What Is a Merchant Cash Advance?
A merchant cash advance (MCA) is technically not a loan. With a merchant cash advance, a financing company provides you with an advance of capital in exchange for a percentage of your daily credit card and debit card sales, plus a fee. In other words, a merchant cash advance is actually a sale of your future debit and credit card sales.
Typically, merchant cash advances are repaid on a daily or weekly basis and the financing company takes the payment automatically from your payment processor. In this way, repayments are based on your sales—if you experience a slow in sales, your payments will also be lower.
Merchant cash advances are usually easy to qualify for (even with bad credit) and fund quickly, however, they’re known for high APRs—and because they’re not actually business loans, little regulation. Generally, you’ll want to consider all of your options for business financing before turning to a merchant cash advance.
Merchant Cash Advance Details
|Max. Advance Amount||Repayment||Factor Fee||Speed|
|Up to $500,000||Paid daily or weekly via your merchant or bank account||Typically ranges from 1.1 to 1.5||As fast as one day|
- Quick access to funds
- Easy approval process
- Accessible to businesses with bad credit
- Suitable for a range of business purposes
- Repayment based on your sales
- Higher fees than most other loans
- Daily deduction of credit card sales reduces cash flow
- Easy to end up in a debt cycle
- Confusing contracts and little regulation
Top Merchant Cash Advance Companies
Best for: Fast access to funding with the possibility of prepayment incentives.
Best for: Fast funding with no collateral requirement.
How Does a Merchant Cash Advance Work?
As we mentioned above, merchant cash advances function differently than most other types of business loans.
Traditionally, merchant cash advances work like this:
- A MCA financing company offers you a lump sum of cash.
- You receive that funding and repay it, plus fees, with your daily (or weekly) debit and credit card sales.
- Payments are withdrawn automatically from your merchant account until you’ve repaid the full amount, again, plus fees.
This being said, because MCAs typically draw from your debit and credit cards sales, they’ve often been used by businesses who rely on those sales for revenue—restaurants, bars, retail stores, salons, etc.
Now, however, some financing companies will draw repayments directly from your bank account (instead of a merchant account), meaning even businesses that don’t rely heavily on debit or credit card sales can utilize this type of financing. In this case, the process essentially works the same, except the merchant cash advance company connects to your bank account and collects repayment, plus fees, using ACH withdrawals.
With this in mind, because MCA providers can plug-in to your bank account or merchant service provider, merchant cash advances are easy-to-access, fast to fund products. They are, however, one of the most expensive financing products on the market.
Merchant Cash Advance Rates and Fees
As we’ve mentioned, merchant cash advances are expensive—and therefore, it’s important to understand how MCA financing companies charge fees. Just as MCAs are structured differently than most business loans, the way you’re charged interest on this financing product is different as well.
Instead of an interest rate, merchant cash advance financing companies measure their fees with a factor rate, sometimes referred to as factor fees. The factor rate you receive on an MCA will be based on the company’s evaluation of your qualifications. Typically, factor rates range from about 1.14 to 1.48.
As with traditional interest rates, the higher your factor rate, the higher the fees you’ll pay, and the more your merchant cash advance loan will cost. This being said, in order to determine the cost of an MCA, you can multiply your loan amount by the factor rate.
For example, if you receive a $25,000 advance with a factor rate of 1.2, this means you’ll end up paying a total of $30,000, which includes fees worth $5,000. Generally, if you convert factor rates to an APR, you’ll find that rates start at 15%, but can reach as high as over 100%.
Moreover, it’s important to note that some MCA financing companies will charge additional fees—most often, you’ll see an “administrative fee” that is charged to set up your account.
Merchant Cash Advance Terms
Whereas traditional business term loans have set a repayment period—you repay a loan with monthly payments over a term of five years, for example—merchant cash advance terms do not work the same way.
As we’ve mentioned, you repay the funds you’ve borrowed from an MCA with your debit and credit card sales, or from withdrawals from your bank account. Most often, these payments are made on a daily basis, but sometimes companies will offer a weekly basis.
This being said, because the repayments are based on your sales, the terms of an MCA will vary. In other words, the terms will end up being however long it takes you to repay the total amount you borrowed.
Overall, the average repayment time for a merchant cash advance is eight or nine months—however, the term can be as short as four months or as long as 18—it all depends on your business. To this point, the higher the fixed percentage of sales you’re paying the financing company with, the shorter your repayment time—and the tighter your cash flow.
Merchant Cash Advance Cost Example
With all of this in mind, let’s walk through an example to get a better understanding of how a merchant cash advance works—and perhaps more importantly, how much an MCA costs.
