What is a Merchant Cash Advance?
A merchant cash advance allows a business owner who accepts credit card payments or has other payment or receivables streams to obtain an advance of the funds regularly flowing through the business’ merchant account. A merchant cash advance (MCA) is not a loan, but rather an advance based upon the future revenues or credit card sales of a business. A small business can apply for an MCA and have an advance deposited into its account fairly quickly.
Merchant cash advance providers evaluate risk and weight credit criteria differently than a traditional banker might. An MCA provider looks at the daily receivables or credit card receipts to determine if the business can pay back the advance in a timely manner. Basically, the small business is selling a portion of future future revenues or credit card sales to acquire capital immediately.
Rates on a merchant cash advance are typically higher than other small business loan options (sometimes higher than triple digit annualized interest rates). An MCA provider will often approve an advance for a business that might not qualify for a business loan, but has a steady influx of credit card payments. Any business owner considering this option should make sure he or she understands the terms being offered so they can make an informed decision about potential ROI.
Table of Contents:
- How Does a Merchant Cash Advance Work?
- Is an MCA Right for Your Business?
- OnDeck MCA Alternative
- Merchant Cash Advances FAQ
How Does a Merchant Cash Advance Work?
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 a future percentage of receivables.
Each day, an agreed upon percentage of the daily revenues or credit card receipts are withheld to pay back the MCA. 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.
Repayment and Loan Costs
A business that uses a merchant cash advance may pay back 20%-40% of the amount borrowed. This percentage is frequently displayed as a factor rate, which would equivalently be 1.20 – 1.40.
NOTE: There’s a difference between the holdback amount a small business pays every day (as a percentage of their receivables) and the repayment amount for the entire advance. There could, for instance, be a holdback of 15%, and a repayment of 30%, so it’s important for the business owner to understand the distinction.
The holdback percentage is typically based on:
• The amount of funds a business receives,
• How long it will take to repay the advance, and…
• How big the monthly receivables are.
For example, a business is advanced $10,000 and agrees to pay back $13,000. This means the payback, or factor rate, is 1.30 or 30% of the advance amount. Moving forward, the business agrees to have 15% of its credit card transactions withheld by the advance company (the holdback) until the $13,000 is collected. If the business is averaging $14,500 a month in credit card sales, approximately $2,160 would be withheld each month and the advance would be paid back in roughly six months.
Typical holdback rates may range from 10%-20%, though this can vary widely based upon the business and the provider’s evaluation of the borrower’s risk.
Is a Merchant Cash Advance Right for Your Business?
An MCA is an option when a business needs to access capital quickly, has adequate cash flowing through their merchant account each day to make payments on the advance, and the loan purpose can justify the potentially high expense of the advance. And, because credit requirements are typically less than a small business loan, it could be an option for a business that does a lot of credit card transactions every month but has a weak credit profile.
The Application Process
The time it takes to get approved for an MCA could be anywhere from an hour or two to a few days, depending on the provider. And once the application is approved, a business could see the funds in their account within two days.
The application process isn’t as complicated as a traditional loan, which often makes the merchant cash advance approval process a faster option. Here are the typical steps a business needs to take:
- Apply for the advance: The application is typically one or two pages and will require your social security number, business tax ID, and other information about your business.
- Provide documentation: You will likely be asked for several months of credit card or payments processing data as well as bank statements. You will probably also be asked to provide proof of citizenship as well as a copy of the lease for the business location.
- Get approved: It could be as quick as 24 hours for your business to be approved for a merchant cash advance
- Set up the credit card processing: This type of funding may require the business to switch to a new credit card processor. It can be inconvenient to switch processors, but it sometimes a necessary part of the approval for many MCA providers.
- Finalize the details: To use the previous example described above, the funding details might be something like this: a small business is approved for $10,000 and required to pay back $13,000. The merchant account will be debited 15% every day until the entire $13,000 is repaid. Make sure you understand when payments will start, because it may be as quickly as the next business day.
- Receive the funds: The money from the MCA will be deposited into the small business’ bank account and repayment via the merchant account will begin automatically.
Alternatives to a Merchant Cash Advance
A merchant cash advance does not help build business credit because it’s not a loan and advance providers do not report repayment history to the business credit bureaus. As a result, many borrowers turn to other options, like an online small business loan, which offers many of the same conveniences and potentially at a lower premium than many MCAs.
If you’re considering a merchant cash advance for financing the purchase of quick-turnaround inventory, equipment, an expansion project, or marketing initiative, a three- to 36-month online business loan is another option if you have at least a year in business and annual revenues of $100,000 or more.
Additionally, online business loan providers (like OnDeck) report your good repayment history to the business credit bureaus and are subject to federal lending laws. Meaning, unlike an MCA, an online business loan may help you build your business credit profile.
What is a Merchant Cash Advance, and how is OnDeck Different?
With a merchant cash advance (sometimes known as a business cash advance), a business owner gets an advance on their future credit card sales. This advance is paid off by the advance company taking a percentage of each credit card transaction until the agreed upon amount has been paid back to the advance company.
For example – Joe’s Pizza gets an advance of $10,000, and they agree to pay back $14,000 (note: OnDeck offers rates are far lower than this). The advance company then takes a percentage (typically 10%-20%) of every credit card transaction until the business has paid back the agreed upon $14,000. It is important to note the difference between the “hold back” (10%-20% in this case) and the “payback” or “interest rate” (40% in this case.)
Three Reasons Why OnDeck is Different
1) OnDeck rates are typically up to 50% lower than a merchant cash advance.
2) Unlike a business credit card advance, OnDeck offers both a fixed rate and a fixed term. This means that a business owner knows the exact amount they will pay back, and the exact date the loan will be fully paid off.
3) With an OnDeck loan, repayment is reported to the business credit bureaus.
Frequently Asked Questions about Merchant Cash Advances:
What are the rates of a merchant cash advance?
The rates of a merchant cash advance will vary by the size of the advance, the perceived risk of the merchant and the term of the payback. Typically, a business will pay back between 20% and 40% of the amount borrowed with a merchant cash advance. In some cases, the rates can range as high as 60% of the amount borrowed. Important note: OnDeck rates are far lower than this.
Do I need to switch my credit card processing to get a business cash advance?
Generally, you do have to switch your credit card processing and point of sale system to get a business cash advance. Cash advance companies measure your revenue through their own proprietary hardware and software that is built into the POS system.
Is a merchant cash advance the same as a business loan?
A merchant cash advance is not the same as a business loan. Though in both cases a merchant will get money up front to pay back at a later date, merchant cash advances are not legally defined as loans and are not reported to credit bureaus.
Does a merchant cash advance build business credit?
Merchant cash advances do not build business credit. Paying back any number of merchant cash advances completely will not improve your business credit.
Can I get a business cash advance if I don’t accept credit cards?
Significant credit card sales are required to get cash advance financing. Cash advance companies measure your revenue by credit card volume going through their own proprietary POS systems.