A new small business is always looking for ways to prop itself up in the short term so the founders can get closer to achieving their long-term goals. This is why a merchant cash advance (MCA) is an option: it allows a business to get cash quickly without going through the applying and approval process of a more rigorous small business loan. Before you go out and get an MCA, it’s important to figure out if it’s right for your business. Here’s what you need to know.
Note: This article is intended to provide a definition of what an MCA is and what it does, and it should not be considered financial advice. We encourage small businesses to research all lending options available to them before making any commitment.
What Is an MCA?
A merchant cash advance comes from a lender and is different from a traditional bank loan. A lender who offers a merchant cash advance will look at your credit card receipts and assess how much you need and how much you could pay them back. The contract you sign with the MCA lender will outline the amount you’re getting and how much interest you’ll have to pay back. Interest rates can vary widely between companies. The state your business is based in also plays a factor in how much you ultimately have to pay, as some states place limits on interest rates.
What Is an MCA Lender Buying?
In basic terms, the MCA lender is buying your future sales transactions. You have a contract with them and MCA lenders will assess your sales to see if you’re eligible for them to lend you the money, but the importance of an MCA is that it gives you an infusion of cash quickly.
If you have some water damage that you want to fix in your coffee shop, but don’t have the funds to divert to the repair, an MCA could be an effective way to quickly raise funding for those unexpected repairs.
How Does an MCA Work?
While getting an MCA is not as rigorous as a loan approval process, an MCA is not just a bag of money with no strings attached. There is a contract with stipulations that you have to be aware of when you’re looking to get a merchant cash advance to aid your business.
Advance Amount
In the MCA contract, this is the agreed-upon amount that the lender will give you as a merchant cash advance. It’s important to assess and ask for exactly what you need, or else you’ll have more to pay back. The advance can be less than, equal to or much greater than your monthly sales. It really depends on how much you need and how long you’re comfortable being on the hook for paying your daily sales back to your lender.
Payback Amount
This will be a larger number than the advance amount because an MCA lender charges a fee, called a factor, in addition to the money they lend you upfront. In some cases, this amount can be far higher than the interest rate on other kinds of loans.
Holdback
While working to pay back your merchant cash advance, there will be a daily amount you have to hold back from your credit card transactions. Before getting a merchant cash advance, you should look over your sales and see how viable this will be during the payback period.
MCA Fees and Cost
The overall cost of your MCA will depend on a number of factors, like the company you get your MCA from, the terms you agree to and your state. Highly qualified businesses will generally get more favorable terms.
Pros and Cons of an MCA
Needing fast cash is an unfortunate problem for a lot of small businesses. Before signing up for a merchant cash advance with a lender, going over the pros and cons will give you a better idea of what you’re in for.
Pros
The biggest benefit of an MCA is quickly getting the money in hand that you need for your business. If you have a project or an improvement that you want to make in your small business and need money to make it happen, a merchant cash advance can be a way to acquire the money needed to do so.
Unlike a loan, you don’t need to have collateral to back up the loan. You also don’t need to worry too much about your credit score. And although the lender will pull your credit score, MCAs tend to be more forgiving for businesses with mediocre or bad credit.
A lender will be able to give you more flexible payment options as well. If you’re going through a slow sales period, you could readjust the daily holdback of your transactions as well.
Cons
Since there is a factor added to the payback amount for a merchant cash advance, if you’re in a period of lower sales, the higher payback amount could do more overall harm than good. The extra cost of paying back the merchant cash advance could take away necessary profits.
Since MCAs aren’t regulated, the factor on top of the payback account tends to be higher than the interest of a traditional bank loan. This can create problems for your business later down the line if the amount you owe is more than you can afford to pay. The payback period will generally be shorter than a loan.
Who an MCA Is Best For
A merchant cash advance is best for a small business that needs some extra money to get their business to be more competitive and generally more functional. Not all small businesses can get bank loans to do all of the things they want to do.
An MCA is not great for a business that had a major disaster that completely shut down business operations. Looking for assistance in the form of a traditional bank loan or a grant will be better than an MCA because they don’t expect you to continue daily transactions in order to pay them back.
The MCA is a good idea for a small business just starting out that wants to make non-interrupting upgrades. But if you’re looking for an alternative means of financing, we recommend checking out our guide to the best merchant account services on the market.
Alternatives to MCAs
If your business doesn’t qualify for an MCA for any reason, you still have options available to you. One alternative is a high-risk merchant account, which is popular with companies that aren’t able to secure financing through traditional means. These services fill an important need, as businesses in many industries are deemed “high risk” and are usually shut out from a normal MCA. For more information, you can check out our guide to the best high-risk merchant account services on the market today.
Frequently Asked Questions (FAQs)
What is a merchant cash advance?
A merchant cash advance is an alternative financing model for small businesses. With an MCA, businesses can borrow a lump sum of money and repay the lender (often a credit card processor) with a percentage of future credit card transactions.
What is a merchant cash advance used for?
A business can use its merchant cash advance however it sees fit. It’s important for the business to have a plan for its MCA and put it to use quickly so it can start earning money back to repay the lender.
What are the alternatives to a merchant cash advance?
A merchant cash advance is just one way to secure financing for your business. Most banks offer more conventional small business loans with favorable terms, but longer turnaround times. And for day-to-day purchases, there are plenty of options for small business credit cards available that offer all sorts of rewards and incentives for new customers. Other potential options include installment loans, Small Business Administration (SBA) loans, SBA Economic Injury Disaster Loan (EIDL) program loans, lines of credit, equipment loans, private investor loans and loans from friends or family members.
What are some key factors to consider when seeking a merchant cash advance?
As with most forms of money lending, the factors you need to consider when selecting an MCA include how much of a loan you can qualify for, the repayment terms, whether collateral or a personal guarantee is required, the estimated APR, the requirements for your business and how quickly you can be funded.
What happens if you don't pay a merchant cash advance?
Since an MCA is a contract between you and the lender, failure to meet the terms could result in getting sued. Instead of missing payments, try to communicate proactively about what might be stopping full payments and see if you can renegotiate the payment amounts and schedule.
Are merchant cash advances legal?
Yes. Although they aren’t loans, they are considered purchases of your future sales.
