What is a Merchant Cash Advance?

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what is a merchant cash advance

If your business needs money, but doesn’t qualify for a traditional loan due to poor credit scores or a short business history, you aren’t out of options quite yet: a merchant cash advance (MCA) provider might be willing to advance you money—and fast.

Unfortunately, many financial professionals warn against using this type of financing; the high cost of borrowing and short repayment periods might send your business into a debt spiral, and the merchant cash advance industry carries a poor reputation overall. However, although these criticisms have merit, a reputable merchant cash advance company might have a lot to offer the right merchant.

Is a merchant cash advance right for you? And how do you find the right provider? At Merchant Maverick, we have spent hours reading articles, reviewing merchant cash advance companies, and talking to industry professionals to help you answer those questions.

Read on to learn everything you need to know about merchant cash advances. Or, if you’d prefer to just cut to the chase, check out a comparison of our favorite merchant cash advance companies or our full list of reviews.

Merchant Cash Advance Basics

If you think “merchant cash advance” is just a fancy way of saying “business loan,” think again; a merchant cash advance is a sales agreement. Instead of becoming a debtor, the merchant (the “seller”) is selling their future revenue at a discount to the merchant cash advance company (the “buyer”).

Aside from technical differences, merchant cash advances vary from traditional loans in a few ways. Instead of charging interest, cash advance providers charge a one-time fixed fee, calculated by multiplying a “factor rate” (sometimes called a “buy rate” or “one-time fixed fee”) by the borrowing amount.

For example, if you have a factor rate of 1.35, and you are requesting $10,000, the merchant cash advance company will collect $13,500 ($10,000 x 1.35). In other words, the fee is 35% of the borrowing amount.

Typically MCA fees range anywhere from 1.09 to 1.6 (or 9% – 60% of the borrowing amount), but you might be able to find fees that are higher or lower. The provider may require other fees, such as an origination fee or closing fee, in addition to the factoring fee.

To collect their money, advance providers usually deduct a percentage of your credit and debit card sales. Because repayment fluctuates with your cash flow, there is no set repayment date; however, most merchant cash advances are designed to be repaid in 18 months or less.

What Businesses Are Eligible?

Merchant cash advances are often touted as a method of attaining funding for businesses that cannot get a more traditional loan. Funders such as merchant cash advance providers are typically more concerned with your current cash flow than your future profitability; if you have a strong, consistent cash flow, you may be eligible for an advance regardless of your time in business, credit score, or other business factors.

That said, most MCA providers still require that borrowers fit a certain profile. They have much less stringent qualifications than a bank would, though. As long as you have a credit score above 500, a business that is at least 3 months old, and consistent cash flow, you should not have a difficult time getting a merchant cash advance. 

Because of their unique focus, merchant cash advances are not typically suited for businesses with inconsistent cash flow. If you aren’t frequently and consistently processing payments, you may want to look for an alternative type of financing, as you are unlikely to qualify for an advance.

Repaying Your Merchant Cash Advance

The days of cutting a check are over. There are a few different ways to repay a merchant cash advance—all are automated in one way or another.

Typically, MCAs are repaid on a daily basis, but some providers may offer weekly or even monthly repayments.

ACH Withdrawals

These days, ACH withdrawals are the most common way to repay your advance. ACH withdrawals can be fixed or variable, depending on the agreement.

If they are variable, the provider will receive a copy of your credit card statement and deduct a percentage of your profits. For example, if the merchant cash advance company is deducting 15% of your sales, and you make $1,000, they will deduct $150. If you make $1,200 the next day, the company will deduct $180.

If the withdrawals are fixed, the provider will simply deduct the same amount of money each payment period. For example, if you make about $1,000 a day, the provider will deduct $150 daily.

However, even if your withdrawals are fixed, your cash advance provider may be willing to alter your payments if you experience a decline in sales. In the example above, your provider might be willing to alter your daily payments to $120 if your sales slow down and you’re only making about $800 every day.

If in doubt, it’s a good idea to ask if your MCA provider is able to alter their payments before entering into an agreement with a fixed ACH payment.

Split Payments Processing

In the past, most merchant cash advances were repaid via split payment processing. The merchant cash advance would team up with your payments processor (or ask you to switch to a partner payments processor). The payments processor would reserve a percentage of every sale for your advance provider before sending you the remainder.

For example, if the MCA was deducting 15% of every sale, your payments processor would send $150 to the MCA and $850 to you for every $1,000 processed.

Split processing is by far the easiest method of repayment, because it’s completely automated. However because merchants typically have to switch payment processing services to use this method, or use the MCA provider that works with their current payments processor, there’s a lot of room to wind up in a bad payment processing agreement, a bad advance provider, or both.

