Business Tips

Merchant Cash Advance: What to Know for Your Small Business

Merchant cash advances are more popular than ever when starting or growing your business. The truth is, many businesses today are low on cash. In fact, about 80% of businesses rely on some form of credit. The merchant cash advance industry has changed rapidly with improvements in technology and online lending. But, if you’re new to business funding, you may be asking yourself “What is a cash advance?” If your business does not qualify for a traditional loan due to a short business history or low business credit score, a Merchant Cash Advance (MCA) might just be the right solution for you. In this article, we’ll go over the cash advance definition, how they work, and your options moving forward.

What is a Merchant Cash Advance?

A merchant cash advance is a type of business funding provided by a merchant services provider. This type of cash advance allows you to borrow money against your future profits. A merchant cash advance is ideal for small businesses that process use credit card processing.

Cash Advance Definition (MCA)

A cash advance is a sales agreement where the “merchant” sells their future revenue to a cash advance company for immediate working capital. Simply put, a merchant services provider loans your business a lump sum of money, which you pay back with a percentage of your credit and debit card sales over time.

How Does a Merchant Cash Advance Work?

what is a cash advance

Merchant services providers collect their loans through a percentage of your business’s credit and debit card sales. This means there are no set repayment dates, as your payments depend on the cash flow of your business. However, most cash advance providers expect repayment within 18 months. What you’re borrowing against is your future revenue in exchange for a lump sum. If you’re in need of funding quickly and know you’ll be making sales to repay the advance in the future, a merchant cash advance is a great option.

Cash Advance Vs. Loans

A cash advance may sound similar to a traditional loan, but there are fundamental differences between the two. When it comes to merchant cash advances, the terms of your agreement typically take effect immediately after you receive your capital. This means the lender will begin collecting a percentage of your daily card transactions.

Additionally, the government heavily regulates the business loan space, while merchant cash advances operate outside their sphere. Some states are implementing regulations on these types of sales agreements. However, as a borrower, you should not expect the same protections as you would with a traditional loan.

How Much Will a Merchant Cash Advance Cost Your Business?

Unlike traditional business loans, merchant cash advances do not have a set term length. While this may depend on your provider, typically these cash advances are based on income. Therefore, setting established payments and end dates is not feasible. In fact, the whole process varies upon the number of card transactions your business makes. This equates to every transaction ran through your credit card machine or virtual terminal.

Cash advances have a one-time fixed fee instead of an interest rate. To calculate your cash advance fee, multiply the “factor rate” (also known as a “buy rate”) by the agreed-upon amount borrowed. Fee rates vary depending on providers and agreements and there may be additional fees such as processing and closing fees. As previously stated, loans are usually repaid in fixed installments, while merchant cash advances are repaid with a percentage of your daily credit and debit card sales. In fact, these fees are not that different from the credit card processing fees you’re used to.

Repayment Structures

Repayments automatically come out of your merchant account. This happens daily, weekly, or monthly, depending upon the agreement with your lender. Your provider may have a repayment structure already in place, but there could be room to negotiate. There are a few popular repayment structures that vary between providers.

ACH Withdrawals

Automated Clearing House (ACH) withdrawals are the most common way to repay a merchant cash advance. They consist of automatic withdrawals from your merchant account to your cash advance provider. They may be fixed or variable depending on your agreement but if you are experiencing a decline in revenue, your lender may be willing to alter your payments. However, for your protection, this should be determined before entering into a merchant cash advance with a fixed ACH payment.

Lock Box Withholding

The cash advance provider will set up a lockbox in your name controlled by their company. You will then have your sales connected to this new bank account instead of your business account. Your lender will deduct their percentage of the sales and send the rest to your business account. You should be aware that choosing this method may cause delays in the transfer of funds. Overall, this repayment structure is not very popular. This is because it gives your financier direct access to all of your sales and profits before you can access the funds yourself.

Split Payments Processing

Split payments processing is the easiest repayment structure because it automatically deducts from your sales. Every time your business makes a sale, you will receive your portion of the profits, while your provider will receive theirs. This means you won’t have to go through the hassle of watching your business gain and lose a percentage of profits throughout the business day. This payment method is not as common among MCA providers and will need to be arranged before entering your sales agreement.

Pros of an MCA

For many, merchant cash advances solve all of their business funding problems. Here are just a few of the positives when considering a merchant cash advance:

  • Quick business funding
  • Minimal paperwork
  • Transparent structure
  • Repayment is manageable

If your business has a strong cash flow but does not meet the terms for a traditional loan, you might be a good candidate for an MCA. Merchant cash advances also have quick application processes with minimal paperwork. After submitting your application, it only takes a few business days before you have cash in hand. This can mean the world to new or struggling businesses.

merchant cash advance definition

The variable repayment structures can also be a draw, as these payments fully depend on your sales. This means when business is slow, you don’t need to worry about having enough revenue to cover your repayments. Finally, there is no collateral required for a cash advance and you will generally not be asked to put down any sort of deposit to receive your financing.

Cons of an MCA

Despite all of the positives listed above, merchant cash advances do have some drawbacks. Here are a few of the cons that come with this type of business funding:

  • They can be expensive
  • Delayed repayments are possible
  • Not as regulated as loans

One of the drawbacks to cash advances is pricing. It’s important to analyze every aspect of your MCA or merchant account agreement to make sure you are being charged a fair and reasonable rate.

Providers may require you to use certain payment processors, regardless of any current business contracts or personal preferences you may have. This varies by merchant services provider but it is best to check before signing. Merchant cash advances can also come with delayed payments, particularly if you are using the lockbox repayment structure. Your lender will have primary access to your revenue and, though uncommon, there is a risk of your funds being withheld. If you’re worried about this, seek out a merchant cash advance that uses another method to accept payment.

Some providers may also practice double dipping, which becomes problematic when a merchant needs to renew or refinance an advance with a fixed fee. That fee is due in full, regardless of whether or not the advance is paid off early. This makes it so refinancing or renewing an advance causes a merchant to pay interest on interest. It is best to choose a provider who does not practice double dipping.

Merchant cash advances are not as fully regulated as loans and therefore offer you less protection. Merchant cash advances are generally not covered by the usury laws that govern loans because of their definition as a sales agreement. However, you may still want to consider a merchant cash advance if you do not qualify for other forms of financing.

Are You a Good Candidate for a Merchant Cash Advance?

Merchant cash advances may not be the best choice for every business. If you deal mostly in cash, have good credit, want your revenue flow to remain uninterrupted, and want an exact end date for your agreement, you may need to look into other financing options. Short-term loans, invoice factoring, and traditional installment loans may be better for your personal needs and business practices.

However, if you need hassle-free business funding in a flash, a merchant cash advance is your answer. Because of the repayment structure, easy application, and established connection to your merchant services provider, a merchant cash advance is a great tool for new and existing businesses to flourish. Ask your merchant services provider what they can do to help your business grow.

PaymentCloud Author Caroline McMullen

Caroline McMullen

Caroline is a writer and editor based in Los Angeles, CA. She has been working in the writing sphere for the last five years, covering everything from breaking news to lifestyle features, and now digital payments. Caroline is currently a Marketing Coordinator at PaymentCloud, a merchant services provider that offers hard-to-place solutions for business owners across the nation.