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Most people know what a small business loan is, but fewer people know what a merchant cash advance is and what it could do for them. An MCA, as it is often called, is best suited for businesses that are paid primarily through credit cards, and are similar to a loan but technically different in important ways. Here’s how it works:
Merchant cash advance companies (like Swift Capital) can advance you a certain amount of cash depending on the monthly revenue of your business. You agree to pay back that advance, plus a fee, by letting the MCA provider keep a portion of your credit card sales each day until the advance and fee are paid off.
To determine exactly how much your business pays back, the MCA provider will assign a “factor rate” to the advance you receive. The amount of the advance is multiplied by this factor rate to determine the total amount that must be paid back. Factor rates can range from 1.14 – 1.44. The other important number to consider is the “withholding” amount, which is the percentage of your credit card sales that the MCA provider will keep until the full amount has been repaid. Withholding amounts average around 15%, but can be as low as 5% and as high as 40%. Most advances are paid back in full in 6 – 9 months.
Imagine an ice cream shop, in need of a fast small business loan, that turns to an MCA provider. The provider agrees to give the shop owner an advance of $20,000 with a 1.25 factor rate and 10% withholding rate. As a result, the shop owner agrees to pay back $25,000 by relinquishing 10% of his daily credit card sales. From that day forward, the MCA provider will automatically receive 10% of the shop’s daily credit card sales until the $25,000 is paid off. On days when business is slow, the shop owner pays back fewer dollars because the percentage is fixed. Of course, on days when business is strong, the owner pays back more dollars.
A merchant cash advance gives your business access to quick cash, often much faster than a loan. Furthermore, collateral is seldom required and people with poor credit scores can still obtain a merchant cash advance. As such, the MCA industry is helping fill the hole created by banks’ unwillingness to lend to small businesses.
However, there are some risks and costs associated with those advantages. For example, MCAs have much higher fees than traditional bank loans. This is because a factor rate is not the same thing as APR. The difference is that a factor rate fee is typically paid back in less than a year, whereas APR refers to an annual rate. Furthermore, because you have to give up a percentage of your daily sales, you need to make sure your business can thrive on the reduced cash flow for a period of time.
Ami Kassar, CEO of loan consultation firm MultiFunding and small business loan columnist in the New York Times, recently pointed out that sometimes these advances are “short term and force the borrowers into renewal after renewal.”
But he points out the benefits of merchant cash advance loans as well. There’s a time and place for them, and if a small business owner understands his or her risk, MCAs can be a useful tool for quick growth. Kassar says MCAs should mostly be “constructed to serve as bridges that help business owners move into more reasonably priced financing.”
Alternative lenders offer fantastic financing options for business owners so long as they do their homework. Understanding the differences between a traditional loan and a merchant cash advance is a good place to start, and if your business processes a lot of credit card transactions, an MCA may be a great option to explore further.