Merchant cash advance

Merchant cash advance – fast cash for your business

As a small business owner, you know that sometimes a little extra cash can really come in handy to fuel your growth, or to give you some additional working capital to make it through a seasonally slow period. But you also know that for many small businesses, getting this cash through traditional business loans is often difficult or impossible.

If you find yourself in this situation, a Merchant Cash Advance (MCA) may be the answer. MCAs are an innovative way of getting your business the cash it needs, when it needs it, and allowing you to pay it back in a flexible way. Because they fund you based on expected future sales, not current assets and credit rating, MCAs can often fund businesses that banks will not. And because they understand that businesses have their ups and downs, MCAs structure the payback to expand and contract with you. You pay more when times are good, and less when things are slower.

How does a merchant cash advance work?

The way a typical MCA works is quite simple but also very interesting: the MCA funding company advances your business cash based on your expected future credit card receipts. It’s not a loan, with a rigid payback schedule. Instead, they are purchasing the right to take a set percentage of your credit card sales until the agreed-upon amount has been paid. So, if your sales are strong one month, you pay back a big chunk of the total. But if you have a slow month, you pay less, allowing you to keep more of the revenue you need to cover that month’s costs.

The payments for the MCA are made every day, directly from your credit card processor. The amount, called the “Holdback,” is taken automatically, never even making it to your bank account. Thus, you don’t have to worry that the bank account balance you see is going to be decreased once the payment is made to the MCA. Payments are often made on a daily basis.

Meet Vincent and his pizza place

Consider the example of Vincent, who owns a pizza restaurant with steady sales that makes him a modest monthly profit. Based on improving neighborhood demographics and low competition, Vincent believes his business can grow significantly if he installs an additional oven to increase the number of pizzas he can produce, combined with an ad campaign on local television and radio to drive that additional traffic. The challenge is, he doesn’t have enough cash on hand to make these investments, so despite the great potential, his business is stuck at its current level. He has searched for a business loan or a line of credit, but his credit score is too low to qualify. Then a friend tells him about merchant cash advances, and he decides to investigate.

The restaurant typically does $20K in monthly credit card sales volume, and Vincent turns to an MCA funding company to get the capital his business needs. After submitting a small amount of information, including his last several months of credit card sales statements, Vincent receives a cash advance of $20K (minus any applicable origination fees) within 3 days. The agreement is that the MCA will receive 25% of his daily credit card sales until they are paid a total of $25K. The numbers are set at these levels so that, based upon historical sales figures, the full amount will be paid back in roughly 5-6 months.

After getting the funding, Vincent has to shut down his kitchen for a few days while the oven is being installed, so his first month has lower than normal credit card receipts of $15K. Per the agreement, he pays only $3.75K toward the MCA, instead of the $5K he would pay in a typical month with sales of $20K. The smaller payment makes it much easier for him to meet his monthly expenses, despite the lower revenue total.

The next month, after the oven is installed and the ad campaign starts to run, business booms. Vincent’s projections were correct. Pizza sales nearly double, and he can handle it now that he has the additional oven space. The business does $36K in credit card receipts for the month, by far its best month ever, and Vincent pays $9K toward the $25K total MCA. Paying out this larger amount is no problem, because his sales and profits are so much greater as well. Monthly revenues continue at this higher level from month 3 on, and he pays back the full $25K in about 3 and a half months.

You can see how the flexibility of the MCA allowed Vincent not only to get the cash his business needed, but also to handle the ups and downs that were created while putting that cash to work.

My business doesn’t do a lot of credit card sales. What can I do?

As the MCA industry has grown, funders have begun to introduce other methods of advancing cash to businesses. So if your business does not have a significant volume of credit card sales, an MCA may still be an option for you.

Another popular form of MCA is known as an ACH Merchant Cash Advance. The concept is similar to the standard MCA method described above, except that it involves the MCA company making fixed daily or weekly debits from your business’s bank account, rather than taking a percentage of your credit card sales. This direct debiting process is known as an Automated Clearing House (ACH) withdrawal, which is where the name comes from.

