Merchant Cash Advance Financing

In business, cash shortfalls happen, and expenses and opportunities can arise unexpectedly. But sometimes, traditional financing just isn’t in the cards — whether it’s a matter of timing, credit score or years in business. 

With a merchant cash advance (MCA), you can acquire the capital you need now to act on an opportunity or keep your operations running.

A merchant cash advance, or MCA, is a lump sum of capital lent against a business’s future sales. This is what makes this type of financing an advance and not a loan.

By definition, a business cash advance is short-term and repaid through smaller daily (or weekly) payments until the total cash advance and lender fees are paid in full.

A small business owner can apply for a merchant cash advance and, once approved, have the cash advance deposited into a bank account the same day.

Merchant cash advances work differently depending on the type of advance you choose. 

In its traditional form, merchant cash advances are suitable for businesses that deal with large volumes of debit and credit card transactions. Today, the product has evolved into a second program that can benefit any small business.

The difference boils down to how the advance is repaid and how an MCA lender assesses rates and fundability.

Traditional Merchant Cash Advances

In a traditional cash advance agreement, a lender deducts a percentage of your credit or debit card sales on a daily or weekly interval. The process is known as a holdback.

The repayment period typically ranges from 3 to 24 months, though there’s no set-in-stone end date. The higher your credit card sales, the faster you’ll pay the advance off.

For example, say your lender holds back 15% of your daily credit card and debit card transactions. As your sales rise and fall, so do your MCA payments.

With a traditional merchant cash advance, your payment shifts to the pace of your income, helping you avoid cash flow disruptions when sales are down.

Traditional Cash Advance Requirements

MCA lenders determine advance amounts based on projected credit and debit card sales, whereas the holdback percentage is calculated on the advance amount and the expected payback time. Typical holdback rates fall within the 10% to 20% range, though this can vary based on the business and risk.

ACH Merchant Cash Advances

The second variation of a merchant cash advance is known as an ACH MCA, or an Automated Clearing House withdrawal.  

In this agreement, payments to MCA lenders are fixed and occur over a set term. This means your daily or weekly payment will remain the same regardless of your sales volume. Funds are drawn automatically from a business owner’s linked bank account.

ACH Merchant Cash Advance Requirements

ACH advances are based on a business’s total projected revenue, not on credit card or debit card transaction totals alone. As a result, this type of business advance applies to all small business owners — not just those with high credit and debit card sales.

A business that utilizes a merchant cash advance will typically pay back 10% to 30% or more of the amount borrowed. This percentage is known as a factor rate, and it’s most commonly expressed in decimal form. For instance, a factor rate of 10% or 30% would be represented as 1.1 and 1.3, respectively.

How Do Merchant Cash Advance Factor Rates Differ From Interest Rates? 

Unlike interest that accumulates over time and is a calculation based on depreciating principal, MCA fees are calculated once at origination. The cost is worked into your scheduled payments and doesn’t change. So if you pay off your advance in 4 months or 12, the total amount paid remains the same.

To better understand how these rates affect your total payback, let’s look at a few examples:

Advance Amount X Factor Rate = Total Payback Amount

Merchant cash advances are best used to address short-term capital needs. For example, responsible use of an MCA would be to purchase inventory your business can turn around quickly to generate a profit. Companies that have success using an MCA have a clear understanding of the costs associated with this type of financing compared to the potential return on investment.

What Are the Pros and Cons of a Merchant Cash Advance?

Pros

• Quick approval process: Compared to other forms of business financing, the MCA application and approval process is less involved. After reviewing past bank statements and business information, many MCA lenders can make a funding decision within hours.
• Same-day funding available: MCAs are one of the fastest forms of financing on the market. Some merchant cash advance lenders can release funds the same day an application is approved. 
• No collateral required: Merchant cash advances are a form of unsecured financing, meaning you do not have to back the advance with collateral. 
• Most credit scores qualify: MCA lenders work with business owners even if their credit needs work. If you have the cash flow to support repayment, you’ll likely be eligible for an MCA. 

• Approval Rates

  According to the Federal Reserve Banks’ State of Small Business Credit Survey, 84% of firms that applied for merchant cash advances were approved. This was the second-highest financing approval rate; equipment financing was the first. 

Cons

• Higher fees: On average, merchant cash advances are more expensive than other forms of financing. 
• Shorter repayment terms: MCAs are a short-term financing option. Though repayment periods will vary by lender and the individual qualifications of the borrower, many times advances must be paid back in 12 months or less. 
• Lower borrowing amounts: Advance amounts are based on your sales potential. Therefore the amount you qualify for may be lower than other forms of financing.
• Daily or weekly repayment frequency: MCA lenders may deduct funds on a daily or weekly basis, which can impact cash flow.

Merchant cash advance providers evaluate risk differently than loan lenders. Unlike conventional financing, where personal and business credit scores are more heavily weighted, MCA providers consider the consistency of your historical deposits and average daily balances to determine future revenue and approval amount.

Underwriting criteria of the best merchant cash companies include:

• Industry: Different industries present different levels of risk to MCA providers. For example, sectors that routinely experience periods of high and low sales are riskier for lenders to work with, resulting in potentially higher factor rates.
• Length of time in business: Most MCA lenders require small businesses to operate for a minimum of 4 months. Typically, the younger the business, the higher the factor rate.
• Business sales and growth: A merchant cash advance provider will perform a financial assessment of your ability to repay the advance. As MCAs are based on future revenues, showing consistent sales and a proven history of growth bodes well for more favorable rates and terms.
• Business credit history: Because an MCA is an advance, your business credit score is less of a deciding factor, but it still comes into play. In general, with MCA financing, the better your credit score, the lower your factor rate.

Merchant cash advance providers specialize in short-term financing. Some cater to businesses with bad credit, whereas others offer higher limits. Before deciding on an MCA offer, evaluate each provider to determine the best fit for your business. 

Most merchant cash advance lenders handle the application process entirely online. Though requirements will differ from MCA lender to MCA lender, be prepared to show proof of identification and business ownership and up to 6 months of past bank statements.

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