MCAs may seem like an attractive solution for businesses that have had a disruption in cash flow or need capital to pursue a time-sensitive opportunity, but the terms are often unsupportable, and if you don’t understand how to manage properly them, can quickly result in cash flow disruptions for your business.
A Merchant Cash Advance (MCA) is an unconventional finance product (i.e. loan) whereby a business is given a cash advance (typically on credit and debit card sales, but not necessarily) in exchange for repayment from future sales. A merchant cash advance is an advance on future revenue. The payments are deducted from a merchant’s revenue account each day until the advance is paid in full. Most business cash-advances require a daily repayment which can become challenging if the business experiences financial distress.
Think of it as a payday loan for businesses. A company lends money to a cash-strapped business in exchange for future earnings. A merchant cash advance is a popular but sometimes dangerous form of business funding. It differs from a traditional loan in the sense that it is a buy-out of future credit card receivables with a built-in margin for profit. There is no actual interest rate, and the industry is not regulated with the same scrutiny as its consumer counterpart. Most businesses choose a Merchant Cash Advance when they need quick capital or cash because they are easy to apply for and can deliver funds quickly.
How Do Merchant Cash Advances Work?
Most business owners want to pay their debt in full. In order to pay past due amounts, many business owners resort to Merchant Cash Advances to generate quick cash. The payment requirements may sound small, but because they are typically deducted from accounts on a daily basis, these small payments can really add up over time.
As previously explained, merchant cash advance companies provide a sum of money to a business, and in return, the business agrees to give the company a percentage of the business’s income (usually credit card transactions) over time. Payments are typically made daily (and automatically) as the business generates credit card transactions. The total amount to be repaid is calculated by a factor rate, a multiplier generally based on a business’s financial status.
An agreement is made between the small business and the MCA provider regarding the advance amount, payback amount, and holdback percentage. Once an agreement is made, the advance is transferred to the business’ bank account in exchange for the agreed-upon future percentage of receivables or credit card receipts.
Each day, an agreed-upon percentage of the daily revenue or credit card receipts are withheld to pay back the MCA. In many cases, this is done by accessing the business’s processing account directly and taking the percentage straight from the daily settlement deposit. This is called a “holdback” and will continue until the advance is paid in full. Access to a business owner’s merchant account eliminates the collateral required for a traditional small business loan.
Because repayment is based upon a percentage of the daily balance in the merchant account, the more transactions a business does, the faster they’re able to repay the advance. And, should transactions be lower on any given day, the draw from the merchant account will also be less. This means during times of slow business, the business’ payback is relative to their incoming merchant account deposits.
Pros and Cons of Merchant Cash Advance
Pros
There are many benefits to an MCA when compared to a loan for small business owners. Some of them are as follows:
No Need for Collateral or Credit: A merchant cash advance is an alternative approach to accessing cash and receiving cash safely for your business. Commercial loans can affect credit ratings, but MCAs depend on future sales. That is why these types of debts stay off credit reports in most cases. Merchants who take a cash advance also avoid the risk of losing collateral, no matter what happens with the business.
Fast Collections and Applications: With an MCA, funding will always be a really fast, and straightforward process from start to finish. A commercial lender will evaluate everything from financial statements, tax returns, credit reports, and the current business plans. MCA Providers, on the other hand, will usually consider simpler criteria: length of time business and monthly income received through credit card receipts or sales.
Fast Cash Access: There is not much paperwork to process when it comes to applying for a merchant cash advance, so the turnaround for the delivery of cash advance funds is very fast. A traditional loan can take months to be processed, whereas MCA funding is usually available within a week, or sometimes a day, of submitting the application. This fast response can be an important asset if the business needs immediate funding to pay off a creditor or take advantage of an unexpected opportunity.
Really High Approval Rate: Merchant Cash Advances rely on real business performance and positive cash flow rather than credit and financials to evaluate applicants. When we compare the approval rates of the MCA and of the regular commercial bank loans, it instantly becomes obvious that the MCA has the highest approval rate. This flexible approach allows almost any stable business to qualify for an advance.
Collections Based on Revenue: A big problem with commercial bank loans is that when sales are not made, the company will have problems making its monthly payments. With a merchant cash advance, this is no longer a problem since repayment happens only when the company makes money.
Cons
Some business debt can be a great way to grow your business but too much debt will only hurt your business, with no end in sight or ability to pay it all off. In particular, merchant cash advances can quickly land you in debt.
It’s expensive: Merchant cash advance debt is an expensive form of financing. In addition to their repayment terms, merchant cash advances charge abundant fees. Before accepting a merchant cash advance, read the fine print to know what you’re getting into and exactly how much you’ll be expected to pay in the long run.
You’ll have to deal with high, repetitive payments: Paying off your merchant cash advance in less than a year may sound like a great deal, but the consistent payments might not be worth the tradeoff. As well, there’s no benefit to paying off a merchant cash advance quickly: The higher your credit card sales, the more money you’re losing to the MCA provider that day, and the more deeply you’re going to feel the effects of that debt.
Merchant cash advances won’t benefit your credit: Many businesses turn to merchant cash advances when they think they’re out of other loan options. If you truly have no other options, a merchant cash advance will work, since many MCA providers accept bad credit. On the other hand, one of the benefits of a merchant cash advance is that it won’t hurt your credit history, either. You’ll have to assess whether this is harmful or not for your business.
It’ll land you in a cycle of debt: MCA should be a one-time, short-term, last-resort loan option. Consider all other financing options prior to accepting a merchant cash advance. Due to the never-ending merchant cash advance cycle, a merchant cash advance can be what you need to fix a cash-flow problem. But paying it off daily might put you right back into a cash-flow problem and unable to grow your business.
Final Thoughts
Merchant Cash Advances can be a beneficial type of debt for some companies if they approach the decision with care. The quick access to funds, ease of approval, and overall low hurdle to obtaining financing makes it easy for companies to take advantage of MCA funds. But these same positives can lead to serious consequences if the companies borrowing MCA funds don’t take into account the affordability of the advance long term. One advance may lead the need for another, and as these advances stack up, companies can find themselves struggling to make ends.
If you find that your company is struggling to make its payment commitments due to excessive daily or weekly MCA payments, give us a call. Our experienced debt advisors can help your business reduce your payments by negotiating new terms with your MCA providers.