The ACH method allows MCA funders to make advances to businesses that aren’t primarily tied to credit card sales, and the frequent debits from your account mean that you won’t be forced to come up with a large lump sum at the end of the month.

One clear and important difference between the ACH and the credit card advance is the ACH’s fixed payments. When your payment is made as a percentage of credit card sales, you have the flexibility of paying less in slower periods. But with the ACH, you have to be much more confident that you will have the cash required on a consistent basis, or else your business can rapidly find itself in over its head and spiraling downward into a very dangerous position.

Most MCA companies offer ACH as well as the standard credit card model and even some other innovative concepts. You should be sure to explore all the options available when you engage with an MCA provider.

An Important Word of Caution: You should be sure you understand every aspect of the agreement you are entering before accepting an ACH merchant cash advance. For any type of MCA – standard or ACH – it’s probably worth spending a few bucks and having a lawyer take a look at the documents to be sure that they mean what you think they do. Stories abound of a few unscrupulous MCA funders whose marketing materials claim that the business and its owner will have zero liability if they can’t make the payments, but which in fact quietly dupe the owner into signing contracts that do obligate them to such liability. A simple review of the documents by your lawyer will help you avoid unwittingly falling prey to this type of deceptive and potentially illegal business practice.

What do the numbers look like for merchant cash advances?

For a standard merchant cash advance, the amount you pay is based on the Factor Rate assigned by the MCA funding company. The amount you pay back comes from multiplying the amount you receive by the Factor Rate, which is typically in the range of 1.1 to 1.5. In the example of Vincent above, his Factor was 1.25:

Total Payback = (Amount Advanced ) X (Factor) = ($20,000) X (1.25) = $25,000

The amount of the advance is based on the business’s average monthly credit card receipts, with amounts usually ranging from 50% of monthly receipts to 250%. The rule of thumb in the industry is that most businesses receive around 100% of their monthly average.

The percentage of sales paid each day, the Holdback Rate, is chosen so as to create a desired time to expected payback. Payback times can range from anywhere from 90 days to 18 months, although most MCA’s are structured to be paid back within 6 to 8 months.

The amount of the MCA and the Factor combine to give an estimated time for payback. As we saw in Vincent’s case, if he continued his historical monthly average of $20K in credit card sales, he would pay back $5K per month, and in 5 months he would pay back the full $25K.

In addition, MCAs often come with up-front “origination fees.” This term may be familiar to you, because such fees are a standard cost with many kinds of loans as well. These fees can range from zero up to around 4% of the funding amount, so they can definitely play a role in increasing the effective cost of the MCA funds.

Origination fees are paid at the time of funding in the form of a reduction in the actual amount of funding the business receives. In Vincent’s case, if his $20K in MCA funding had come with a 2% origination fee, or $400, he would have received only $19,600 instead of the full $20K.

How do funders set the factor rates for merchant cash advances?

MCA funders are not particularly interested in traditional credit scores for your business. Instead they are focused on expected future sales amounts, and how likely these projections are to come true. For this they closely examine your company’s recent credit card processing and bank statements. The purpose is to assess the risk that your business will not be able to make the agreed upon payments. Higher levels of risk lead to higher Factor Rates.

There are other factors considered in the risk assessment as well, including:

Industry: Not all industries are created equal, and certainly not with equal risk. MCA providers are well aware of this fact. One hot button item for higher risk is industries that typically have periods of high and low sales, e.g. seasonal businesses. Any industry the MCA provider determines to be higher risk is likely to receive a higher Factor Rate.

Age of the Business: it’s not a firm rule with all MCA providers, but most require a business to be in operation for at least 6 months. Younger businesses generally receive higher Factor Rates.

Historical Financial Performance: A growing business with solid historical financials is a much more attractive candidate for an MCA. The provider will thus be evaluating your company’s financial performance in the past in order to estimate your ability to pay them out of future sales. The stronger and more consistent your past revenue and growth numbers, the lower your expected Factor Rate.

Is a merchant cash advance right for my business?

