Business Funding

What is a Merchant Cash Advance?

Read Time: 11 min

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 form of financing that allows you to use the credit card transaction volume you’re already processing to borrow money from a bank. Unlike traditional loans, which are for a set amount of time, a Merchant Cash Advance gives you access to funds on an as-needed basis over a set period of time. 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 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.

How to qualify for a merchant cash advance

To qualify for a merchant cash advance, you will need to have at least 6 months of consistent sales history. A merchant cash advance is typically only issued when your monthly payment volume is $10,000 or higher.

You will also need to have merchant processing. A merchant cash advance can be used with any merchant service provider; it does not have to be yours specifically.

Your credit score will also factor into the qualification process, so make sure that you’re running an online credit report before applying for an MCA.

What if you default on your merchant cash advance?

In the event that a borrower defaults on merchant cash advance, the merchant cash advance provider may be able to take action. They could go after the merchant’s bank account, attaching merchant’s funds from other merchant accounts, or even seize merchant equipment. That is why it is important to keep close tabs on all merchant cash advances and make sure you have enough financial resources to repay them.

Some MCA lenders will also require a personal guarantee for a merchant cash advance, which can be risky depending on your financial situation.

Cash advances vs. loans

A cash advance may sound similar to a traditional business term 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.

What are the merchant cash advance rates?

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 that goes 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.

What is a holdback?

When it comes to merchant cash advances, a holdback is the amount of daily sales your lender applies to your advance. This is a percentage you agree upon when you set your initial terms. This means the more credit card transactions your business makes, the faster your repay your advance. Likewise, if your business has a slow day for credit card sales, you won’t pay as much in holdbacks.

What is the difference between holdback and interest rates?

Holdbacks are the percentage of your daily sales that are applied to repay your advance. Interest rates are the amount you pay on top of that for the ability to receive the advance.

Merchant cash advance calculator

The merchant cash advance calculator can be found on many MCA providers’ websites. This tool will help you determine how much capital you qualify for and estimate your monthly payment. To use it, enter your credit card processing volume and a monthly amount to borrow in the text boxes on the cash advance calculator.

Factors that affect your MCA rate

One of the most important factors pertaining to merchant cash advance is your credit score. If you have a low credit score and are applying for an MCA, it may be difficult to find lenders who will be willing to work with you.

Just like other types of loans, merchant cash advance providers base their interest rates on a few different factors. These include your income, the type of advance, term length, and more. They charge higher rates for merchant cash advances that provide more flexible repayment terms or shorter repayment periods. There are some circumstances in which MCAs may be more expensive than traditional loans. This may be because the merchant probably does not have good credit and has not established a financial history.

MCA Repayment Structures

Repayments automatically come out of your merchant account. This happens daily or weekly, 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.

1. 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 day. This payment method is not as common among MCA providers. Because of this, you’ll need to arrange it before entering your sales agreement.

2. 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. However, 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.

3. 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.

Pros and Cons of MCAs

Merchant cash advances can help you if your business needs a quick injection of capital. They are often approved within 24 hours and don’t always require collateral, although they do require merchant credit card processing history.

Pros

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

  • Quick business funding: Merchant cash advance providers will often approve merchant funding within 24 hours, while it can take weeks or even months to get traditional merchant loans approved.
  • No collateral needed: Traditional merchant lenders have strict financial requirements and they may require you to provide collateral if you don’t have a great business history. Merchant cash advances allow for more lenient business standards.
  • Minimal paperwork: Unlike traditional term loans, you can qualify for a merchant cash advance without showing significant financial statements as long as you have sufficient accounts receivable.
  • Transparent structure: An MCA is a fixed term loan, meaning you’ll establish your interest and payment terms in advance and they won’t change with the market.
  • Repayment is manageable: Since your payments come out of your profits before they go into your bank account, you don’t have to set aside capital for payments at the end of every month.

Benefits of merchant cash advances

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, cash advances do not always require collateral. This means you will generally not have to put down any sort of deposit to receive your financing.

Cons

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: Since qualifying criteria are much less stringent than those of typical small business lenders, MCAs often have higher interest rates.
  • Delayed repayments are possible: MCA providers are usually more lenient on repayment terms than traditional lenders. They can work with you to modify your terms so it works with your cash flow.
  • Payment history is not reported to the credit bureaus: Since a merchant cash advance is not a loan, providers don’t report your payment history to the business credit bureaus. This type of financing does not help build or strengthen a business credit profile.

Drawbacks to merchant cash advances

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 paying 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 lender withholding your funds. If this concerns you, seek out a merchant cash advance that uses another method to accept payment.

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.

Merchant Cash Advance Regulations

The merchant cash advance industry is not heavily regulated in comparison to the lending industry. The merchant cash advance industry consists of businesses that provide credit to a merchant based on their daily credit card sales. They are transferred funds which are secured by the merchant’s accounts receivable and inventory.

Merchant cash advance lenders do not report payment history to the business credit bureaus. Because of this, MCAs do not help build or strengthen a business credit profile. This is one of the drawbacks to cash advances since they miss out on important information such as your payment history.

Lenders can also require you to use certain payment processors, regardless of any current business contracts or personal preferences you may have. This varies by merchant service provider but it is best to ask your provider before signing on the dotted line. Since these advances are not legally considered loans, lenders are not subject to the same federal regulatory oversight that banks and other lenders must comply with. This is a technicality that allows some lenders to charge high interest rates and escape the usury laws of their particular state.

Alternatives to MCA

There are a few different merchant cash advance alternatives to traditional merchant cash advances that you might want to explore.

One alternative is merchant and investor funding which is a type of merchant cash advance, but with the merchant as the investor. The merchant invests in their own business by purchasing a merchant cash advance.

Another merchant cash advance alternative is factoring, which is a form of financing that can be achieved through an invoice factoring service. Invoice factoring provides funding for invoices due up to 180 days from date of invoice issuance. This type of merchant cash advance does not require the merchant to provide much personal information about themselves or their business. Other alternatives include:

  • Equipment financing
  • Invoice financing
  • Working capital loans
  • No doc loans
  • Business term loans
  • Business line of credit
  • Asset based loans

Be aware that merchant cash advance alternatives are generally more expensive than traditional merchant cash advances. This is due to several federal regulations as well as the merchant’s increased risk involvement.

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.

Merchant cash advances are a good source of immediate capital for your business. If you are a business owner looking for quick funding, a merchant cash advance could be the most suitable option for you. To determine if this type of financing is right for your business, fill out a quote and get started today.