Determining if Merchant Cash Advance is Right for Your Business
If you need quick and convenient Business Lending, a merchant cash advance (MCA) may be the ideal option. An MCA is an ideal alternative to conventional loans, which are hard to obtain because of the lengthy process and strict credit requirements. Technically, an MCA is not a loan; it is a cash advance offered by a financing company to be repaid with part of your future daily credit card and debit card sales, inclusive of a small fee.
A merchant cash advance could be a solution to your financing problems, especially if you do not have collateral, a proven business history, or a great credit score. Often, MCA providers have flexible eligibility standards, which make it easy for small businesses to qualify. A merchant cash advance may particularly favor businesses that generate a big portion of their revenue via credit card payments. For example, if you own a retail store or a restaurant, you can depend on MCA as a short-term financing option. This financing can help you meet short-term obligations such as inventory purchases, debt payments, working capital, and unexpected payments.
Providers of MCAs determine credit criteria and assess risks differently than bankers. Typically, an MCA provider evaluates your business’s daily credit card receipts and uses the findings to determine whether you can be able to repay the funds promptly. A merchant cash advance is approved within a short period; you may have the funds approved and deposited into your account in just one or two days.
How Does Merchant Cash Advance Work?
During the application process, an MCA provider and business owner agree on the amount to advance, the payback amount that includes the applicable fees, holdback, and the term/period of the advance. Once the MCA provider and the business owner agrees, the money is transferred to the borrower’s business bank account. An agreed daily percentage of the credit card receipts are set apart to repay the MCA. This is known as holdback, and it continues until the MCA is repaid in full.
The ability of the MCA lender to access a business owner’s merchant account eliminates the collateral requirement, unlike conventional loans that are secured with collateral. The MCA repayment is based on a percentage of the daily merchant account balance. Therefore, a business with numerous daily credit card transactions can repay the cash advance faster. Similarly, if the credit card sales for a particular day are low, the amount drawn from the merchant account to repay the MCA will also be lower.
For a merchant cash advance, the payback is directly proportional to your daily credit sales; the more the sales, the higher the daily payback and the lower the credit card sales, the lower the daily payback amount. This payment arrangement is ideal, as you cannot strain to repay a higher amount than your daily sales allow.
You may also choose to repay your MCA through fixed debits made every day or every week from your business account. This form of repayment is known as ACH (Automated Clearing House) withdrawals. This form of repayment allows businesses that do not deal with credit card or debit card payments to apply for a merchant cash advance. According to former MCA broker and the founder of deBanked, a trade magazine, Sean Murray, ACH payment is the most common repayment option for merchant cash advances. Unlike a loan where you make one fixed installment every month for a defined period of repayment, you will make fixed everyday payments or every week payments including the applicable fees, until you pay the MCA in full.
The Cost of MCA
The Cost of a merchant cash advance varies depending on the factor rate set by the MCA provider. After assessing the risk of lending, the MCA provider sets a factor rate, which typically ranges between 1.2 and 1.5. The lower the factor rate, the lower the fees you will pay, and a higher factor rate translates to higher fees. To get the total repayment amount for your merchant cash advance, you multiply the factor rate set by the provider with the amount advanced. For example, if you get an MCA of sixty thousand dollars ($60,000) with a factor rate of 1.3, the total repayment amount will be seventy–eight thousand dollars ($78,000).
The Benefits of Merchant Cash Advance
Businesses in every field need capital to run their operations. There are various Business Lending options available; however, not every business can qualify for a loan. Most small to medium businesses have trouble accessing credit. Precisely, new business struggles to acquire financing as it is hard to prove themselves and win the trust of moneylenders. With a merchant cash advance, businesses can freely assess cash, new businesses included. Some of the benefits of merchant cash advance include:
Access Cash Quickly
Unlike applying for a loan, which may take longer, the process of applying for a merchant cash advance is fast and convenient. Once you apply for an MCA, you will have the money deposited into your account in less than one week. In some instances, you may get the money in less than two days; it all depends on the MCA lender. Therefore, a merchant cash advance is ideal financing for business emergencies. For any successful company, timing is a critical factor for success, and having access to funds when you need it most could greatly enhance your business.
Higher Approval Rate
Many business owners prefer merchant cash advance to conventional loans as MCAs have a higher approval rate and are easy to acquire. The chances of getting your MCA application approved are much higher than the chances of getting a loan or credit card approval. The process of applying for an MCA is simple and straightforward; you may fill physical application documents or fill an online application. You may still qualify for an MCA even if your credit history is not appealing.
