Merchant Cash Advances: A Complete Guide

Upfront, a merchant cash advance sounds appealing to help shore up cash flow for business owners. A merchant cash advance provides a quick solution for those in need of short-term financial assistance and for business owners who’ve been denied a traditional loan from their local bank. They require very little paperwork, no collateral, and can be approved and funded within a day or two, even with a low credit rating.

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Unfortunately, the convenience of cash advance loans comes with a catch—mostly in the form of exorbitant interest rates and hefty fees. If you’re considering applying for one, make sure you fully understand the up - and downsides - of merchant cash advances.

What are Merchant Cash Advances?

If you sign on with a merchant cash advance company, they will provide funds to your business in exchange for a percentage of the daily credit card income. A processor clears and settles the credit card payment, drawn from customers' debit and credit-card purchases on a daily basis, until the obligation has been met. Most providers form partnerships with payment processors and then take a fixed or variable percentage of future credit card sales.

How merchant cash advances work

An MCA is not a loan in the traditional sense. If you take out an MCA, a financing company advances cash to you in a lump sum. They then take a percentage of your daily credit card and debit card sales, on top of charging a fee. An example from Wikipedia® outlines a sample transaction:

A business sells $25,000 of a portion of its future credit card sales for an immediate $20,000 lump sum payment from a finance company. The finance company then collects its portion (generally 15-35%) from every credit card and/or debit card sale until the entire $25,000 is collected.

SmartBiz Loans recommends that the merchant carefully review any MCA agreement (and other loan products) with an attorney or another financial professional to ensure the merchant understands how the agreement works and how the MCA product differs from a business loan.

Merchant cash advance application process

Getting an MCA can be easier than other types of funding to apply for with a fast online process. MCA companies review your credit card processing statements to determine if you have enough business volume. Some MCA companies ask for credit scores and bank statements, as well. Others don’t require this.

Applications for an MCA are typically online and you can get approved the same day you apply. However, buyer beware. The old adage applies here: fast cash is expensive cash.

What do merchant cash advances cost?

According to FitSmallBusiness.com, MCAs typically range from $5,000 to $500,000, and have factor rates between 1.1x and 1.5x. Repayment is based on a holdback percentage that varies by lender, and can range from 8% to 30%.The average repayment time frame for a merchant cash advance is 8 or 9 months but the term can be as short as 4 months and as long as 18, depending on your business.

MCA factors to consider

Here are details to take into account when weighing the pros and cons of an MCA:

Factor Rate: This is the total cost of the money you’re advanced. You’ll need to pay back the original sum you receive plus costs.

Holdback Percentage: If you have a high holdback percentage, the MCA provider takes more out of your daily credit card totals.

Additional Fees: You might be responsible for setup fees or advance fees that can equal 5% or more. Make sure you understand these fees before signing up so you won’t get a surprise when collecting funds.

Merchant cash advance regulation

Is there any legal regulation of MCAs? The answer is, not really. Since MCA companies “purchase” your future credit card sales in exchange for upfront funds, it’s considered a sale, not a loan. MCA companies don’t need to follow state usury laws, regulations governing the amount of interest that can be charged on a loan. They are almost entirely unregulated because they are not supposed to be loans. They are not subject to usury laws or banking laws like the Truth in Lending Act.

Business restrictions

To make sure they get paid, lenders have restrictive stipulations for your business. For example, you may be prohibited from making any changes to your credit card processor until after the advance has been repaid.

Occasionally, businesses may encourage customers to pay cash in order to avoid credit card fees or giving a percentage to the MCA providers. Encouraging cash payments, by offering discounts for example, could be restricted by merchant cash advance lenders.

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Advantages and Disadvantages of Merchant Cash Advance

Before you jump online and apply, it’s important to be aware of the pros and cons. Here’s a list to review.

Advantages

Easy application process

No need to prepare a business plan or gather a pile of documents. Most MCA providers initially require only the business owner’s social security number, a business tax ID, and general business information. Once you move forward in the application process, you might need to produce 2+ months of credit card processing data, 2+ months of business bank statements, and evidence of 2+ years accepting credit cards.

Qualifying is Easy

Unlike bank loans, it’s easy to qualify even if you have low credit scores. The application for a merchant cash advance means that you won’t need to supply as much documentation to potential lenders. Plan on gathering 4–6 months of bank statements, as well as other basic financial documentation. Depending on the lender, you may also need to submit your tax returns, accounts receivable report, and profit and loss statements.

Fast turnaround

An MCA is one of the fastest kinds of business financing available. Average turnaround for most business-owners is just a few days. Because the decision is weighted on revenue and sales records, paperwork is limited, accelerating decision-making process.

