Cash flow is crucial for any small business. But when you have a bad cash flow, things can seem dire. That’s why business owners like you try to find the fastest ways to receive money. Merchant cash advances seem like the quickest deal available for many.
But, what exactly is a merchant cash advance?
Is it really a good option?
Could getting your hands on quick cash could cost more than you bargained for?
This in-depth article details how a merchant cash advance works (also referred to as MCA), its pros and cons, and what’s required to qualify for one. You may be surprised that other alternative lending options are just as appealing and more advantageous in the long run.
What is a Merchant Cash Advance?
Merchant Cash Advances, also referred to as simply Cash Advances, are a financing option that gives access to money rather quickly. The amount you receive is based on your current credit card sales. You will pay for the MCA with your future credit card sales.
While MCAs are a financial product, they’re not considered a loan.
How do merchant cash advances work?
When you get an MCA, your business will receive cash advances, usually by direct deposit from the finance company (this usually happens very quickly). The better credit card sales you have, the more money you will receive because the lender knows you will be able to pay it.
Most MCA lenders require you to make daily payments (but some offer weekly or monthly payments). You could either pay them directly, or the lender will withhold a percentage of each sale. Of course, you don’t always sell the same amount, you could be going through a low-season or a high-season of sales. This means that, depending on your sales, it could take more or less time to repay the MCA.
With regular business loans, you know how much money you’ll pay in interest rates. But MCAs don’t use this method, they use factor rates, which go from 1.1 to 1.4. Now, this could look confusing, so we recommend looking at them like percentages: a factor rate of 1.1 equals 10%, 1.2 equals 20%, and so on and so forth.
MCA lenders don’t ask you for collateral, so your personal and business assets stay safe. But, in a way, your future credit card sales are the collateral.
An example of how MCAs work
Let’s take a look at an example:
Miguel is a business owner in serious need of quick cash. He applies for an MCA of $10,000. The lender offers him the required amount with a factor rate of 1.4 (or 40%). This means Miguel would have to pay back $14,000.
He receives the money he needs the next day, and he starts investing it in his business. This helps improve the cash flow during the low season.
But now it comes time to repay. Miguel agreed to have the lender withhold 20% of his daily sales. But because it’s a low season, it will take Miguel longer to repay the Merchant Cash Advance. Imagine he is making only $16,000 a month. Of that money, he would have to give $3,200 to the MCA lender (the 20%).
Then he needs to pay his employees, pay rent, buy supplies… That would leave him with not that much revenue, and practically the same where he was at square one.
It would take Miguel a little over 3 months to pay the MCA.
Merchant Cash Advance: Characteristics
How much can you get?
Funding amounts could average $5,000 to $1,000,000 depending on your business’s annual credit card sales.
How fast will your receive your MCA?
MCAs are attractive because, typically, you’ll have money in the bank within 2-5 days.
Repaying: How much do you pay?
The business owner receives immediate capital, but he agrees to pay back the MCA to the lender based on a sales percentage. This results in paying the MCA lender back daily (if that’s how often you get paid by your credit card processor). Of course, what the owner has to pay includes the advance plus fees.
For example, on a lump sum advance of $25,000, business owners can choose to pay back 10% (or a different percentage) of sales daily, weekly, or monthly based on the business’s average credit card revenue per month. That percentage is also referred to as the holdback percentage.
Repaying: Factor rates
Business owners agree to repayment terms based on a factor rate, which averages between 1.1 to 1.4. For instance, when applying a 1.2 factor rate to the same $25,000 advance mentioned earlier, the total repayment amount would be $30,000.
Keep in mind that this can result in an extremely costly form of financing.
Paying a 1.2 factor rate on a 4-month loan is equivalent to an APR of 121%! Before applying for an MCA, we strongly recommend you to use a Factor Rate to APR Converter to know exactly the cost of your MCA and how it would compare to the interest in a traditional loan.
Repaying: How much time do you have?
MCAs are typically short-term: the funding lasts between 3 and 12 months.
Do you need a good credit score?
One benefit of MCAs is that lenders usually are very flexible about the credit score you have (remember: a solid credit score is one of the most common requirements among traditional lenders). They typically don’t have a minimum threshold and base their credit decision mainly on the merchant account activity.
What can MCAs be used for?
MCAs appeal to business owners who need cash fast to purchase new equipment, replenish inventory, or have more money on hand to cover payroll, so their business thrives.
Before you consider applying for a MAC lured by the lack of collateral, the quick access to the funds, and the fewer requirements, consider other options.
Camino Financial is an alternative lender that doesn’t require collateral, with less strict requirements than most lenders, and with a fast and easy process: you can receive your funds within 4 to 10 business days.
Requirements to Qualify for an MCA
If you do decide to get an MCA, what requirements would you need to meet?
1. Annual Sales
Annual sales should be at least $50,000, and usually, you need to supply two years’ worth of actual credit card sales (although some lenders may settle for less time in operations).
