Does your business need to get a cash advance from the merchant?

Owner of a flower growing business

A merchant cash advance (MCA) is an alternative form of financing for businesses that need cash quickly but lack credit and therefore lack access to conventional business loans. While the credit score and collateral requirements for MCAs are much more flexible than other types of business loans, they are also much more expensive. A business that obtains an MCA sells its future credit card receivables. The company providing the financing will be reimbursed by taking a fixed percentage of the company’s daily credit card sales. Here’s what you need to know to determine if your business is in need of this type 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 participate in the company’s credit card sales. The part taken by the MCA provider is called withholding. The holdback amount is automatically debited from the company’s bank account each day and electronically transferred to the MCA provider.

Typically, the holdback is 10-20% of the amount in the company’s credit card merchant account, which represents daily credit card sales. Because the hold is based on the amount of credit card sales, which can fluctuate, there is no set payment amount. The higher the dollar amount of daily credit card sales, the faster the MCA will be repaid. On days with low credit card sales, the hold will be smaller.

ACM providers do not receive interest on the sums they advance. Instead, the cost of financing is called the factor rate. This is a percentage that can range from 20% to 50% of the amount of the lump sum advance. MCAs are short-term financing arrangements that are expected to be repaid in less than a year and sometimes in just a few months. According to the Federal Trade Commission, MCAs can have estimated triple-digit annual percentage rates, making them one of the more expensive types of business financing.

MCA Advantages

Merchant arranging a merchant cash advance

Merchant arranging a merchant cash advance

MCAs do not require the company receiving the advance to provide security. Future sales constitute the security of the MCA supplier against non-repayment. In addition to not requiring collateral, MCAs are available to business owners with a credit score of less than 600, which is lower than the credit score required by most commercial lenders. One of the great advantages of MCAs is quick access to funds. A company that signs an MCA contract could receive the lump sum within a week or, in some cases, as early as 24 hours. Business loans, by comparison, can take weeks or months to fund.

Applying for MCA is straightforward and most applicants are approved. The only ones who are not likely to be approved are homeowners with personal bankruptcy on file and businesses that do not have sufficient regular credit card sales volume.

Since the MCA reimbursement is based on the daily volume of credit card sales rather than a monthly payment of a predefined amount, the business is not at risk of not being able to make a payment. An MCA is not considered debt and the organization of an MCA will not appear on a business credit report.

Disadvantages of MCA

Owner of a meal delivery business

Owner of a meal delivery business

The main disadvantage of an MCA is its cost, which is much higher than other forms of business financing, including business credit cards. The high cost of financing can put considerable pressure on the company’s ability to pay other bills. The company may eventually 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 automatically drafting the company’s bank account every day. The company, for its part, can only reimburse the amount of the withholding. He cannot prepay the expensive MCA by withdrawing funds from other accounts as might be the case with a loan.

While banks, credit unions, credit card companies, and other business finance institutions are heavily regulated, MCAs are not. So it is very important for MCA customers to understand what they are getting into. However, fees and costs can vary widely between MCA vendors, and agreements can have unfamiliar jargon and confusing terms and conditions.

Where possible, businesses are likely to find cheaper alternatives to MCAs, such as business credit cards and business lines of credit. Online lenders may be more flexible and be able to accommodate businesses turned down by banks.

The bottom line

MCAs are alternative forms of financing available to businesses that do not have the collateral and credit history required by most commercial lenders. However, MCAs cost much more than other sources of funds, so they are not considered good sources of capital except in emergencies. The Federal Trade Commission warns that these types of loans can carry triple-digit annual percentage rates.

Tips for small businesses

  • Consider working with an experienced financial advisor if you are considering applying for a merchant cash advance. Finding the right financial advisor for your needs doesn’t have to be difficult. SmartAsset’s free tool connects you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you reach your financial goals, start now.

  • One of the best ways to avoid needing an emergency business loan like an MCA is to work on managing your cash flow. Once you figure this out, check your business budget to find ways to cut expenses.

Photo credit: © iStock.com / dragana991, © iStock.com / SDI Productions, © iStock.com / svetikd

The Position Does your business need to get a cash advance from the merchant? first appeared on the SmartAsset blog.


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