Let’s say, for example, you’re advanced $20,000 from a financing company to fund some renovations for your retail shop. The financing company is charging a factor rate of 1.18.
If you multiply the $20,000 by 1.18, you’ll get $23,600—which is the total amount you’ll need to repay with your daily debt and credit card transactions.
Now, the merchant financing company will be taking 15% of your credit card sales, so the amount that you’ll be paying on a daily basis will vary based on your sales. The higher your sales, the faster you’ll be able to pay off the advance.
This being said, let’s say you estimate $25,000 per month in credit card sales. In this case, the financing company is taking 15% of your sales, so if you divide the $25,000 by 30 days in a month, you’ll get approximately $833 per day, and 15% of $833 is $125.
So, each day that month you’ll be paying the financing company $125, which, at that rate, means it will take 189 days for you to repay the total amount of $23,600. Although $125 per day may not seem like much, when it comes down to it, the APR on this merchant cash advance loan is nearly 66%—which is extremely high.
It’s for this reason that MCAs are so misleading—at first glance, the numbers seem reasonable and a factor rate of 1.18 seems low. However, when you calculate the APR on these products, they often end up being very expensive, especially in comparison to other types of business financing.
For this reason, before you agree to a merchant cash advance from a financing company, you’ll always want to convert the factor rate to an APR to determine the true cost of this debt and decide whether or not it’s something you can afford.
Pros and Cons of a Merchant Cash Advance
At this point, you may have started to see some of the inherent advantages and disadvantages of a merchant cash advance. Therefore, in order to help you decide if this type of financing might be right for your business, let’s break down these pros and cons in greater detail.
- Quick access to funds: When it comes down to it, a merchant cash advance will be one of the fastest types of financing for businesses. In general, you can apply for an MCA online and receive approval and funding in as little as 24 hours. Compared to other loans that require extensive documentation, MCAs have very simple application processes.
- Easy approval process: Not only is the process itself simple, but MCAs are one of the easiest financial products to qualify for. MCA companies will often pull your credit score and evaluate your other qualifications, however, they’re much more lenient when it comes to approval. Many financing companies will work with startups, businesses with bad credit, as well as those with previous financial issues. Of course, your qualifications will not only affect your ability to get approved for a merchant cash advance loan, but your rate as well. If you have bad credit, for example, you’re more likely to see higher rates.
- Suitable for a range of business purposes: Overall, a merchant cash advance can be used to fund essentially any business purpose. You can use an MCA for working capital, to purchase inventory, cover payroll, or any other similar short-term costs.
- Repayment based on your sales: Whereas repayment on a traditional business loan remains the same regardless of how your business is performing, your MCA payments will vary based on your business’s sales. If your business has a slow period, therefore, you’ll be paying less on a daily or weekly basis. For this reason, MCAs are often used by seasonal businesses, retail shops, and restaurants.
- Higher fees than most other loans: We can’t stress this point enough—at the end of the day, a merchant cash advance will be one of the most expensive forms of business funding. Although the rates and terms of an MCA may seem reasonable, when you look further (and calculate the APR), you’ll see that rates significantly exceed any other type of financing. Plus, as we mentioned above, even though businesses with lower qualifications can get approved for MCAs, they’ll face the highest rates, which makes it difficult to repay the capital they’ve borrowed.
- Daily deduction of credit card sales reduces cash flow: Again, although a benefit of merchant cash advances is that payments vary based on your sales, the actual structure of an MCA makes it difficult on a business’s cash flow. Because you’re repaying an MCA so frequently, and directly from your incoming sales, this type of financing significantly impacts your cash flow. Additionally, because of the way a merchant cash advance works, there’s no advantage to repaying your loan early—a perk of many other types of business funding.
- Easy to end up in a debt cycle: As you may have inferred based on our last two points, it’s very easy to end up in a debt cycle with a merchant cash advance. If you’re a less qualified business in need of financing, an MCA may seem like your only option, but with high fees deducted straight from your cash flow, it can be difficult to repay. Therefore, many borrowers attempt to refinance or add another MCA, which only leads to further financing issues and a risk of default.
- Confusing contracts and little regulation: Another common problem with MCAs is that due to the way they’re structured—with factor rates, percentages of daily sales, and no specific terms—their contracts can be extremely confusing and business owners may sign them to get funds quickly without fully understanding the agreement. Additionally, as we mentioned above, because merchant cash advances aren’t technically loans, they don’t face the same regulations as other types of business financing. Historically, this has led businesses to fall victim to misleading sales tactics and advertising, especially from merchant cash advance brokers who approach them promising fast funding and easy approvals.