available as quickly as 24 hours in many cases.

Low credit score requirements: Another benefit of merchant cash advances is that they typically have lower credit score requirements than other business loans. MCAs are an excellent option for businesses that may not qualify for different types of financing.

Flexible repayment terms: Merchant cash advances also tend to offer more flexible repayment terms than traditional loans. This can be beneficial for businesses that experience fluctuating or seasonal sales.

No collateral is required: Unlike traditional bank loans, merchant cash advances do not require collateral. This makes them an attractive option for businesses that may not have the necessary assets to secure a loan.

Drawbacks of Merchant Cash Advances

High costs: One of the primary drawbacks of merchant advance funding is that it can be quite expensive. The fees associated with these products can make them very costly in the long run.

Potential for negative amortization: Another potential drawback of merchant cash advances is that they can lead to negative amortization. If your sales are not high enough, you might not be able to meet your required payments and cover the interest.

No early repayment: There is no advantage to repaying the merchant loan advance early. You’re locked into making fixed fees, and the provider will simply keep all of the fees already paid.

No federal regulation: Unlike traditional loans, MCAs are not regulated by the federal government. This means that no laws are in place to protect consumers from unfair or predatory lending practices. MCA providers and their procedures are regulated by the Uniform Commercial Code, a uniformly adopted state law, which is less strict than federal laws that regulate other financing options.

Confusing contracts: The contracts associated with merchant cash advances can often be difficult to understand. This is partly because merchant cash advance companies use factoring rates expressed in decimals instead of percentual APR. Borrowers might find comparing merchant cash advances to other financial products challenging. 

So there you have it - the pros and cons of merchant cash advances. These products can be a great option for startup businesses needing fast funding, but it’s important to be aware of the potential costs involved. Be sure to research and choose the repayment structure that best suits your needs before taking out an advance.

What Are Merchant Cash Advance Alternatives?

Before looking for merchant cash advance companies, you should look for other small business financing options. 

Small business loans are one option that can provide you with the funding you need. Even if you have bad credit, you may still be able to qualify for a small business loan, but you may have to pay a higher interest rate.

Another alternative to merchant funding is a business line of credit. This type of financing can give you access to cash when you need it, and you only have to pay interest on the amount you borrow. 

Is a Merchant Cash Advance Right for Your Business?

After learning what a merchant cash advance is, you should also consider all available financing options. Explore the benefits of each solution and take some time to determine whether the anticipated income from the opportunity is sufficient in return for the risk involved.

MCAs can be an excellent option for businesses that need a quick infusion of cash. But before you jump into it, it’s important to understand how they work and if they are right for you. A hasty decision might hurt your business in the long run.