A merchant cash advance allows a business owner who accepts credit card payments or has other payment or receivables streams to obtain an advance of the funds regularly flowing through the business’ merchant account. A merchant cash advance (MCA) is not a loan, but rather an advance based upon the future revenues or credit card sales of a business. A small business can apply for an MCA and have an advance deposited into its account fairly quickly.
Merchant cash advance providers evaluate risk and weight credit criteria differently than a traditional banker might. An MCA provider looks at the daily credit card receipts to determine if the business can pay back the advance in a timely manner. Basically, the small business is selling a portion of future credit card sales to acquire capital immediately.
Rates on a merchant cash advance are typically higher than other small business loan options (sometimes higher than triple digit annualized interest rates). An MCA provider will often approve an advance for a business that might not qualify for a business loan, but has a steady influx of credit card payments. Any business owner considering this option should make sure he or she understands the terms being offered so they can make an informed decision about potential ROI.
How Does a Merchant Cash Advance Work?
An agreement is made between the small business and the MCA provider regarding the advance amount, payback amount, and holdback percentage. Once an agreement is made, the advance is transferred to the business’ bank account in exchange for a future percentage of receivables or credit card receipts.
Each day, an agreed upon percentage of the daily revenues or credit card receipts are withheld to pay back the MCA. This is called a “holdback” and will continue until the advance is paid in full. Access to a business owner’s merchant account eliminates the collateral required for a traditional small business loan.
Because repayment is based upon a percentage of the daily balance in the merchant account, the more transactions a business does, the faster they’re able to repay the advance. And, should transactions be lower on any given day, the draw from the merchant account will also be less. This means during times of slow business, the business’ payback is relative to their incoming merchant account deposits.
Repayment and Loan Costs
A business that uses a merchant cash advance, according to several MCA provides, may pay back 20%-40% (or more) of the amount borrowed. This percentage is frequently displayed as a factor rate, which would equivalently be 1.20 – 1.40.
NOTE: There’s a difference between the holdback amount a small business pays every day (as a percentage of their receivables) and the repayment amount for the entire advance. There could, for instance, be a holdback of 15%, and a repayment of 30%, so it’s important for the business owner to understand the distinction.
The holdback percentage is typically based on:
- The amount of funds a business receives,
- How long it will take to repay the advance, and…
- How big the monthly receivables are.
For example, a business is advanced $10,000 and agrees to pay back $13,000. This means the payback, or factor rate, is 1.30 or 30% of the advance amount. Moving forward, the business agrees to have 15% of its credit card transactions withheld by the advance company (the holdback) until the $13,000 is collected. If the business is averaging $14,500 a month in credit card sales, approximately $2,160 would be withheld each month and the advance would be paid back in roughly six months.
Typical holdback rates may range from 10%-20%, though this can vary widely based upon the business and the provider’s evaluation of the borrower’s risk.
Is a Merchant Cash Advance Right for Your Business?
An MCA is an option when a business needs to access capital quickly, has adequate cash flowing through their merchant account each day to make payments on the advance, and the loan purpose can justify the potentially high expense of the advance. And, because credit requirements are typically less than a small business loan, it could be an option for a business that does a lot of credit card transactions every month but has a weak credit profile.
The Application Process
The time it takes to get approved for an MCA could be anywhere from an hour or two to a few days, depending on the provider. And once the application is approved, a business could see the funds in their account within two days.
The application process isn’t as complicated as a traditional loan, which often makes the merchant cash advance approval process a faster option. Here are the typical steps a business needs to take:
- Apply for the advance: The application is typically one or two pages and will require your social security number, business tax ID, and other information about your business.
- Provide documentation: You will likely be asked for several months of credit card or payments processing data as well as bank statements.
- Get approved: It could be as quick as 24 hours for your business to be approved for a merchant cash advance.
- Set up the credit card processing: This type of funding may require the business to switch to a new credit card processor. It can be inconvenient to switch processors, but it is sometimes a necessary part of the approval for many MCA providers.
- Finalize the details: To use the previous example described above, the funding details might be something like this: a small business is approved for $10,000 and required to pay back $13,000. The merchant account will be debited 15% every day until the entire $13,000 is repaid. Make sure you understand when payments will start, because it may be as quickly as the next business day.
- Receive the funds: The money from the MCA will be deposited into the small business’ bank account and repayment via the merchant account will begin automatically.
Alternatives to a Merchant Cash Advance
A merchant cash advance does not help build business credit because it’s not a loan and advance providers do not typically report repayment history to the business credit bureaus. As a result, many business borrowers turn to other options, like an online small business loan, which offers many of the same conveniences and potentially at a lower premium than many MCAs.
If you’re considering a merchant cash advance for financing the purchase of quick-turnaround inventory, equipment, an expansion project, or marketing initiative, a six- to 18-month online business loan is another option if you have at least a year in business and annual revenues of $100,000 or more.
Additionally, online business loan providers (like OnDeck) report your good repayment history to the business credit bureaus and are subject to federal lending laws. Meaning, unlike an MCA, an online business loan may help you build your business credit profile.