Business Funding

What Is a Merchant Cash Advance? Everything You Need to Know

Read Time: 7 min

A merchant cash advance (MCA) is a form of funding in which a business’s sales volume is used to secure capital from a lender. There’s no doubt that business funding is a key component of success. In fact, about 80% of businesses rely on some form of credit.[1] “Sources of Financing for Small Business“. Accessed November 28, 2022. However, that form of credit needn’t be a business loan, as many alternative forms of financing—such as merchant cash advances—may be more beneficial to your business operations.

Below explains what a merchant cash advance is, details how to secure this form of financing, and outlines the associated benefits and drawbacks. Read on to decide if a merchant cash advance is the best way to advance your business operations!

Introduction to Merchant Cash Advances

graphic of a businessman in front of bar charts and falling coins asking what is a merchant cash advance

Unlike traditional business loans with defined term lengths, a merchant cash advance gives you access to funds on an as-needed basis. Because this type of financing allows you to borrow money against your future sales, it is an ideal form of lending for businesses accepting payments.

How Does a Merchant Cash Advance Work?

Merchant cash advances are usually paid back through a “holdback” of your credit card sales. (Don’t worry, we explain what a holdback is below!) This typically means there are no set repayment dates, as your payments come out of your transactions. However, most merchant cash advance providers expect repayment within 18 months.

Due to this repayment structure, lenders assess your current and projected revenue when evaluating your MCA application. That said, a merchant cash advance can be an excellent form of financing for businesses that do not qualify for a traditional business loan due to a low business credit score.

Note: Businesses with low credit scores have limited financing options. While a low score won’t prevent you from securing a merchant cash advance, improving your business credit score will unlock additional financing options.

What is a holdback?

A holdback is the dollar amount of daily sales your lender retains and applies to your advance. This dollar amount is a percentage you agree upon when setting your MCA terms. As such, the more sales you make, the faster you repay your advance.

What is the difference between holdback and interest rates?

A holdback is an agreed-upon percentage of your daily sales revenue that is withheld to repay your advance. On the other hand, an interest rate is an agreed-upon percentage of your borrowed capital that must be repaid to the lender.

Common Use Cases for Merchant Cash Advances

While there are numerous reasons a business owner may obtain a merchant cash advance, below are the most common:

  • Unexpected business expenditures
  • Maintaining payroll or hiring new staff
  • Business expansion
  • Marketing and advertising expenses
  • Partner buyout(s)
  • Inventory and equipment purchases

How to Qualify for a Merchant Cash Advance

To qualify for a merchant cash advance, your sales volume must be $10,000 or higher. Additionally, you must produce proof of at least six months of consistent sales. Average daily balances, along with any outstanding business debt, also factor into the qualification process.

Note: Depending on your financial situation, some MCA lenders require a personal guarantee for a merchant cash advance.

What happens if you default on your merchant cash advance?

In the event you default on a merchant cash advance, your lender can impose judgments on your merchant account funds or even seize your assets. However, cash advance lenders are typically more flexible than institutional banks. That means they may be willing to work with you to come up with a more feasible repayment plan. Since these lenders have the autonomy to make such decisions, it’s prudent to maintain communication with your lender should you find yourself in a situation in which repayment becomes difficult.

business owner sitting on coins as money and documents fall from the sky after approval for a merchant cash advance

Merchant Cash Advance Fees, Costs, and Rates

Unlike traditional business loans, merchant cash advances do not have a set term length. Repayment is usually based on revenue. Therefore, setting established payments and an end date is not an option.

To calculate your cash advance fee, multiply the factor rate by the borrowed amount. Keep in mind that there may be additional fees, such as processing and closing fees.

Interest rate icon.

Factors that affect your MCA rate

Two of the most important factors pertaining to merchant cash advances are your business’s revenue and its average daily balance. As with other types of lending, providers base approval terms on the financial exposure associated with funding your business. The lower the likelihood of repayment, the higher the associated risk and, in turn, the higher the factor rate. Other factors impacting your MCA rate include:

  • Business income
  • Deposit history
  • Average daily and monthly balances
  • Business model
  • Term length
  • Financial statements

Cash advance lenders offer flexible repayment terms, lenient qualifications, faster approvals, shorter repayment periods, and much less required documentation. These advantages do come at a cost, as MCA lenders typically charge higher rates than traditional financing options.

