The Basics of Merchant Cash Advances

If your small business needs capital – and needs it now – one of the quickest ways to get the liquidity is a merchant cash advance (MCA). The convenience that an MCA provides comes at a high cost, though, so you should know all of the ins and outs of an MCA before you commit to taking one out.

How do merchant cash advances work?

An MCA is not a loan; rather, it is an advance that someone gives you against the money that your business makes in the future. You get a lump sum up front, and you pay it back automatically over time, as the lender gets a set percentage of the credit/debit card receipts you take in each business day.

The amount you pay back each day or week is called the retrieval rate or holdback, and it ranges between 5 and 20 percent. The percentage depends on how big the advance is, the repayment period and the amount of credit/debit card sales that your business does. The repayment term is usually calculated somewhere between three and 18 months. As soon as you receive the lump sums, your payments start immediately.

The MCA provider uses your average credit card sales to determine how much to front you. The provider looks at your last three to six months of receipts to figure out the proper amount. 

What are the benefits of an MCA?

There are several reasons why merchant cash advances make a sound funding solution for some businesses. Let’s take a look at how MCAs have helped many entrepreneurs.

  • Quick funding process – Approval and funding can happen within several business days, and you can find out the decision within hours. If you’ve had a major expense come at you out of the blue, or if you don’t know how you’re going to meet payroll at the end of the week, this can be a real lifesaver.
  • Straightforward application – You can do the whole process online, uploading the required documentation (bank account statements, business tax returns and statements from your credit processors). You don’t have to schedule an appointment with a bank and take half a day asking one lender to help you.
  • Imperfect credit is OK – Most business lenders require that you have a strong credit score, both personally and with your business. However, MCA providers have more flexibility with credit. Instead, they focus more on the consistency with which you bring in money through credit or debit cards and the amount of time you have operated your business.
  • You don’t have to put up collateral – Banks usually ask for some form of collateral when you take out a business loan. If you default on the loan, you lose the collateral. An MCA is unsecured, which means you have no assets at hazard.
  • Payments are flexible – A small business loan comes with a fixed monthly payment. This can help you make a stable budget, but if business is slow and you can’t meet the payment on a particular month, that can lead to trouble. You simply pay the retrieval rate from your daily credit card receipts. So when you have a big day, you pay more, and when you have an off day, you pay less.
  • Limits are higher than with a small business loan – Some MCA providers give as much as $2 million in advances, but there are other providers willing to advance just a couple thousand dollars. If you have iffy credit, there’s no one else who will do that for you.

Who should take out an MCA?

If you have a business that needs fast access to cash, and if you have put together a solid credit card history, then you are a strong candidate, as with a restaurant or retailer. However, there are some things to consider before you take out the funds.

  • The factor rate can drive your costs high – You don’t pay interest on an MCA. Instead, there’s a factor rate associated with your advance (usually between 1.15 and 1.45), and it indicates how much you pay back. So if you take out a $100,000 advance with a 1.3 factor rate, you multiply the amount by the factor rate to get the amount you pay back, or $130,000 in this case. If you pay it back in 12 months, that’s an effective interest rate of 30%. However, the APR could be much higher. If your retrieval rate is 15%, and you anticipate $70,000 a month in credit card sales, your daily payment would be $350, which means that you would pay the loan back in just over a year – giving you an APR of almost 54%.

So you see that, while you get a lot of convenience out of an MCA, you also pay a lot of money. Try and negotiate the lowest retrieval rate that you can to keep your costs down.  You’ll pay less back each day and bring your effective APR down.

There are some other ways to find the funding that you need, with lower costs for the credit. We always suggest exploring less expensive options before considering an MCA.

  • Business credit card – You can cover expenses and also pick up points, cash back, travel miles or other types of rewards. The business card interest rate often ranges between 10 and 20%, although you can get a promotional 0% rate for six months, or a year, or some other promotional period. However, you need to have a relatively strong personal credit score to qualify.
  • Term loan – You take out a set amount and pay fixed payments each month over the term of the loan. The term can last from a year to a decade, depending on how much you take out, and the APR is a lot lower.
  • Business line of credit – You gain approval for a set amount but only take out what you need, and then you pay it back, either weekly or monthly. You can get rates that are fairly low, but they are also frequently variable, so if the prime rate goes up, so does your rate.

Need more answers about your own situation? Give one of our business loan pros a call today.

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