This article is part of a larger series on Business Financing.
A merchant cash advance (MCA) is a business financing product that allows companies to receive a lump-sum advance payment in exchange for a fixed percentage of their daily credit card receipts. MCAs are an expensive form of credit and should only be used as a last resort by businesses that cannot qualify for other forms of financing.
The size of an MCA is based on the amount a lender is willing to advance based on the daily credit card sales of a business. The lender collects repayment using a holdback percentage or a portion of the daily credit card receivables. The total cost of the loan is calculated using a factor percentage of the cash advance. For example, a $10,000 MCA with a 1.25x factor rate would have a total repayment of $12,500.
Daily payments will be taken until the loan is repaid. If a business experiences slow periods, it could extend the repayment term, or the MCA provider might require the business owner to make up the difference.
There are many other types of business financing that are much more affordable. Lendio offers a variety of business financing options. Before moving forward with a merchant cash advance, visit Lendio’s website to see if you qualify for a more affordable business financing product.
Pros & Cons of a Merchant Cash Advance
|Quick funding||Very expensive|
|Low minimum qualifications||No control over payment size|
|Payments based on revenue||Requires daily payments|
Who Merchant Cash Advances Are Right For
Scenarios in which a merchant cash advance is the best or only option include:
- Business owners unable to qualify for other financing: Almost any other type of business financing will be more affordable than merchant cash advances. An MCA should be a last resort.
- Businesses with unpredictable revenue: If business revenue fluctuates greatly, an MCA and its variable repayment structure may be preferable to a fixed repayment plan. However, a business owner should calculate daily payments by taking the holdback percentage and multiplying it by the average daily credit card receivables to determine the true cash flow impact of an MCA.
- Business owners with bad personal credit: If a business is turned down for other types of loans due to the owner’s credit score, it might be able to qualify for an MCA. However, business owners should check out other bad credit business loans, which likely will be more affordable, before considering an MCA.
When to Avoid Getting a Merchant Cash Advance
If you can qualify for a more affordable type of business financing, you should avoid getting a merchant cash advance. Other types of financing typically have fixed repayment terms that are easier to budget.
Alternatives to a Merchant Cash Advance
Before considering a merchant cash advance, look at the following types of business funding.
Short-term Business Loans
Short-term business loans have a quick application process, simple repayment plans, fast funding, and a lower annual percentage rate than MCAs.
Business Lines of Credit
A business line of credit allows business owners to draw against an established credit limit as needed rather than receiving the full amount of the loan upfront. Interest is charged on the amount used, and borrowers repay in installments.
Invoice factoring is a good way for businesses that invoice their customers to receive funding quickly when cash is needed. Unpaid invoices are assigned to a factoring company, which will advance approximately 80% of the invoice upfront. The customer repays the factoring company instead of your company. Once the invoice is satisfied, the remainder of the invoice, minus fees, is distributed to your company.
An equipment loan is fixed financing from a lender which can be used to either purchase or refinance vehicles and heavy equipment. The purchased collateral secures the loan. Equipment loans can be secured from many sources, including banks and nontraditional lenders. Because of the strong collateral, lenders offer low rates on equipment loans, ranging from 6% to 9%.
Home Equity Loans or Lines of Credit
A business owner can use personal finances through either a home equity line of credit (HELOC) or a home equity loan (HEL). HELOCs and HELs use the equity in your property―usually a primary residence―as collateral for the loan. These funds can then be used for the business. In general, you’ll need to have equity in the residence, a debt-to-income (DTI) ratio of 50% or lower, and a credit score of at least 650 to qualify.
Business Credit Cards
Because of the high annual percentage rate (APR) involved with a merchant cash advance, even a business credit card would be a better option due to the lower APR. Business credit cards help with cash flow management and can offer perks and rewards for the business. However, they’re still best used for small recurring charges rather than large capital expenses. While they’re a more affordable credit option than MCAs, business credit cards can become expensive if debts are large or carried for a long time.
