A merchant cash advance (MCA) is an alternative form of financing for companies that need cash fast but lack credit and, thus, access to conventional business loans. Although credit rating and collateral requirements for MCAs are much looser than other types of business loans, they are also much more expensive. A business that gets an MCA is selling its future credit card receivables. The company providing the financing will get repaid by taking a fixed percentage of the business’s daily credit card sales. Here’s what you need to know to determine if your business needs this kind of loan.
How an MCA Works
When a company signs a contract for an MCA, it receives a lump sum payment for a specified amount. To repay this amount, the company gives the MCA provider the right to take part of the business’s credit card sales. The part taken by the MCA provider is called the holdback. The amount of the holdback is automatically debited from the business’s bank account every day and electronically transferred to the MCA provider.
Typically, the holdback is 10% to 20% of the amount in the business’s credit card merchant account, representing daily credit card sales. Because the holdback is based on the amount of credit card sales, which can fluctuate, there is no set payment amount. The bigger the dollar amount of daily credit card sales, the faster the MCA will be paid back. On days with few credit card sales, the holdback will be smaller.
MCA providers don’t collect interest on the sums they advance. Instead, the cost of the financing is called the factor rate. This is a percentage that can be from 20% to 50% of the amount of the lump sum advance. MCAs are short-term financing arrangements with repayment expected to be complete in less than a year and sometimes in as short a time as a few months. According to the Federal Trade Commission, MCAs can have estimated annual percentage rates in the triple digits, which makes them among the most costly kinds of business financing.
MCAs don’t require the business receiving the advance to provide any collateral. Future sales are the MCA provider’s security against failure to repay. In addition to not requiring collateral, MCAs are available to business owners with credit scores below 600, which is below the credit score required by most commercial lenders. One of the big pluses of MCAs is rapid access to funds. A business that signs an MCA contract could receive the lump sum amount in a week or, in some cases, as soon as 24 hours. Business loans, by comparison, may take weeks or months to get funded.
The application for an MCA is simple, and most applicants are approved. The only ones not likely to be approved are owners with a personal bankruptcy on their records and companies that lack sufficient regular credit card sales volume.
Because MCA repayment is based on daily credit card sales volume rather than a monthly payment of a preset amount, the business does not risk being unable to make a payment. An MCA is not considered a debt and arranging for an MCA won’t show up on a business’s credit report.
The main downside of an MCA is the cost, which is much higher than other forms of business finance, including business credit cards. The high cost of the financing can put considerable pressure on the business’s abilities to pay other bills. The business may ultimately have to refinance the MCA, sometimes by taking out another MCA. The resulting financial burden can make the situation worse than it was before receiving the MCA.
The MCA provider is guaranteed to receive payment by auto-drafting the business’s bank account every day. The business, meanwhile, can only repay the amount of the holdback. It can’t prepay the costly MCA by taking funds from other accounts as could be done with a loan.
While banks, credit unions, credit card companies and other business financing institutions are heavily regulated, MCAs are not regulated. This makes it extra important for MCA customers to understand what they are getting into. However, fees and costs can vary widely between MCA providers and agreements may feature unfamiliar jargon and confusing terms and conditions.
When possible, businesses are likely to find less costly alternatives to MCAs, such as business credit cards and business lines of credit. Online lenders can be more flexible and may be able to accommodate businesses turned away by banks.
The Bottom Line
MCAs are alternative forms of financing available to businesses that lack the collateral and credit history required by most business lenders. MCAs cost far more than other sources of funds, however, so they are not seen as good sources for capital except in emergencies. The Federal Trade Commission warns that these kinds of loans can carry annual percentage rates in the triple digits.
Tips for Small Businesses
- Consider working with an experienced financial advisor if you are thinking of applying for a merchant cash advance. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- One of the best ways to avoid needing an emergency business loan like an MCA is to work on your cash flow management. Once you’ve got that nailed down, check your firm’s budgeting for ways to reduce expenditures.
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