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Merchant Cash Advances: The Good, The Bad, and More
Merchant cash advances (MCAs) are an alternative to business loans that provide a business with a lump sum of cash from a funder (usually a supplier or vendor) who is paid back through a portion of future credit card and debit card sales. The payments can be made daily, weekly, or monthly depending on the agreement.
This is a good solution if you need to secure immediate funds and are having trouble getting approval for a small business loan, or if the long approval process of a traditional business loan won’t get you the financing you need quickly enough. The tradeoff for the faster access to financing is a higher fee than traditional interest on a loan, but your business operations and time-sensitive opportunities won’t have to be sacrificed.
This guide to merchant cash advances walks you through everything from why a vendor would be willing to become a funder, how to calculate if this is a better solution than a loan, the risks both parties take, and when it does and does not make sense to use a merchant cash advance.
Why Funders Offer Merchant Cash Advances
Funders offer merchant cash advances because they provide a healthy return on investment from a trusted business relationship. It strengthens the bond between the two companies while generating additional revenue without the administrative tasks of giving a traditional business loan. Unlike a traditional business loan, merchant cash advances use factor rates.
Factor rates are expressed as decimals vs. the percentages used with interest rates and typically range from 1.1 to 1.5. This is the amount the lender will take as a fee. The total cost for the factor rate is calculated by multiplying the cash advance by the factor rate, so if you received an advance of $50,000 with a factor rate of 1.2, you would need to pay back $60,000 – plus any additional fees such as origination, administration, or underwriting fees.
(Cash advance received x Factor rate) + any other fees = Total repayment
How Merchant Cash Advances Work
Merchant cash advances work by following a three-step process:
1. Contact the vendor and present a plan with the amount of financing you need, how the money will be used, and the expected timeframe for repayment.
2. Negotiate and agree on the factor rate while holding back the percentage of card sales that will be debited from your account, unless you have opted for a fixed payment rate.
3. Receive the cash flow boost and begin the payments on the card transactions.
While the repayment schedule will be down to the rate of your sales, the terms will be structured so that the advance is paid off within 18 months or sometimes up to 24 months, based on your usual rate of credit card sales.
The Risks of Merchant Cash Advances
A merchant cash advance involves risks for both the funder and business.
For the funder
- There is no specific collateral tied to the advance in the event of a default.
- Creditors may already have liens against assets for other financing.
- Repayment schedule may be unpredictable as it is based on the business’s sales.
For the business
- If a confession of judgement is created, the funder will be able to secure a judgement against you without going to court. It will be easier to seize assets to offset their losses, and your business will have a judgement on its record, hurting your ability to get future financing.
- Costs can be higher than with traditional loans.
- MCAs are not loans and so are not subject to usury laws or maximum interest rate limits.
Pro-tip: If you have to sign a confession of judgement, be sure you are certain of the lender’s definition of default and the limitations on what they can seize. If you sign it as a sole proprietor or provide personal guarantees, this may allow them to seize both business and personal assets.
Benefits of Merchant Cash Advances
The benefits of a merchant cash advance include having to deal with fewer administrative steps than with a traditional business loan. They also allow for faster approval times, increased cash flow for the borrower, more profit for the lender, and a strong bond between the two companies when the debts are repaid without default.
For businesses
- Quick access to funds: Some funders provide funds within 24-48 hours.
- High approval rates: MCAs have higher approval rates than other financing products as the funder often already works with you and knows your business.
- No collateral needed: You borrow against future sales, so you don’t need to provide other assets.
- Repayment at the pace of your sales: Instead of having to meet a repayment schedule, you pay a portion of your sales. Therefore, if business is slow, you face lower costs, just paying a fixed percentage based on your sales.
For funders
- They can receive higher profit margins compared to traditional term loans.
- They can offer services to businesses they might not otherwise be able to approve.
Disadvantages of Merchant Cash Advances
Quick access and a low bar for approval come with some tradeoffs for businesses and funders, including potentially high costs.
