If you’re a small business looking for a little extra financing, you may have considered a merchant cash advance (MCA) but aren’t sure if it’s right for you.
An MCA is a lump sum of money given to a business in exchange for agreed-upon terms, including a percentage of future sales. It differs from a loan because it does not require collateral or fixed repayment terms.
Read on for more information about merchant cash accounts.
Advantages of a Merchant Cash Advance
In the wake of the financial crisis of 2008, it has been harder for small businesses to get standard loans through banks. This not only severely limits the ability of small businesses to function, but can lead to their ruin. Enter in MCAs. Unlike loans, merchant cash advances are provided by financial technology (fin-tech) companies and require a more lenient set of requirements for acceptance.
In contrast to a loan, MCA providers will only use your credit score to help determine the factor rate instead of denying you outright. You also don’t have to provide any collateral, which can help you keep a peace of mind if you are ever unable to repay your MCA. The repayment schedule is also based upon your credit and debit card sales, so if sales are down, so are your repayments.
Since most MCA applications are processed online, it can also be faster to receive than a typical loan. This makes it a good option for emergency situations.
Disadvantages of a Merchant Cash Advance
The trade-off for an MCA’s ease of application and approval leniency is their high cost. Because of the risk involved for the MCA provider, it can actually have higher rates than most loans, sometimes reaching triple digits. For this fact, the debt-cycle danger can be particularly high.
There’s also no benefit to repaying your loan early because you are repaying a fixed amount whether you pay it early or not. There is also no federal oversight for MCAs because they are structured like a business transaction instead of a loan. This means that they are regulated by the Uniform Commercial Code in each state.
Due to the risks involved, many consumer advocates warn that MCAs should be considered as a last resort financing option.
Qualifying for a Merchant Cash Advance
You will most likely apply for an MCA online and will need many of the same pieces of information as you would need for a bank loan. This includes your credit report, bank statements and business profile.
The MCA provider will use this information to determine your risk factor, how many of your transactions come from credit and debit card sales, and how many years your business has been operating.
Because your repayment hinges upon your credit and debit card sales, businesses that deal primarily in cash are not good candidates for MCAs.
Terms You Should Know
Each MCA will have different requirements and stipulations, but here are some common factors to keep in mind.
Advance amount and term – The advance amount is the total amount of money given to your business while the term refers to how long you have to pay it back. The advance amount can range from $2,500 to $250,000, while the term can be anywhere from 3-18 months.
Factor fee – A factor fee functions similarly to interest rates and is usually 15% or more APR.
Holdback – A holdback refers to the amount of money held back every day from your credit and debit card sales to go towards your repayment. The MCA provider works with your credit card processor to receive their slice of your sales, usually between 10% and 20%. Holdbacks can delay the time it takes to receive your money.
Fixed daily withdrawals – Some agreements include fixed daily withdrawals which entitle the MCA provider to a daily or weekly fixed amount payment, despite your sales volume.