A Comprehensive Guide to Merchant Cash Advances, When and Why you Need It?

Originally, a merchant cash advance (MCA) was designed to give a company a one-time payment in exchange for a predetermined share of future debit and/or credit card purchases. Barbara Johnson came up with the concept since she needed money for her small business franchise. Thus, Barbara, her husband Gary, and Les Falke co-founded the first MCA business, AdvancMe, which subsequently changed its name to CAN Capital.

Les Falke coined the term "merchant cash advance" (MCA) to refer to AdvanceME's product, but it is now widely used to refer to a range of financing options for small businesses that buy future sales revenue in exchange for monthly payments that are smaller and usually made every business day, rather than the larger amounts and longer terms associated with traditional bank loans. These financing options are typically under 24 months. Short-term company loans and purchases of future credit card sales receivables can both be referred to as "merchant cash advances."

Characteristics of Merchant Cash Advances

Repayment Structure: Instead of fixed monthly payments, merchant cash advances are repaid through a percentage of the business's daily credit card sales. This percentage, known as the "holdback," is typically deducted automatically from the business's merchant account until the advance, plus fees, is fully repaid.

High Costs: Merchant cash advances loans often come with higher costs compared to traditional loans, including factor rates rather than interest rates. Factor rates are expressed as a decimal figure (e.g., 1.2) and represent the total amount the borrower will repay, including fees, for every dollar borrowed.

Fast Funding: One of the primary benefits of MCAs is their speed. Businesses can typically access funding within days of applying, making MCAs an ideal option for addressing time-sensitive financial needs or seizing opportunities for growth.

No Collateral Required: Unlike traditional loans that may require collateral, such as real estate or equipment, merchant cash advances are typically unsecured, meaning they do not require collateral to secure the financing.

Credit Card Sales Requirement: Since repayment is tied to credit card sales, businesses must have a consistent volume of credit card transactions to qualify for a merchant cash advance. Lenders typically assess the business's historical sales volume to determine eligibility and advance amount.

Application Process for Merchant Cash Advances

The application process for merchant cash advances is typically straightforward and can be completed online or through a merchant cash advance provider. While specific requirements may vary by lender, the process generally follows these steps:

Application: Businesses submit an application for a merchant cash advance, providing basic information about their business, such as revenue, industry, and time in business.

Documentation: Lenders may request additional documentation to assess the business's eligibility and creditworthiness, such as bank statements, credit card processing statements, tax returns, and business financials.

Underwriting: Lenders evaluate the business's creditworthiness, revenue, and repayment capacity to determine the advance amount, factor rate, and repayment terms.

Approval and Funding: Upon approval, the lender provides the business with a funding offer outlining the advance amount, factor rate, holdback percentage, and repayment terms. Once the business accepts the offer, the funds are typically disbursed within a few days.

Benefits of Merchant Cash Advances

Quick Access to Capital: MCAs provide businesses with rapid access to capital, allowing them to address immediate financial needs or capitalize on growth opportunities without the lengthy approval process associated with traditional loans.

Flexible Repayment: The repayment structure of MCAs is tied to the business's credit card sales, providing flexibility and aligning payments with the business's cash flow. During slow periods, businesses pay less, while during high-sales periods, they pay more, helping to manage cash flow fluctuations.

No Collateral Required: Since merchant cash advances are typically unsecured, businesses are not required to provide collateral to secure the financing, reducing the risk of loss in the event of default.

No Fixed Monthly Payments: Unlike traditional loans that require fixed monthly payments, MCAs do not have a set repayment schedule, making it easier for businesses to manage their finances and avoid the risk of late or missed payments.

Drawbacks of Merchant Cash Advances

High Costs: MCAs often come with higher costs compared to traditional loans, including factor rates, fees, and additional charges. Businesses must carefully consider the total cost of the advance and assess whether it is worth the expense.

Impact on Cash Flow: The repayment structure of MCAs, which deducts a percentage of credit card sales, can impact the business's cash flow, particularly during slow periods when sales are lower. Businesses must ensure they have sufficient cash flow to cover operating expenses and other financial obligations.

Potential for Debt Cycle: Some businesses may become trapped in a cycle of debt if they rely too heavily on merchant cash advances to cover recurring expenses or fund unsustainable growth. Borrowers must exercise caution and use MCAs judiciously to avoid accumulating excessive debt.

Limited Regulation: The merchant cash advance industry is less regulated than traditional lending, leading to potential risks for borrowers, such as predatory lending practices, hidden fees, and unfavorable terms. Businesses should thoroughly research lenders and carefully review the terms and conditions of the advance before accepting funding.

Best Practices for Responsible Borrowing

Assess Financial Needs: Before applying for a merchant cash advance, carefully assess your business's financial needs and objectives. Determine how much funding you need, how you plan to use the funds, and whether the benefits outweigh the costs.

Compare Lenders: Shop around and compare offers from multiple merchant cash advance providers to find the most competitive rates, terms, and fees. Consider factors such as the factor rate, holdback percentage, repayment terms, and customer service reputation when evaluating lenders.

Read the Fine Print: Thoroughly review the terms and conditions of the merchant cash advance agreement, including the factor rate, holdback percentage, fees, and any other applicable charges. Ensure that you understand all the terms before accepting the funding offer.

Understand the Total Cost: Calculate the total cost of the merchant cash advance, including fees and charges, to determine the true cost of borrowing. Compare this cost to the potential benefits of the advance to assess its affordability and value to your business.

Plan for Repayment: Develop a repayment plan that aligns with your business's cash flow and revenue projections. Ensure that you have sufficient cash flow to cover the daily holdback percentage and meet other financial obligations while repaying the advance.

Merchant cash advances offer businesses a flexible and accessible funding solution to address immediate financial needs, seize growth opportunities, and manage cash flow fluctuations. With their quick approval process, flexible repayment structure, and minimal credit requirements, MCAs provide businesses with a viable alternative to traditional loans. However,