What Is A Merchant Cash Advance?

Many startups fail within the first year of commencing business. One of the leading causes of this significant rate of failure is a cash-flow shortage. The inability to meet the operational expenses can result in a disturbed cash flow, affecting your routine business operations. Not having enough cash to pay for the inventory, employees, and other working-capital-related expenses will make it difficult to operate a business.

The easiest and fastest way to deal with cash flow shortage is the merchant cash advance. While it can help fix your capital-related requirements when required, this type of funding is pretty expensive. It’s advisable to borrow loans for small businesses or consider other funding options and keep merchant cash advances as your last resort.

If you are wondering what a merchant cash advance is, how to obtain it, and what are its pros and cons, you have come to the right place. In this post, we’ve explained all you need to know about a merchant cash advance.

What is Merchant Cash Advance?

MCA or Merchant Cash Advance is an alternative funding option for small businesses that are in need of instant cash. The lender evaluates your credit card statements to see your repayment capacity and the total amount you need. Your credit score, existing debt, and the financial health of your company are also factored in when calculating MCA.

The difference between a traditional transaction and MCA lies in the repayment method. Note that the merchant cash advance is an unsecured form of loan, which is repaid using a percentage of profit from your sales, plus a small fee. It’s a good alternative to traditional loans for small businesses that accept credit/debit card payments.

It’s a contract signed between an MCA lender and the buyer where the latter agrees to pay their future sales, including a fee. You are also supposed to pay interest on this amount, which may vary from state to state.

How does the Merchant Cash Advance Work?

MCA is not a typical business loan that you have to repay within the specified period and a fixed interest. It’s rather instant cash help from a lender, who buys you future sales. This means your lender expects to be repaid from your future sales with interest. The lender waits until cash starts flowing in. The repayment works in two ways explained below.

The standard method to repay MCA is by allowing the lender to deduct a percentage of your debit/credit card sales until the full amount is paid. The payment is structured either on a weekly or monthly basis.

The major benefit of MCA is that it doesn’t include repayment terms, which are a part of typical business loans. You can repay the advance in 3-18 months or take longer, depending on your total sales and lenders’ expectations. It also depends on how fast you can generate profits. The more card sales you generate, the faster you can repay the advance.

Advance is the upfront amount you request the MCA lender to issue to you. This can be lesser or higher than your monthly sales. The advance determines how much you have to pay back and how long you’ll be giving your daily/weekly sales to the lender. Merchant Cash Advance might incur a fee much higher than the standard interest rates at banks.

Alternatively, the lender and the business may decide to structure the repayment weekly or monthly in such a way that a fixed amount is deducted from the business’s bank account, regardless of how much they earn from sales. It’s a fixed repayment plan where your lender gets paid a percentage of the total advance amount every week or month until the advance is paid in full. This payment method is suitable for companies that earn stable revenues and are not dependent on their credit/debit card sales to repay the debt.

This repayment structure also allows you to calculate how long it will take to make the full payment and how much you have to keep aside for the repayment every week/month.

Here’s a simple step-by-step process of how MCA works.

• You request an advance from a lender based on your business’s cash flow requirements.
• They evaluate your credit profile and lend you the advance.
• Based on your chosen payment structure, they will deduct weekly or monthly card sales from your bank.

How Much Does the Merchant Cash Advance Cost?

The repayment amount will be much higher than the advance you borrowed from the Merchant Cash Advance company. The rate may vary from one lender to another, as there is no standard factor fee. Unlike interest rates, factor fee is calculated based on many factors.

The business’s ability to repay the money, its risk level, and the total sales it generates are a few things affecting the factor rate. Ideally, this rate should be between 1.1 and 1.5, but it can be higher depending on your business’ risk assessment. Note that the factoring fee doesn’t include additional fees, such as administrative or underwriting fees, which the MCA company might charge.

Calculating the merchant cash advance is straightforward. You just need to multiply the total advance by the fee (factor rate). Suppose you have borrowed $30,000 from an MCA lender at the factor rate of 1.5. So, your total would be $45,000, meaning you will pay $15,000 in fees. Your APR increases or decreases based on our repayment duration.

Pros and Cons of Merchant Cash Advance

Like loans and other forms of lending, a merchant cash advance doesn’t come without risk. Here are some pros and cons of this payment structure you should know before borrowing.

Pros

• Quick Funding: Unlike banks and typical lenders that may take days to accept your application, MCA is a relatively faster and easier method of funding. The lender requires minimal documentation and issues the credit mostly within 24 hours. It’s best for businesses that are in urgent need of cash.
• Uncomplicated Requirements: MCAs are for startups, small businesses, and companies stuck in financial difficulties. Since the method doesn’t require any collateral, it’s easier for businesses of any size to obtain credit fairly quicker than typical business loans. The major consideration when issuing MCA is your debit/credit card transactions and the total revenues. The factor fee is calculated based on your sales.
• Flexible Repayment: The biggest benefit of Merchant Cash Advance lending is that it takes the “pay a fixed amount within a specified duration” burden off. Your repayment amount is calculated based on how your business is performing. So, you can rest assured that you won’t have to pay a fixed amount.

Cons

• Expensive: The fast financing and fewer documents requirement come with a high APR. As compared to the traditional loans that have 9-99 percent APR, the merchant cash advance is extremely expensive with the APR going up to 350%. Of course, it depends on many factors, like your repayment term, total revenues, etc. But, it’s mostly higher than loans and lines of credit.
• A Complex Debt Cycle: Since MCAs are paid daily, they are highly likely to affect your cash flow. Not just the frequent repayment, but the high overall cost can take a toll on your financial health. Besides, it can trap you in a debt cycle. The problem arises when you need more money, but your financing options will be limited because of the MCA.

Defaulting on a Merchant Cash Advance (MCA)

Banks and financial institutions offering business loans and other forms of credit have an agreement, which is followed if the borrower defaults on a loan. Usually, their properties or physical collateral are forfeited. Since MCA lending is not associated with federal regulations, defaulting on this credit can have a worse effect on your business than a typical loan.

If you believe you are at risk of defaulting on the payment, you can reach out to the MCA company to discuss options to restructure payments. They might hold your payment for a while. Or, you can get a traditional loan from a bank to repay the MCA with the factor fee. One of the many drawbacks of MCA is that it doesn’t include any physical collateral or a written clause of what happens if you default on the payment.

Qualifying for this instant cash advance is fairly easy, but if you don’t qualify for it, there are other alternatives available. Some banks or private lenders might offer you a loan at a negligible interest rate.

Bottom Line

Merchant Cash Advance can help businesses generate instant cash when needed without carrying the burden of repaying a fixed amount at regular intervals. Fewer documentation requirements make it the most attractive option for borrowers, but with that comes certain drawbacks.

MCA is not just expensive, but it can lead to detrimental consequences if you default on the payment. The lack of regulation gives lenders an opportunity to get their advances back by any means. So, it’s advisable to consider its requirements and payment terms before requesting an advance.