Business LoansHow Does a Merchant Cash Advance Work?

Merchant Cash Advance Companies – Should You Use One?

Rates & Fees in this piece are accurate as of the date of publishing.

As a small business owner, you may find it tough to get approved for a traditional bank loan. That will especially be true if you have poor credit or have been in business for less than two years (the usual threshold banks look for in approving business loans). But many small businesses need financing at some point, whether it’s to grow the business, take advantage of an opportunity or cover a cash flow shortfall. And many owners will turn to alternative lenders for that financing.

Alternative lenders often have lower requirements for loan approval and can turn around a loan much faster than a bank. The tradeoff is that the cost of the financing in the form of interest and fees will almost always be higher.

One of those alternative types of funding is a merchant cash advance. It’s a quick and fairly easy form of financing, but one you’ll have to be careful about since it can be very expensive.

Understanding merchant cash advances

A merchant cash advance isn’t a loan, but, as the name suggests, a cash advance. With an MCA, you agree to pay back the advance with a certain percentage of your future debit and credit card sales until that amount and the fee is paid off. The payments are usually taken out daily or weekly. Some payments are a fixed amount no matter what your sales are, while most are a percentage based on how your sales are that day. So if your sales are higher than usual that day, you’ll pay more, and if they’re lower, you’ll pay less. The repayment period is usually short, typically 24 months at the most.

MCAs are a very fast form of financing. Funding is usually approved in two to 24 hours, with funding coming anywhere from 24 hours to three days after approval. The approval requirements for an MCA are also much less stringent than for a bank loan or most types of financing. Someone with a credit score of 600 or less (considered poor credit) could be approved for an MCA where a bank would likely require a credit score of at least 680. Many merchant cash advance companies will also require only six months time in business and some may require even less if your business has strong revenues.

Merchant cash advance companies

If you’re considering an MCA, you’ll want to think about the ramifications of the advance itself and research the company that’s offering the MCA. Here is a look at some of the major merchant cash advance companies.

    • CAN Capital — CAN Capital offers short-term loans to small and mid-sized businesses as well as MCAs. They offer MCA funding amounts from $2,500 to $250,000 with funding in a few days or less. Business performance and cash flow will be considered for approval and there is no collateral required. Repayments are daily and vary according to the business sales that day. The company charges a $395 administrative fee to set up the MCA.
  • Credibly —  Credibly offers MCAs up to $150,000, with a typical duration of 3 to 14 months. The lowest factor rate starts at 1.15. Credibly charges a one-time underwriting fee of 2.5% of the total advanced amount deducted from your proceeds. To qualify for an MCA, you’ll need a credit score of 500 or above, six months or more in business and $15,000 in average monthly bank deposits. The remittance number fluctuates with your daily sales.
  • Fora Financial — The company offers $5,000 to $500,000 in funding for its MCAs, which may be funded within 72 hours of approval, which you’ll know within 24 hours. Fora Financial offers early payoff discounts and does not require collateral. To qualify for an MCA with Fora Financial, you’ll need at least six months in business, $5,000 or more in monthly credit sales and no open bankruptcies or dismissed bankruptcies in the past  year.
  • The Business Backer — The Business Backer offers a variety of types of small business funding, everything from long- and short-term loans to lines of credit and SBA loans to invoice factoring. For its MCAs, it offers MCA funding of $5,000 to $200,000 and the option of daily, weekly or semi-monthly repayments. The lowest factor rate starts at 1.12.
  • Reliant Funding — Approval for an MCA through Reliant Funding usually happens in a few hours and funding typically comes the next day. Reliant Funding offers advances between $5,000 and $500,000. Approval requirements include at least one year in business, at least $10,000 in monthly sales and no open bankruptcies. Personal collateral isn’t required.
  • Rapid Finance — Rapid Finance offerings include small business loans, a line of credit, an SBA bridge loan and an MCA. Repayment for the MCA is based on a percentage of a business’s daily credit card sales. To qualify, most business owners will need $5,000 a month in revenue and have one year in business. Approval may come as quickly as a few hours and funding in one day. Business owners can potentially receive up to 250 percent of their monthly credit card sales volume. Rapid Finance also offers a starter MCA that offers businesses with as few as three months of credit card sales to apply for funding of up to 50 percent of monthly average credit card sales. Lower cost options may be available to businesses in operation for three years or more.

