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According to the Federal Reserve’s latest study on small business financing, 10% of all the SMBs that sought funding in 2021 went for merchant cash advance (MCA). It’s the fourth most popular type of business financing after term loans, lines of credit, and business credit cards. Historically, MCA has had a pretty good approval rate too, in the 70% to 80% range.
Sounds tantalizing, but is merchant cash advance the right financing product for your business? Find out as we discuss how merchant cash advance works, its pros and cons, and its ideal use cases.
What is merchant cash advance?
Merchant cash advance is an alternative means of business funding to traditional loans and lines of credit. It’s a short-term financing solution where an MCA provider or lender extends a cash infusion, which the borrower pays back, plus fees and interest, through a percentage (repayment rate) of their credit/debit card sales. Payments are usually deducted automatically on a daily or weekly basis.
The interest on most MCAs is given in factor rates expressed as decimals. A 1.3 factor rate, for example, means that the payable amount is 130% of the principal. You can also look at it as 30% fixed interest. But some MCAs also express interest rate as APR (annual percentage rate).
Repayment can be structured in either of two ways. One, the lender deducts a percentage of each credit/debit card transaction at the point of sale. Alternatively, the lender takes a percentage or fixed cut of the total daily or weekly credit/debit card sales. This continues until the debt is paid off. The repayment term and cycles are not declared upfront but depend upon the borrower’s sales volume, the deduction arrangement, and the repayment rate.
The pros and cons of merchant cash advance
Here is a list of pros and cons showing how merchant cash advance stacks up as a small business funding solution:
The pros
Easy qualification
In fiscal terms, MCAs are not classified as loans but as commercial transactions. As such, qualifications for merchant cash advance are set at a very low bar. With most lenders, all you need is proof of at least one year in business and substantial sales figures to qualify for a merchant cash advance. You don't require a strong credit score, collateral, or guarantor to get MCA approval.
Quick Financing
Typical MCAs have a wait period of just a few days; some even have same-day approval and disbursement. This gives business owners nearly instant access to cash whenever in need, making MCAs ideal for emergency funding.
Flexible repayments
MCAs do not have the strict repayment terms you'll find on term loans or lines of credit. In fact, an MCA’s repayment structure is rather arbitrary because there are no fixed payments or clearly defined repayment cycles. You basically pay depending on how well your business is doing sales-wise, which is a neat arrangement for businesses with highly erratic income.
The cons
High interest and fees
MCA regulations fall under the Uniform Commercial Code (UCC), a universal set of laws governing commercial transactions at the state level. Unlike traditional business financing, MCAs do not follow any state or federal usury laws that limit how much interest lenders can charge on financing. So, while the average MCA factor rate ranges between 1.35 and 1.7, some lenders can charge up to three-figure interest rates.
Heavy draw on cash flow
The automatic daily or weekly repayment withdrawals can significantly impact the borrower's cash flow, particularly those solely reliant on retail sales for revenue. Most retail purchases have very slim margins, meaning that even a 10% deduction can take away a considerable chunk of the retailer’s working capital.
No reward for repaying early
Unlike conventional term loans and lines of credit, paying off an MCA debt early does not reduce its cost. This is because the total repayable amount is determined upfront and is not dependent on the timeframe or lump sum payments.
Confusing contracts
Everything about an MCA, from the repayment terms, factor rate, and fees to the advance limit, depends on its provider. These providers are often criticized for unclear and sometimes predatory contracts with hidden confession of judgment clauses. And since merchant cash advances are not regulated as financing, they have no standard structure, which makes it hard to compare them against other financing products. It can also be difficult to predict payments and the term length since credit/debit card sales often fluctuate wildly.
Alternatives to merchant cash advance
After weighing the pro and cons, it becomes clear that merchant cash advance might work for some businesses as a crucial source of funds. But other businesses might only turn to cash advances as a last resort. While MCA may be quite popular, the ideal borrower is any business with a high credit/debit card sales volume that needs urgent cash and, for whatever reason, does not qualify for or fancy other types of financing.
The minimal qualification requirements and fast approval of MCA are its strongest allures. But the high interest rates, drag on sales income, and unpredictable payment schedule are quite the turnoff for many small business owners. But again, all this depends on the MCA provider.
Before taking a merchant cash advance, ensure you understand the contract’s terms and associated costs. And take your time to compare different products from as many MCA providers as possible. Better still, check your qualification status for other more borrower-friendly short-term business financing options. Common merchant cash advance alternatives include:
- Microloans from alternative lenders or the SBA
- Business credit cards
- Working capital loans
- Accounts receivable financing and factoring
- Trade credit
- P2P loans
Discover your financing options with Lendzero
Do not settle for just any funding deal, merchant cash advance or otherwise, before sampling all the products we offer. You might just be surprised at the wide range of lucrative financing available to your business. But who has the time to call dozens of lenders asking about their offerings? Luckily, you don’t have to painstakingly scour the lending market on the hunt for a good deal, thanks to Lendzero.
Lendzero lets you explore dozens of prequalified financing offers at any time without filling out endless forms or making long calls. It's an online platform that automatically matches your business with a variety of funding offers from banks, online lenders, private investors, and many other creditors within Lendzero’s portfolio. Additionally, all the listed offers come pre-negotiated, so you don't have to haggle with lenders.
Best of all, Lendzero is a free service with no strings attached. Sign up today and discover the new hassle-free way to shop for small business financing.