In traditional lending sources, however, you cannot access credit if your credit history is questionable. MCA providers do not focus too much on your credit score. Instead, they evaluate the amount you make each month in terms of credit or debit card sales. The credit card receipts are an indicator of your ability to repay the MCA. As long as your business makes adequate credit card sales, accessing an MCA will be easy.
For businesses that do not record frequent credit card or debit card sales, a merchant cash advance is still accessible. On acquiring an MCA, these businesses make fixed daily or weekly remittances from their accounts towards the MCA repayment.
Unlike conventional loans that may need collateral, a merchant cash advance is an unsecured loan that does not need any form of security. Therefore, if you acquire an MCA and then your business fails, and you are unable to make payments as anticipated, you will not be at risk of losing your home, personal property, or business property that you may have placed as collateral. According to David Goldin, the Small Business Finance Association’s president, if an MCA borrower goes out of business, the MCA lender goes out of luck.
In the place of collateral, the MCA provider may request for a written agreement, personal guarantee, in which you commit to repay the advance granted. A merchant advance is not a loan but a sales transaction. The facilities are not reported on credit reports and do not require collateral like business loans.
After applying for an MCA, you do not owe predetermined monthly payments, and you do not have a set repayment term. You may pay high or low monthly payments depending on the month-to-month performance of your business. When you apply for an MCA, you agree to receive a lump sum of money, and in return, you offer some of your future credit card sales proceeds. Experts argue that by applying for an MCA, you are not borrowing money; you are selling some of your future profits. When you have a busy and more profitable month, you will pay more. When you have a slow month with less profit, you will make a lower payment to your merchant cash advance. With the flexible repayment option, you are not going to strain to make high payments, especially in hard economic times.
Freedom to Spend
Most business loans come with some restrictions on how you can spend the money. Where spending restrictions exist, it may be hard to find financing that can meet all your business needs. Most business owners prefer merchant advances to other credit options due to the spending freedom MCAs offer. After getting money from a cash advance provider, you can use it as you like without adhering to some strict restrictions. You may use the funds to pay off business debts or to run day-to-day business activities. If you need to meet several business costs, MCA may be the best funding for you as you will be free to allocate the funds.
You Can Apply for a Small Amount
A main benefit of MCAs is the freedom to apply for as much or as little funding as you may desire. For conventional loans, lending institutions may not support very small loans due to the high processing costs. For example, the procedures and the costs involved in processing a one hundred thousand dollars ($100,000) loan are the same costs and procedures for processing a one thousand dollar ($1,000) loan. Therefore, loan lenders mainly prefer advancing large amounts of money as this offers better returns on investment. Most small business owners may not need such big loans. With MCAs, however, you are free to get any amount of cash advance you need and as often as you need as long as you honor the repayment conditions.
Amount Owed Remains Constant
An MCA is not a loan and does not have interest charges. Instead, merchant advances have a factor rate that is constant and cannot change once determined. With loans, however, interest rates may fluctuate over the life of your loan, and you may end up paying a different amount than you anticipated. MCAs give you peace of mind as you enjoy the certainty of knowing that the amount you apply for will not change even when the market conditions change. Once you agree with the lender on the factor rate, you can be sure that you will pay what you signed for. An MCA may take longer to repay depending on your sales proceeds, but the overall repayment amount will remain constant.
Automatic Payments and No Late-payment Fees
After acquiring an MCA, payments are made directly from your credit card or debit card sales. Direct debits may also be made directly from your bank account if you do not deal with credit card payments. The payment process is automatic, and you will not have to worry and plan for payments. You are not at risk of making late payments and attracting penalties as in the case of loans.
The Shortcomings of MCAs
Even if merchant advances offer some advantages over conventional loans, there are some shortcomings in seeking MCA financing. Therefore, MCAs may not always be the perfect Business Lending option for you. Some of the disadvantages of using MCAs include:
MCAs are Expensive
When determining the cost of funds, it is important to calculate the applicable annual percentage rate. The annual percentage rate (APR) is the total annual cost of acquiring funds; it includes all the associated fees and interest of the funds acquired. The annual percentage rate for a cash advance by merchants is much higher than the rate for regular loans.
Depending on the lender, the amount advanced, the strength of business credit sales, and the advance repayment term, the annual rate for MCAs may range from forty percent (40%) to three hundred and fifty percent (350%). This rate makes MCAs much more expensive than conventional loans.
The annual rate for conventional loans rarely exceeds ten percent (10%). For online small and medium business loans, the applicable total annual rate ranges from eight percent (8%) to ninety-nine percent (99%) The APR for business credit cards averages between twelve point nine percent (12.9%) and twenty-nine point nine percent (29.9%). Therefore, a merchant cash advance is an expensive business financing option.
