When a small business owner takes out a merchant cash advance (MCA), they’re given a lump sum of cash, which they repay via a percentage of their daily credit and debit card sales. Less commonly, you can get a MCA with terms that include a fixed daily payment based on an estimate of your monthly revenue. Merchant cash advance companies typically partner with credit card processors.
Methods for Paying Back a Merchant Cash Advance
In some cases, the repayment can be handled by your credit card processor, which deducts the owed funds automatically from your credit card sales and transfers the agreed-upon daily sales percentage to the MCA company.
In the case of a lock box or trust account withholding, credit card sales go to a bank account controlled by the MCA company. The MCA company then takes its share of the money and transfers the rest to the business’s bank account.
With ACH withholding, the repayment is made via automatic debit from the business’s checking account to the MCA company.
Pros of a Merchant Cash Advance
With a MCA, you can get the cash quickly, with an easy application process. Merchant cash advances are easy to get if your business brings in a decent volume of daily credit and debit card sales since that’s how the money is paid back. This means if your personal credit is poor, it won’t deter some merchant cash advance companies from approving you.
Since payments to the MCA company typically come from daily sales, cash flow may be more predictable than with a fixed payment loan that doesn’t vary depending on how much money you bring in.
If you go out of business and are unable to pay back the merchant cash advance, the MCA company typically doesn’t have recourse to go after you for the money. However, some MCA companies require a personal guarantee, in which case they will continue to hold you personally responsible if your business is unable to make the payments. Always make sure you read the fine print on what you’re signing up for.
Cons of a Merchant Cash Advance
A small business owner has to be much more mindful of the fees and structure and do some serious due diligence before agreeing to the terms of a merchant cash advance. It’s critical to perform calculations to figure out if the cost of a merchant cash advance is really and truly worth it before taking on this type of deal because less expensive options are probably available to you.
Because they aren’t technically considered to be loans, merchant cash advances aren’t subject to usury laws that limit lenders from charging much higher fees and interest rates than banks. They can also carry fees and a structure that makes it very easy to hide exactly how expensive they are.
The major problem with a merchant cash advance is that, when you sit down and do the math, they can carry APRs in the triple digits. Compare that to a credit card interest rate, which ranges from approximately 14 – 24% APR, or a microloan with rates of approximately 7 – 34% APR.
This means MCAs are one of the most expensive ways to get cash for your business. If you can take a little bit of time to find a more affordable way to fund your business, it could save you a lot of money down the road.
Potential Dangers of a Merchant Cash Advance
Because there’s no federal oversight of MCAs, they can sometimes fall under the definition of predatory lending, which essentially means the loan terms are unfair to the borrower. But to make matters even more confusing, because MCAs aren’t technically loans, the “borrower” is considered a customer and doesn’t enjoy the protection of the Truth in Lending Act.
MCAs may typically have a higher APR if you pay the loan off faster, and you may be subject to prepay penalty fees if you try to pay the loan off early.
The biggest danger by far of taking out a merchant cash advance is that of winding up in a vicious cycle of debt. If you find yourself unable to make payments by the agreed-upon terms, you might find yourself taking out more loans or another MCA in order to make your payments, a cycle that can be chronic if your business winds up with too much debt to pay off.
Alternatives to Merchant Cash Advances
It’s natural to have concerns about the high cost of a merchant cash advance, and it’s worth looking into other funding options for your small business. Let’s explore some better options.
Accion can approve a loan and get you the funds in as little as 12 days from the time of your loan application. A microloan provides your business with a lump sum of cash. You then pay the loan back plus fees and a fixed interest rate in installments over the length of the loan. The APR on microloans tends to be lower than most MCAs and many credit cards.
To get approval for a microloan, Accion takes a holistic approach to assessing the potential of an individual and their business. Accion also provides business education and advice to make it more likely your business will be successful. Accion can lend to individuals with credit problems, and this holistic, helpful approach is a win-win: it mitigates lender risk while ensuring the loan can be repaid via the success of your business.
Business Credit Card
A business credit card can also give you quick access to much-needed funds for your business. A business credit can be considered somewhat riskier than a microloan, as the rates can be higher and there is the potential for a vicious cycle of debt if you find yourself unable to make payments; increased interest rates and large late fees can snowball if you’re late with credit card payments. Approval is based in large part on personal credit history.
Business Line of Credit
Your bank may be able to extend to you a business line of credit. This is a good option if you don’t necessarily need a large lump sum of cash, but you need occasional access to greater amounts of cash than is available in your bank account. This lending method can save you in interest since you only use what need and pay interest on that, rather than getting a larger lump sum than your business requires. Like most lending options, a business line of credit must be repaid with interest and so there is a risk involved if cash is tight when you must repay what you borrow.
There are many financing options available to small business owners in need of cash. While merchant cash advances might seem like a convenient, fast way to secure funds, it’s also one of the most expensive. If you can wait a few days, it’s important to explore other less risky ways to shore up the financials of your business to make sure you and your business can thrive and succeed for the long haul.