While you may still be able to find split processing arrangements, this repayment solution is not as common today as it used to be.

Lock Box Withholding

In a lock box withholding arrangement, the merchant cash advance company sets up a lock box that is in your name but controlled by their company. You will route your sales to this new bank account. Every day, your financier will deduct their percentage of the proceeds and then send the remainder to your business.

Given the numerous problems that can arise—such as money transfer delays—and merchant’s general uncertainty about giving another company direct access to all their proceeds, lock box withholding has never been terribly popular. Nonetheless, you may run into this repayment solution while searching for an MCA provider.

Merchant Cash Advance Pros and Cons

There are multiple benefits to using a merchant cash advance, but many reasons you might want to avoid this particular type of financing as well. Here are the biggest pros and cons of accepting a merchant cash advance offer.

Why Use a Merchant Cash Advance?

Despite their poor reputation, there are tangible benefits to using a merchant cash advance:

  • Low borrower qualifications: As stated above, many businesses can qualify for a merchant cash advance, even if they can’t qualify for other types of business financing. As long as you have strong cash flow, you have a good chance of qualifying for an MCA.
  • Fast application process: Merchant cash advances generally have a very fast application process. Typically, the application can be completed in a few minutes with a minimal amount of paperwork. After initial application, underwriting and capital dispersal only takes a few business days.
  • Variable repayments: Most merchant cash advances have variable repayments, which means that payments are lower when sales are slow, and higher when sales speed up.
  • No collateral required: A lack of collateral is not a problem for cash advance providers. You will generally not have to put up any collateral to receive financing.

Why Avoid a Merchant Cash Advance?

Merchant cash advances may be an easy and convenient source of capital, but there are some downsides.

  • Expensive fees: Cash advances typically carry very expensive fees. You might have to pay fees up to 60% of the amount you’re borrowing. Depending on your fees and how fast you repay, the advance might have an effective annual percentage rate (APR) that reaches into the triple digits.
  • Fast repayment: Although repayment fluctuates with your cash flow, you’ll still have to repay a lot of money very quickly.
  • Reduced sales: Because the MCA provider is deducting a percentage of your daily sales, you will have reduced profits until you pay off the advance.

Evaluating Your Merchant Cash Advance Offer

Because merchant cash advances are so different than other types of financing, merchants are often at a loss regarding how to analyze an offer presented to them. Because advances don’t carry interest rates, which is how we’re used to evaluating loan offers, understanding the costs can be a little more difficult.

Fortunately, many providers are starting to make this job easier. Some providers lay out the important information in an easy to understand format, such as a SMART Box.

If not, the following are the factors you should consider when evaluating an offer:

  • The total cost of capital: The amount of money you’ll have to repay in total.
  • The cents on the dollar cost: The amount you’ll have to pay in fees per dollar borrowed.
  • The effective annual percentage rate (APR): The estimated APR. Although it’s not technically possible to calculate the APR on a merchant cash advance, you can get a rough estimate for comparison’s sake. For more information, read our article on MCAs and APRs.
  • The monthly payment: About how much you’ll have to repay per month.
  • Prepayment penalties or discounts: Whether or not the provider gives you a discount for repaying early, or participates in double dipping.

Final Thoughts

If you need a cash infusion to grow your business or overcome cash flow gaps, a merchant cash advance might be for you. Although merchant cash advances have gotten a bad rap in the past, and you should give an offer a lot of consideration before accepting it, merchant cash advances can be a useful and legitimate way of attaining business financing.

This is a basic overview of merchant cash advances. For further reading, check out these resources:

Bianca Crouse

Bianca Crouse

Bianca is a writer from the Pacific Northwest. As a product of the digital age, she likes absorbing large amounts of information and figures she might as well pass it on. When not staring at a screen, she is probably foraging for food outside, playing board games, or harassing somebody with theories about that movie she just watched.
Bianca Crouse
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4 Comments

    Tak Ogihara

    hi, great article. Can you now point us in the right direction for finding and choosing the right merchant cash advance?

    Bianca Crouse

    Hi Tak,

    I’d recommend taking a look at our merchant cash advance comparison chart and our full list of MCA reviews.

    Sam Fisher

    For somethings like this, is it always a variable payment? I’d think that you would want a fixed payment so that way you could plan your budget accordingly. However, I’m sure that it works out either way.

    Bianca Crouse

    Hi Sam,

    Merchant cash advances are always variable. The idea is that the repayments will fluctuate along with your cash flow. However, most cash advance providers also offer a fixed fee short term loan, which is like a cash advance, but repayments are fixed. And you are correct, a lot of people prefer the fixed repayment method over the variable method of merchant cash advances.

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