Because MCA’s aren’t technically loans, they don’t come with an interest rate. However, using the anticipated payback schedule, which is based on your Factor Rate and Holdback %, it’s possible to figure out what the annualized interest rate would be for a loan with the same payback schedule. In Vincent’s case, the MCA is equivalent to a loan with a 112% annual interest rate. If the MCA included origination fees, the effective interest rate would be even higher.

There’s no question that 112% is a very high interest rate, which seems unfair to the business owner. Entering into an agreement like this requires some very careful consideration, and two key points to think about are:

1. What is the money going to be used for, and do I really need it?
2. Will I realistically be able to meet my mandatory expenses without the roughly 25% of credit card revenue that will be held back?

Of course, there is the unspoken point that comes before them all – Do I have any other options?

The reality for business owners considering an MCA, including Vincent, is that most of them have already explored the options for traditional financing, and they have found that they are not eligible. Either they don’t have a long enough track record in business, their personal credit score is too low, or they are unwilling to sign a personal guarantee that puts their family’s financial future at risk. In other cases the business may be able to qualify for traditional financing, but the cash is needed in the very near term, and the owner is aware that the time frame required to go through the loan application and approval process is far too great. So they consider the expensive choice of an MCA. But while they are expensive in an absolute sense, MCA’s can be worth it to the right business owner in the right situation.

In Vincent’s case, he had strong reason to believe that investing the advance in a new oven and an ad campaign would allow him to significantly increase his revenue, enabling him to pay back the advance and move forward with a much larger and more profitable business. Even though the $5K in “interest” he paid was a lot, his increased monthly profits resulting from the investments paid for this amount almost immediately.

When Vincent considered whether he would be able to meet his expenses after the 25% Holdback of credit card revenue, he recognized the benefit of a payback schedule that flexes with his ups and downs in revenue. This meant that in the worst case, if sales were to actually decline from their historical average, he could still afford the payments, because they would be smaller along with his revenue. In the end, it would simply take him longer to pay back the full $25K, but he would survive.

Only you can know for sure whether an MCA makes sense for your business. Be sure to make your decision with a firm understanding of the facts.

Who Is a merchant cash advance appropriate for?

• Business owners with less than stellar credit but strong sales numbers
• Businesses that do a significant percent of their sales via credit card
• Businesses in need of immediate capital for new equipment and inventory purchases, or short-term working capital, but are unable to qualify for more traditional types of financing
• Businesses that need capital immediately and cannot wait for standard business financing approvals, which can be very slow

Who is a merchant cash advance not appropriate for?

• Businesses that have access to other, less costly types of financing
• Businesses with time to go through the slower process of applying for and receiving standard business financing
• Businesses that do very little in credit card sales
• Businesses in industries deemed to be higher risk, like adult entertainment, gambling, cryptocurrency, nightclubs, etc.

What are the advantages and disadvantages of a merchant cash advance?

Here are a few of the advantages and disadvantages of MCAs for your business:

Merchant Cash Advance Pros & Cons
Pros	Cons
Fast and simple Fast and simple process of application and release of funds	Expensive financing MCAs can be a very expensive financing alternative (see above discussion of interest rates)
Perfect credit not required However, many MCA providers require you to meet some minimum credit score to qualify	No legal limit on interest rate The industry is not regulated, meaning that unlike banks, there is no legal limit to the effective interest rate that can be charged for an MCA
No collateral required If the business fails and is unable to fully repay the MCA, there is no legal liability. The assets of the business owner are not at risk, as they would be with a bank loan.	Business operation restrictions may apply MCA providers often place restrictions on business operations in order to protect themselves from fraud. Restrictions include forbidding business owners from offering discounts to customers for paying cash (to avoid the Holdback), closing or re-locating the business, taking out a business loan, or changing credit card processors, until the MCA has been paid back
Flexible payments Payments rise and fall with your credit card receipts, allowing you to pay less when your business is slower
Automatic repayment prevents late charges Repayment is performed automatically so there is no possibility of late charges from forgetting to make a payment, which often happens with bank loans