- Payments occur at the rate of sales vs. payments being spread evenly over time, so the amount of revenue and costs fluctuate.
- Businesses pay the same costs over the term no matter how quickly the debt is paid back, eliminating the potential savings on interest by repaying a traditional loan early.
- Factor rates often cost more than interest rates, which is a disadvantage to the business but an advantage to the funder.
- Merchant cash advances are not likely to be reported to a credit bureau, so the business will not be able to build their business credit score by making payments.
- Merchant cash advances are not subject to federal regulation and are instead overseen by the Uniform Commercial Code in the state where the parties are located. This can create legal hurdles in the case of defaults or issues that need to be resolved with counsel.
Comparing the Cost of a Merchant Cash Advance
Merchant cash advances can be compared against other business financing products by calculating an effective APR (annual percentage rate). To do this, take the factor rate (the percentage of sales you pay to the funder), your holdback percentage (the portion of credit card sales being taken to repay the principal, and your estimated monthly sales paid by credit card.
You can calculate how long it will take to pay back the advance and the effective APR with the following formulas:
- Estimated repayment period in days = Total to pay back / ((Expected monthly credit card sales x Holdback percentage) / 30)
- Effective APR = ((Total to pay back – Cash advance) / Cash advance) / Repayment period) x 365
The examples below show that the merchant cash advance that pays funds faster does not reduce the borrowing costs like paying a loan early and actually increases the effective APR of borrowing the money.
| Cash advance | Factor rate | Holdback percentage | Estimated monthly credit & debit sales | Total to pay back | Repayment period (days) | Daily payment | Effective APR |
| $100,000 | 1.2 | 10% | $50,000 | $120,000 | 720 | $166.67 | 10.14% |
| $100,000 | 1.4 | 20% | $50,000 | $140,000 | 420 | $333.33 | 34.76% |
| $100,000 | 1.4 | 20% | $75,000 | $140,000 | 280 | $500.00 | 52.14% |
| $200,000 | 1.2 | 20% | $75,000 | $240,000 | 480 | $500.00 | 15.21% |
When a Merchant Cash Advance Makes Sense
If you have consistent credit card and debit card sales but you are facing an immediate short-term cash flow problem, a merchant cash advance makes sense when a short-term loan or business bridge loan is not doable.
Another situation where a merchant cash advance makes sense is a retailer facing a financial lull before the holiday shopping season starts. If they cannot get a payroll loan or working capital loan, their vendors and suppliers may be open to a merchant cash advance helping to keep things afloat. The same retailer may have a marketing campaign that goes viral and needs more stock, and their vendor may offer the merchant cash advance faster than a bank—and offer it more easily because they feel confident the sales volume will be there.
Merchant cash advances are not always the right choice, especially if you have time to wait for a loan application to get approved.
When a Merchant Cash Advance Doesn’t Make Sense
Business loans are less costly than merchant cash advances, so if you have the time to wait for an approval process, a small business loan will likely serve you better. Further, if a manufacturer is looking for funds to increase capacity but the need isn’t immediate, they’re more likely to get better terms from an equipment financing product.
If you need funds immediately, you should also consider whether an emergency or cash flow loan might be a better option than a merchant cash advance. Though, you will probably need to use owned assets as collateral. A restaurant facing unexpected costs may need a cash injection, and a short-term emergency loan will allow them to keep operating at a lower interest rate than the factor rate of a merchant cash advance.
Merchant cash advances tend to work best as a one-off solution for financial pressure, as selling future sales regularly can result in a growing cycle of debt because you are paying back a significant portion of your revenue. If you are anticipating the need for regular access to credit, a business line of credit will allow you to access funds on an as-needed basis vs. taking a lump sum upfront with the need to renegotiate each time you need more cash flow.
Merchant cash advances are short-term bursts of cash flow that require less restriction and paperwork than traditional business loans but cost more and have less flexible payment terms. If you cannot get approved for a business loan, this could be a great way to build a bond with a vendor or supplier while getting the funding you need to keep your business growing.
