If you’ve exhausted all of your business financing options and you’re still unable to get funds for your business, there are some circumstances when a small business owner may want to use a merchant cash advance. A merchant cash advance (MCA) is a quick way to get cash for your business without collateral.
Though many financial experts believe that a merchant cash advance should only be used as a last resort, for those with bad credit a merchant cash advance may be the only financing option to cover an emergency business expense.
What is a merchant cash advance?
Businesses with revenue from credit or debit cards can qualify for a merchant cash advance. An MCA is usually obtained when a merchant, like a retail shop or restaurant owner needs cash fast. An MCA provider will provide cash upfront for a percentage of future sales used to repay the advance. Or, the borrower can repay the advance with a fixed payment in daily or weekly payments over an agreed upon repayment period.
Typically these payments are done through ACH, which is an automatic payment set up through the business bank account. The cost to use merchant financing depends on the fees set by the provider. The providers will apply a factor rate of 1.2 to 1.5 percent of the advance.
The higher the factor rate, the higher the cost to repay the advance, and the faster you’ll want to pay it off. If the owner is repaying the advance with a percentage of sales, the provider will set a percentage from debit and credit sales, and then the provider will be paid that percentage until the full amount of the advance and fees are repaid.
What is the difference between a cash advance and a loan?
There are many differences between a cash advance and a loan. Most borrowers like that merchant financing is fast. A borrower can apply for an MCA and get funds within a week or two after a provider examines the credit card receipts and business financials. When you’re in need of a quick influx of cash for your business, and a short term loan isn’t possible, a merchant cash advance can fulfill the need.
An MCA is an unsecured form of financing. A merchant does not need collateral or to use personal or business assets to guarantee the loan. This means that a business owner won’t lose his or her house, or business equipment if repayment is not made.
While this does not mean the merchant is not responsible for repayment, a provider may still request a personal guarantee, and of course, as with any form of financing, neglecting to repay the loan will result in a default on repayment and debt collections.
If you select a fixed percentage of your sales for repayment, you’ll pay back only the amount of money your sales will allow. This means, if for some reason your revenue changes, you’re still only paying a percentage of your sales, not a fixed daily and weekly payment that you cannot afford.
A merchant cash advance also has a much higher APR than a business credit card or small business loan. An MCA can have 40% to 350% in interest, in addition to the factor rate fees. A traditional bank loan is far less with interest rates under 10%. Business credit cards are typically between 12-30%.
How a merchant cash advance works
With a merchant cash advance, a business provider essentially sells future sales from credit card sales to repay the merchant cash advance. The merchant gets the funds they need without collateral and makes payments based on revenue from credit and debit card sales from their store or restaurant.
Let’s say you recently updated your restaurant and its services, but your marketing efforts have not brought in enough new customers yet. Since your bills and payments to employees will be due despite the lack of cash flow, a merchant cash advance provides the money you need to pay your expenses.
When you enter into an agreement for a merchant cash advance, you will associate your merchant account with your provider and get the money you need right away. Then, each day (or week depending on the agreement you set), there’s a “holdback” on funds that are transferred from your account. This percentage of yours sales is automatically sent to your MCA provider for repayment.
Going back to the restaurant example, once your restaurant rebounds with more customers, your revenue will increase and so will your payments for your merchant cash advance. The funding will have helped you cover the expenses in the meantime while your cash flow bounces back.
Benefits of cash advance financing
A merchant cash advance is the most expensive form of financing for small businesses due to their high interest rates and expensive fees. However, there are still some benefits for business owners.
Some providers can offer business owners up to $100,000 depending on their credit and debit card revenue. Borrowers can have a less desirable credit score than typical lenders since a merchant cash advance isn’t a loan; it’s an advance on your revenue.
In some cases, repayment can be quick, within 4-18 months your repayment of a merchant cash advance can be completed. Another benefit of a merchant cash advance: if your agreement is to pay a fixed monthly percentage for repayment, the amount you pay is based on your revenue.
For businesses with fluctuating income, a merchant cash advance can be better because a forced fixed amount could cut into the cash flow you’re trying to remedy with the MCA in the first place.What happens if you default on a merchant cash advance?
While no one wants to default on a merchant cash advance, sometimes businesses struggle or fail despite the small business owner’s best efforts. Cash flow is the number one reason why businesses do not succeed.
In the event that you cannot repay a merchant cash advance, in some cases your business may close and you will not need to continue repayment of your MCA. Since it’s technically not a loan, and a merchant cash advance provider is technically not a lender, the risk of repayment is on them -- it’s an unsecured form of financing.
However, some merchant cash advance providers require a personal guarantee, which means you’ll be required to pay the remainder of the advance whether your business fails or not. If you’re unable to make your automatic payments, the best course of action is to contact your MCA provider and speak with them about modifying your payment schedule, deferment, or settling on a lesser payment amount if you plan to shutter your business.
How to find the best cash advance for your business
The most important thing to remember when seeking a merchant cash advance is: will my business be able to handle repayment, and will my business rebound its cash flow by using this advance? If you plan to take out a merchant cash advance, you must be confident you will not end up in a debt cycle.
A debt cycle is a worst-case scenario. It’s when you end up continually in debt and unable to repay your debt, causing you to keep seeking advances to sustain your cash flow without it ever increasing.
To avoid some of the higher costs associated with a merchant cash advance; find an MCA with a low factor rate and low percentage for repayment. And choose a repayment plan that will allow you to pay off the advance successfully given your budget.
Be sure to use a provider with a clear contract that you understand and only use what you need because of the high fees. Borrowing money from an MCA is expensive, so it should only be used as a last resort.
How to apply for a merchant cash advance
When you’d like to apply for a merchant cash advance, you’ll need to show your last four to six months of bank statements and receivables. You’ll also need your driver’s license, business tax returns, and credit card processing statements. You may also need your credit score, but the most important information you need for your application is proof of your ability to repay the advance with future sales.
Fortunately, the application process is fast and you will be able to use the funds immediately through a bank transfer that will be set up for your repayment and any future advances you need for your business.