Merchant Cash Advance

Merchant Cash Advances

A merchant cash advance is a loan based on your monthly credit card sales. If your credit score is less than stellar and your business does not yet have a firm enough reputation to establish a line of credit or similar loan with a bank, merchant cash advances may be just what you need to increase your cash flow. There are lots of reasons to consider this type of loan:

  • Boost cash flow
  • Cover revenue gaps
  • Adapt with a new product or service
  • Grow your business
  • Train staff
  • Manage disruption

 

In many cases, merchant cash advances can be offered to companies that have only been in business for three months, so long as three consistent months of credit card sales can be averaged to prove their value to the lender.

A merchant cash advance has historically been for businesses whose revenue comes primarily from credit and debit card sales, such as restaurants or retail shops. Now, merchant cash advances are available to other businesses that don’t rely heavily on credit card or debit card sales. Merchant cash advance providers say their financing product is not technically a loan. A merchant cash advance provider gives you an upfront sum of cash in exchange for a slice of your future sales.

Merchant cash advance repayments can be structured in two ways. You can get an upfront sum of cash in exchange for a slice of your future credit and debit card sales, or you can get upfront cash that is repaid by remitting fixed daily or weekly debits from your bank account, known as ACH, for Automated Clearing House, withdrawals.

Instead of making one fixed payment every month from a bank account over a set repayment period, with a merchant cash advance you make daily or weekly payments, plus fees, until the advance is paid in full. How much you’ll pay in fees is determined by your ability to repay the merchant cash advance.

Reasons to opt for a merchant cash advances

They’re quick. You can often get an MCA within a week or so with no heavy paperwork. Providers look at a business’s daily credit card receipts to determine if the owner can repay.

You won’t lose your home. MCAs are unsecured, so you don’t need collateral. This means you don’t have to forfeit any personal or business assets if your sales plunge and you fail to repay. “If the company goes out of business, I’m out of luck since it’s nonrecourse,” Goldin says. “There’s no absolute repayment in a correctly structured merchant cash advance.” However, the MCA provider may require a personal guarantee, which is a written agreement that makes you personally responsible for repaying the advance. If this is the case, the MCA provider may still try to recoup any losses.

When sales are down, your payment may be too. When the repayment schedule is based on a fixed percentage of your sales, repayments adjust based on how well your business is doing.

Reasons to be wary of merchant cash advances

Your APR could be in the triple digits. The annual percentage rate, or total annual borrowing cost with all fees and interest included, typically ranges from about 40% to 350%, depending on the lender, the size of the advance, any extra fees, how long it takes to repay the advance in full and the strength of the business’s credit card sales. This is far more expensive than traditional bank loans, whose APRs are typically 10% or less; online small-business loans, with APRs from 8% to 99%; and business credit cards, with APRs from 12.9% to 29.9%.

Higher sales mean a higher APR. For MCAs repaid with a percentage of your credit card sales, the APR depends not just on the total fees paid but also on how fast you repay the loan. If your sales are weak, your payments spread out over a greater length of time and your APR drops. If you’re raking in the credit card sales, you repay the MCA faster — and, subsequently, APR goes up. For example, the company might offer you a $100,000 advance with a factor rate of 1.3, for a total repayment of $130,000. If you repay it in just six months, the APR would be a minimum of 60%. If you repay it in 12 months, the APR would be a minimum of 30%.

There’s no benefit to repaying early. Since you have to repay a fixed amount of fees no matter what, you get no interest savings from early repayment. This differs from a traditional “amortizing” small-business loan, in which early repayment would result in less interest paid. It also means that if you decide to refinance, you’ll still have to pay all of the agreed-upon fees, and you may also get hit with an early repayment penalty.

There’s no federal oversight. The merchant cash advance industry is not subject to federal regulation because MCAs are structured as commercial transactions, not loans. Instead, they are regulated by the Uniform Commercial Code in each state, as opposed to banking laws such as the Truth in Lending Act, according to a report by First Data.

Your credit score may be pulled. Although MCAs typically are an option for business owners with bad credit, that doesn’t mean the MCA provider won’t at least check your credit score during the application process. Background credit checks are a common requirement for MCA providers, Goldin says — but if the provider’s credit inquiry results in a hard credit check, it can hurt your credit score.

There’s a debt-cycle danger. The speed and ease of MCAs can put you into a debt cycle, especially if you don’t qualify for other types of financing. Borrowers may find themselves in need of another advance soon after taking on their first one due to the extremely high costs and frequency of repayments of MCAs, which can cause cash-flow problems. A daily payment of hundreds of dollars, for example, could put a strain on the cash flow of many small businesses and put them at risk of default.

Contracts can be confusing. The costs and repayment structure of MCAs can make them difficult to understand. Contracts are often loaded with unfamiliar terms, such as specified percentage (the percent you repay out of credit card sales), purchase price (the amount you receive) and receipts purchased amount (total payback amount). MCA providers do not provide APRs, which makes it impossible to compare with other financing products. You may also be required to sign a legal document called a confession of judgment, which forfeits your right to defend yourself if the company takes you to court.

Conclusion

There are some great reasons to opt for merchant cash advances and some great reasons not to. Understanding the contractual demands of merchant cash advance lending isn’t for the faint of heart, but with our help we can guide you to the right option for your business. Our role is to find the best option for your business and ensure you are 100% clear about the demands of the loan.

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