How expensive are MCAs?

Because MCAs aren’t loans, they’re not regulated by a state’s usury laws. Which among other things, means there’s no limit to how much interest an MCA company can charge. MCAs don’t use APR, but a factor rate to charge interest. Most factor rates are between 1.2 and 1.5. To find out how much you’ll repay, you would multiply the amount of your advance by the factor rate. So if you borrowed $10,000 and your factor rate is 1.3, you would need to pay back $13,000.

But you can and should convert your factor rate to an APR. The APR range for a MCA can be very high, between 70 to 200 percent. That’s partly because of the short repayment period and how often the payments are taken out (daily or weekly, versus a bank term loan which is almost always monthly). You’ll also have to think about your remittance fee (that’s the percentage of your sales that is being taken out to pay back the advance).

To figure out your APR, let’s use the example of having borrowed $10,000 at a 1.3 factor rate, meaning you would pay back $13,000. If the merchant cash advance company takes 11 percent (your remittance) a day from your credit sales to repay the advance and you usually make about $15,000 a month in credit sales, you would make 237 payments of $55 a day to equal an 84.6% APR.

You’ll also need to watch out for fees. Some fees like an origination fee (charged to process the MCA) or penalties for late payment might not be included in the upfront costs of the MCA.

Pros and cons of MCAs

The approval process for an MCA is much faster than with a traditional loan and easier to get for borrowers with poor credit scores or new business owners. You can apply for an MCA online and if approved, sometimes receive funding as quickly as that day or the next day.

MCAs offer a little more flexibility than a term loan because the repayment is usually based on a percentage of your sales versus a fixed amount of principle and interest due each month. But MCAs are almost always more expensive than a regular loan. Because MCAs aren’t loans, there’s no regulation on how much in interest rates companies can charge.

At the same time, MCA companies can’t ask for a personal guarantee — a written promise that allows lenders to sue for your personal assets if you default on a business loan. Many MCA companies, however, will ask for a performance guarantee, which means you promise you won’t take actions like selling the business or filing for bankruptcy that could hurt the performance of the business.

Pros Cons
 No obligation to repay the advance  Usually much more expensive than a traditional loan
 Easier and quicker approval process than for a regular loan  Typically no discount for early repayment
 Fast funding, possibly as little as 24 hours  Some fees may not be disclosed upfront

 

Alternative financing options

If you have good credit or other factors that would allow you to qualify for a loan or an alternate type of financing, it would probably be smart to look there first before turning to an MCA. That’s especially true if you don’t need the money immediately. Here are some alternative financing options to consider.

Invoice factoring — With invoice factoring, a business sells its unpaid invoices to a factoring company for a percentage of upfront cash, with the factoring company eventually collecting on the invoices. In most cases, businesses can immediately (sometimes within 24 hours) secure between 50 to 80 percent of an outstanding invoice by selling it to a factoring company. Whenever the invoice comes due, the balance is sent to your company minus a factoring fee (typically 3 to 5 percent) — and that percent is deducted daily or weekly until the invoice is paid.

Equipment financingEquipment loans allow businesses to finance equipment purchases, which can include anything from computers to vehicles. Often the equipment being financed serves as the collateral for the loan. These loans usually require good credit and sometimes large down payments.

Business credit cards — Having a credit card for business expenses can be useful to cover short-term purchases and to build credit history. Business credit cards are usually much easier to be approved for than a loan, but the APR will be much higher if you’re carrying a balance.

Microloans — If you only need a small loan, a microloan may be an option. These are loans of usually under $50,000, offered by organizations such as the Small Business Administration and nonprofit lenders. The interest rates may be higher than from big banks, but the approval process is usually less stringent.

Line of credit — These are typically revolving lines that offer an immediate source of cash up to a certain limit. Business owners can draw from the line of credit when needed and only have to repay the amount they’ve drawn. Interest is also only paid on the amount drawn.

The bottom line

Before you consider an MCA, think about your other options. Would you be approved for a short-term loan or a business line of credit? And figure out how much an MCA would fully cost, including converting your costs into an APR so it’s easier to compare against other types of funding. If you opt for an MCA, make sure you know the true cost, including fees, the factor rate and the remittance fee. Your end goal should be feeling confident that you can afford to pay back the advance without hurting your business and hopefully without needing to take on more than one MCA at a time.

 

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