Merchant Cash Advance Costs, Terms & Qualifications
- Factor rate (1.1x to 1.5x on average): The factor rate is the amount the MCA provider charges for using the funds instead of an interest rate.
- Amount advanced relative to the factor rate: Because the factor rate is multiplied against the advance amount, the actual cost of the advance isn’t determined until the advance amount is determined.
- Holdback percentage (8% to 30%): This is the percentage of daily credit card receivables used to repay the advance.
- Expected APR (30% to 150%): Because the repayment terms are short and the cost of borrowing is so high, the APR can range between 30% and 150%. Some APRs can be higher than 150%.
- Advance amount ($5,000 to $500,000): This is the maximum amount of the advance, which is determined by using daily credit card receivables.
- Repayment term (three to 24 months): Business owners who are slow in repayment due to low credit card receivables may be forced to make up the difference.
- Repayment schedule (daily): Most MCA providers require daily repayment.
- Collateral: Most lenders require a blanket UCC filing, but not all.
- Personal guarantee: MCA providers will require a personal guarantee—meaning the owner is liable to repay the advance either with cash or personal assets if the business cannot.
- Funding speed (one to five days): While most are funded within 72 hours, some applications may take up to five days.
- Monthly credit card sales (at least $3,000): Most MCA providers require a minimum credit card sales amount.
- Time in business (at least three months): While you may qualify by being in business for as little as three months, most MCA providers require companies to be operating for at least a year.
- Personal credit score (at least 500): While not all will check your personal credit, those that do often go as low as 500 for qualification.
- Qualifying credit card processor: It is best to find out upfront if your credit card processor and your MCA provider can work together.
Merchant Cash Advance Cost Example
In this example, a business owner qualifies to borrow $100,000 at a factor rate of 1.2x with a 20% holdback percentage. The business has $200,000 in monthly credit card receivables, which means the average daily credit card receivables is $6,667.
If you multiply the average daily credit card receivables by the holdback percentage (20%), you get $1,333.33, which is the daily payment made on the advance. The advance will take 91 days to repay at an APR of 486.67%.
Factors that increase the APR of the loan include:
- Borrowing more money
- Higher factor rates
- Higher holdback percentages
- Increases in revenue
Merchant Cash Advance Providers
If you find yourself in need of a merchant cash advance, it’s a good idea to shop around for the best rates and terms. Here’s our buyer’s guide with some options.
Merchant Cash Advance Application Process
The application process for an MCA is simple and can be completed online in a matter of minutes, allowing you access to funds in as little as one day. If you have decided to move forward with a merchant cash advance, follow these five steps.
1. Fill Out an Online Application
Most MCA applications are one to two pages long and are usually found online. Once the application is submitted, the MCA provider will request additional information.
An MCA application includes:
- Social Security number
- Business tax ID
- General information about the business
Additional documentation for an MCA application includes:
- At least two months of credit card processing data
- At least two months of business bank statements
- Evidence of at least two years of accepting credit cards
2. Get Approved for an MCA
The approval process for an MCA usually takes 24 hours or less. Once approved, the provider will notify you as to how large an advance you qualify for, the factor rate, and the required holdback percentage. At this point, take the time to determine the true costs of the merchant cash advance and consider other options before accepting the offer.
Also, determine if your credit card processor will work with the MCA provider or whether you’ll have to switch processors before accepting the merchant cash advance.
3. Set Up Credit Card Processing
Once the MCA is accepted, set up the merchant cash advance with your credit card processor.
4. Receive the Lump Sum Cash Advance
Once the credit card processing is set up, the MCA provider will deposit the lump sum cash advance.
5. Make Daily Payments From the Merchant Account
The merchant cash advance provider will begin taking a percentage of the daily credit card receipts as payment. The repayment period is variable and depends on the company’s average daily credit card receipts. Typically, it’s between 12 and 14 months.
Merchant cash advances are an expensive form of business credit that should be seen as a last resort unless the business cannot qualify for any other type of credit. However, if you decide that an MCA is your only option, we recommend checking out National Funding’s merchant cash advance product.