No Benefit for Early Payment
When repaying a loan, you may save on interest is you clear the loan earlier. This is not the case with a merchant cash advance. Once you acquire an MCA, you have to pay a fixed amount of money no matter how fast you repay the MCA. You will not enjoy any interest savings for making an early repayment. If for instance, you decide to refinance, you will still have to pay all the amount agreed on with the MCA lender.
Merchant cash advances are not regulated and may expose a business owner to risks. A merchant cash advance is not a loan, and the applicable factor rate is not an interest. For these reasons, lending laws, including usury laws, do not apply to MCAs. MCA lenders may charge high factor rates that result in very high APRs. There are ethical and unethical MCA lenders; lack of regulation of merchant cash advances leave business owners at risk of being exploited by unethical lenders. Predatory lenders may encourage business owners to take more money than they need, and this could greatly strain businesses.
MCAs are designed as commercial transactions, not loans. The merchant cash advance sector is not affected by federal regulations. In each state, Uniform Commercial Code regulates MCAs. Banking laws such as the Truth in Lending Act does not apply to a merchant cash advance, and this may expose the borrower to risk.
Before acquiring an MCA, it is important to do your research. Understand the reputation of the MCA lender you intend to work with.
MCAs May Strain the Business
The fast and easy accessibility of merchant cash advances may put business owners on debt cycles, especially business owners who do not qualify for other types of financing. Soon after taking the first advance, borrowers may find themselves in need of another soon after. The high costs and the frequency of repaying merchant cash advances may strain businesses’ cash flows. For example, for a small business to set aside a percentage of daily sales proceeds to repay an MCA is hard and may strain the business and increase the risk of default.
Hard to Understand
Compared to other financing options, merchant cash advances may be confusing and hard to understand. The repayment and cost structure of the cash advances may be hard to comprehend. MCA contracts are often characterized by technical terms. For instance, the repayment amount out of credit card sales is termed as a specified percentage, while the amount you receive is termed as the purchase price. The total payback amount is often termed as receipts purchased amount. Unlike other lenders who provide APRs, MCA lenders do not avail APRs, and this makes it hard to compare with other financing options.
Limitations on How You Operate Your Business
Some merchant cash advance deals may limit the way you carry out your business. For instance, an MCA agreement may include a clause that prohibits you from discouraging your customers from paying using credit cards. If for instance, you offer discounts for customers paying cash and you fail to do the same for customers paying using credit cards, you may be guilty of discouraging customers from using credit cards.
An MCA agreement may prohibit business owners from changing credit card processing companies until the merchant cash advance is repaid in full. The MCA lenders take these steps to protect the revenue stream for credit cards. Other restrictive terms may include prevention from closing the business for a significant duration, taking out a loan for your business when the MCA is not fully repaid, and changing the business location.
The conditions for MCAs may vary from one provider to the other. At times, borrowers are required to sign a confession of judgment. This document denies you the right to protect yourself if the MCA lender takes you to court.
An MCA may only offer short-term finances to your business. Usually, merchant cash advances are repayable within fifteen months at most. You should only consider using the short-term financing option if it solves your business financial problems and generates enough income to repay the debt, including the interest.
Applying for an MCA
The process of applying for an MCA involves four main steps. The first step entails identifying a reliable MCA lender. It is important to compare different lending companies before submitting your MCA application. When comparing different lenders, consider the cost of the advance; ask for the applicable factor rate. Difference between MCA funders can have a great impact, and it is, therefore, important to make a proper comparison.
It is important to work with a reliable credit card processor. Especially if most payments in your business are through credit cards, you should have a dependable processor. Prospective MCA lenders will seek to know whether you are using a competent credit card processor.
After choosing an MCA lender to work with, proceed to submit your application. The process of applying for an MCA is much easier than applying for a loan. It is a fairly transparent and straightforward process. A merchant advance provider will review your application and determine whether your business qualifies or not.
Review the MCA contract Details after receiving an offer from the lender. Understand all the terms of the contract, including the factor rate applicable. If you are satisfied with the terms and conditions, you can proceed to sign the contract and have the advance credited into your bank account.
In summary, a merchant cash advance offers a timely relief to your business’s financial constraints. After applying for an MCA, you access the money within a short period. You do not have to prove your credit history; neither do you have to provide security/collateral. A merchant cash advance is an ideal source of financing for new businesses or businesses that have low credit scores.
Despite the many benefits of MCAs, there is a downside as merchant cash advances are more expensive than conventional loans. Before you apply for an MCA, evaluate your business, and consider whether an MCA will benefit your business. Take time to understand the MCA lender and all the terms of the advance to make an informed decision.