2. Credit Score
Your FICO credit score is not one of the main requirements.
This is different from most lenders, who use your credit score to evaluate your credit risk and calculate the interest rate you’ll get. However, lenders of MCAs have very low credit score thresholds since they base their decision mainly on the merchant account activity.
3. Credit Card Processor Account
You probably already have a credit card processor account, but you may need a different one that’s compatible with the lender’s requirements.
4. Required Documents
Most applications require your social security number and business tax ID number. In addition to answering general questions about your business, required documentation includes copies of bank and credit card statements. Finally, you may be asked for proof of citizenship or to provide copies of your business lease agreements.
Applications are available online and are straightforward and simple. Approval normally occurs as soon as 24 hours with funding in a few days. Whether you prefer daily, weekly, or monthly repayment terms, repayment can begin as soon as your merchant account is active.
Even though MCAs do not have stringent requirements, they do have hefty holdback percentages and factor rate repayment fees.
In some instances, they make good financial sense when credit card sales are consistently high, so repayments don’t take a bite out of available cash. But don’t forget that there are alternative financing options that provide business loans with the same (or more) benefits and are cheaper.
Merchant Cash Advances: Pros and Cons
- Quick cash to achieve business goals
- A lower credit score doesn’t usually prevent you from qualifying
- Conducive for seasonal businesses like some restaurants, retail merchants, and tourist services where sales fluctuate
- Streamlined application with fewer requirements than most small business loans
- As in any other business loan, the cost (in this case lender fees or factor rate) can be deducted as a business expense on your taxes
- Must have a credit card processor account
- Annual percentage rate averages 40%-150% (or even up to 400%)
- Some lenders require a 2+ year history of credit card sales
- Annual credit card sales should be at least $50,000
- If sales are low, it takes longer to repay MCAs
- They are an “aggressive” form of financing, and the lender can add fees between 5 and 10% of the loan amount
- MACs are not subject to Federal regulation, resulting in little transparency in how fees are disclosed
- High costs and repayment frequency can cause cash flow problems
- Short repayment terms: average between 3 and 12 months
- Late fees may apply
Are MCAs Right for You?
MCAs are attractive alternatives when cash isn’t readily accessible, or you don’t want a loan to appear on your credit report. They can be a reasonable financial solution for seasonal businesses.
However, keep in mind that using a merchant cash advance instead of a business loan has the potential for debt to spiral out of control.
Remember: MCAs are extremely expensive financial products. While the average APR is between 80% and 120%, it’s not unlikely for this to go up to 400%!
If MCAs pique your interest because the application process seems more favorable or you need funds ASAP, be aware that there are other alternatives to consider.
Small business loans are a better option: they’re cheaper, you can receive the money in a matter of days, and they won’t leave you in debt.
When comparing MCAs and small business loans, their differences and outcomes are a lot like the fable “The Tortoise and the Hare”: while the rabbit rushed and acted too quickly, the turtle won the race because it moved at a steady pace.
By rushing ahead too soon you may commit to a merchant cash advance and realize too late that a small business loan was the better option.
MCAs and Business Loans: Similarities and Differences
Compare here the different interest rates in different lenders and types of loans.
Your Best Alternative: a Small Business Loan
Applying for a small business loan from Camino Financial is as simple and quick as a merchant cash advance: you can get your funds within 4 to 10 business days.
|MCA vs. Small Business Loan|
|MCA||Camino Financial small business loan|
|Loan amount||Up to $500,000 (depends on your credit/debit card sales)||$5,000 to $400,000|
|Repayment term||Daily, weekly or monthly||Monthly|
|Time to repay||Up to 12 months||24 to 60 months|
|Annual interest rates||40 to 150% (and up to 400%)||12 to 24.75%|
|Accept ITIN?||Depends on the lender||✔️|
|No credit history accepted?||✔️||✔️|
But the benefits don’t stop there: there are additional advantages that MCAs don’t offer, namely these:
- Loan amounts that adapt to your business needs
- Comfortable and stable monthly repayment terms
- We help you build your credit score
- After 9 timely payments, you can graduate to a better loan with fewer interest rates
- Minimum requirement of $30,000 in annual sales and 9 months operating as a registered business, a quantity and time frame much smaller than those required for an MCA
When you cross the finish line ahead of business owners that opted for merchant cash advances (and wish they hadn’t), you won’t be knee-deep in unpaid debt, and you’ll have peace of mind knowing you made the right decision.
Connect with Camino Financial today and let one of our financial specialists help guide you through every step of the loan process.
The online application is free, doesn’t affect your credit score, and you can know instantly if you’ve pre-qualified. After submitting basic financial records, we’ll offer the best financial solution for your business needs. Once you agree with the offer and terms, you’ll receive funding in a few days. It’s actually that simple!
Apply today and start growing your small business!