Disadvantages

High costs

APRs can be in the in the triple digits. It’s one of the most expensive options for small business owners in need of capital.

Payment isn’t steady

MCA payback is through daily credit card sales that can fluctuate. This makes cash flow management challenging.

You can get caught in a debt cycle

The funds from an MCA can get you over the hump but the high costs can quash any plans you have for growth. You may even need to take out and MCA over and over to keep from defaulting.

Daily payments can crunch your cash flow

SmartBiz® customer Terry Trumbull, owner of Terry Trumbull Meats, had self-financed his business for years but looked to alternative sources for funds. He ended up taking out a short term loan that required daily payments 25 days a month. “That really hurt my cash flow and it wasn’t helpful in reaching my overall financial goals” he said.

MCA Contracts are complex

While there is little paperwork, MCA contracts can be complicated because repayment is often structured in terms of both a stated percentage of the business’ future receivables over a stated period and an agreed fixed repayment amount over the same period. This is provided the merchant has the right to reduced payments once it documents the stated percentage of receivables was less than the fixed payments for the same period.

Matt McClean, another customer and owner of Wicked Chicken restaurant, came to SmartBiz for a better solution to daily payments. “Before I found SmartBiz, I took out what I call a ‘mafia loan’. It cost a ridiculous amount of money and required daily payments…so I started looking for a loan with a better rate.”

McClean weighed the alternatives and qualified for a low-cost SBA loan from a SmartBiz Loans® marketplace bank with a 10-year term and low monthly payments.

Alternatives to Merchant Cash Advances

If you need additional funds to meet business goals, there are other options to explore if you have decent credit and solid business financials. Be sure to review customer feedback before you start working with a lenders. Look for reviews from small business owners who have worked with the company you’re considering.

Business Line of Credit

A business line of credit is a revolving line you can draw against as you need it. You only pay for the money that you use. Lines of credit can be extended by a large bank, a small local bank, or an alternative online lender. The use of funds is flexible, there are no set monthly payments, and no interest is charged on the unused money in the account. When you repay a borrowed amount, those funds are immediately available again.

Cash Advance

A cash advance is a type of short-term, cash loan available through your credit card provider. You can use your credit card to withdraw cash at a bank or ATM, but the amount has to be paid back with interest. This might be convenient when you need fast cash, but like MCA’s, it’s expensive.

Small Business Administration Loans

An SBA loan is a government-guaranteed small business loan that has a long-term and low-interest rates. The Small Business Administration (SBA) is the government agency that partially guarantees SBA loans, making them more attractive to lenders.

SBA loans come with different rates depending on the lender you work with. The SBA establishes the maximum amount that can be charged for these loans. There are several fees associated with SBA loans. However, even after fees, SBA loans are vastly more affordable than the majority of alternative financing and alternative lender options.

To learn if your business is in good shape to qualify for an SBA loan, sign up for the free SmartBiz Advisor® tool. SmartBiz Advisor helps you learn how banks typically evaluate your business and recommends ways to help you increase your credit and financial health so you have a better chance of successfully applying for funding when you need it. Learn more here:

SBA Loan Help: What is SmartBiz Advisor?*

Bank Term Loans

A term loan is a common way to fund a small business. In short, borrowers get a lump sum upfront then repay with interest over a specific period. A standard term loan is paid back over the course of one to five years. These types of loans for small businesses are offered by traditional banks, credit unions, and online lenders and can be a good option for businesses expansion and those who need funds faster than other loan products can provide. SmartBiz works with banks in our marketplace to facilitate bank term loans. Visit the SmartBiz Loans website to learn about this funding option: Bank Term Loans.

Qualifying for the lowest cost funds

If you need funds for working capital, to refinance high interest debt, or other business building initiatives, explore your options before settling on an MCA. Financial experts caution that an MCA can do more harm than good.

Your best bet to qualify for low-cost funds with long terms is to maintain a strong credit score. Both your personal and business credit score will be reviewed by lenders to asses risk.

Credit scores are key if you want to get the lowest cost funds with the longest terms. The SmartBiz Small Business Blog has lots of resources to help you understand and improve your scores. Review this article for information about the importance of high scores and how you can manage yours: How Small Business Owners Can Improve Their Credit Scores.

In conclusion

The cash advance industry is competitive one, so make sure you shop around before you come to a decision. Search reviews from real customers and weigh the positives and negatives. Since cash advances are an expensive way to fund your business, make sure the loan is worth the cost, and that you’ll have the ability to cover both the costs of your business and your loan.

Also, make sure you’ve explored your other options in detail. Even if you’ve been denied by a bank, doesn’t mean other options like an SBA loan or a Bank Term loan are off the table.

*The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes only. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.

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