MCA Repayment Structures

Repayments are debited from each transaction and withdrawn from your merchant account. This happens on a daily or weekly basis, depending on the terms of the MCA agreement. Although repayment structures vary by lender, below are the most popular:

1. Split payments processing

Split payment processing is the easiest repayment structure because it automatically deducts repayments from your credit card sales. Every time your business makes a sale, your lender receives an agreed-upon portion of the profit.

2. ACH withdrawals

Automated Clearing House (ACH) withdrawals consist of automatic withdrawals from your sales to your cash advance provider. Depending on your agreement, repayments may be fixed or variable amount. However, if you are experiencing a decline in revenue, your lender may be willing to adjust a fixed repayment amount.

Merchant Cash Advance Regulations

Compared to other lending industries, the merchant cash advance industry is not heavily regulated. Since cash advances are not legally considered loans, lenders are not subject to the same regulatory oversight with which other lenders must comply.[2] “Merchant Cash Advance Definitely NOT a Loan, New York Judge Rules“. Accessed November 28, 2022. Some lenders take advantage of this technicality and the resulting lack of oversight by charging exorbitant fees. However, thoroughly reading through your MCA agreement can help you avoid malicious actors in this industry.

Male business owner hugging money he recieved from a merchant cash advance.

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Pros and Cons of Merchant Cash Advances

Benefits of a Merchant Cash Advance

Often approved within 24 hours, merchant cash advances are an optimal choice for those in need of a quick injection of working capital. This financing option doesn’t always require collateral, though approval does depend on six months of sales history.

MCA pros

  • Quick business funding: Lenders often approve MCA funding within 24 hours. Meanwhile, it can take weeks or even months to get approved for more traditional business funding options.
  • No collateral needed: Because traditional lenders have strict financial requirements, they may require collateral if you don’t sufficiently meet their financing standards. Merchant cash advances allow for more lenient standards and, as a result, do not usually require collateral.
  • Minimal paperwork: You can qualify for a merchant cash advance without showing significant financial statements as long as you have sufficient accounts receivable.
  • Transparent structure: With a fixed factor rate, you’ll establish your total financing expense in advance, as rates aren’t subject to market fluctuations.
  • Repayment is manageable: Since your payments come directly out of your profits before going into your bank account, you don’t have to worry about setting aside funds for repayment.
  • Payment history isn’t reported to the credit bureaus: A slow sales month can result in a fluctuation in repayment, but this does not hurt your credit score.

Drawbacks of a Merchant Cash Advance

Despite all of the advantages, merchant cash advances have some drawbacks. The first of which is that they can be more costly than traditional forms of financing. It’s important to analyze every aspect of your MCA agreement to make sure you are getting a fair rate.

MCA cons

  • They can be expensive: Since the set of qualifying criteria is less stringent than those of more traditional financing options, cash advances are often subject to higher repayment rates.
  • Does not help build credit: A merchant cash advance is not a loan. That said, providers don’t report your repayment history to the major business credit bureaus. This type of financing will not help build or strengthen your business’s credit profile, which is a huge advantage offered by other financing options.
  • Lack of regulation: Since cash advances aren’t considered loans, MCA lenders aren’t subject to the same restrictions and oversight as traditional lenders are. Some lenders take advantage of the lack of oversight and engage in questionable business practices.
  • You may be required to switch payment processors: Some MCA providers require you to use certain payment processors, regardless of any preexisting contracts or personal preferences you may have. Making the switch can not only be an involved undertaking but also leave you subject to higher processing rates.

Alternatives to MCA

Merchant cash advances aren’t the only alternative financing option available to businesses unable to secure funding through more traditional avenues. Below are other alternative lending options you may consider:

Merchant Cash Advance: Final Thoughts

Because the most important determining factor for approval is a business’s sales volume, a merchant cash advance is a uniquely obtainable funding source for businesses unable to secure traditional forms of financing. Better yet, cash advances offer specific benefits traditional funding options do not: minimal paperwork, same-day funding, and a seamless repayment structure that adjusts with fluctuations in your business’s revenue. While a major drawback is the unregulated nature of the MCA industry, you can sidestep this by partnering with a merchant services provider! When you partner with PaymentCloud to obtain a merchant cash advance, a financial professional can streamline the application process, expedite the approval process, and ensure you’re getting the best available financing terms.

Article Sources

  1. “Sources of Financing for Small Business“. Accessed November 28, 2022.
  2. “Merchant Cash Advance Definitely NOT a Loan, New York Judge Rules“. Accessed November 28, 2022.

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