What is a merchant cash advance?

Have you recently found yourself asking, “What is a merchant cash advance”? If so, this guide is here to provide the answers you seek.

A merchant cash advance, also known as a business cash advance or MCA loan, is an alternative financial product that you can use to obtain funds for your small business. With a merchant cash advance, a company will front you a lump sum in exchange for a percentage of future sales plus an additional fee.

Here’s everything you need to know about MCAs so you can determine whether they’re a good option for your business.

How does a merchant cash advance work?

When you take out an MCA, the provider will give you a predetermined amount of cash. It is essentially purchasing future sales or invoices, which you’ll use to repay the capital you borrow. The lender will also charge a fee.

If you’re confident that your company’s future sales will be able to cover your expenses and repay the advance, an MCA may be the right choice. But if you can’t repay it and default on the loan, the lender could freeze your accounts and seize your assets. 

To authoritatively answer the question “What is a merchant cash advance,” we’ll need to look at the two common MCA loan structures, as well as rates and fee schedules.

How merchant cash advances are structured

There are two commonly used MCA repayment structures:

• Percentage of debit/credit card sales: Traditionally, an MCA company will automatically deduct a percentage of your credit or debit card sales until your loan is repaid. It may deduct these sales percentages daily or weekly. 
• Fixed withdrawals from a bank account: Some MCA companies will withdraw funds straight from your business account. Under this structure, your payments are fixed, and withdrawals occur either daily or weekly.

There’s no set loan term under the percentage-based repayment model — if you have a large volume of sales, you’ll repay the loan sooner. Conversely, if sales volume is low, it can take much longer to pay off your balance.

The fixed withdrawal model allows you to determine exactly how many payments you’ll need to make to repay your loan.

Merchant cash advance rates and fees

Merchant cash advance companies don’t charge a standard interest rate. Instead, they charge a factor rate, which may range from 1.1 to 1.5.

If the MCA company believes loaning your business money is a high-risk prospect, they’ll charge you a higher factor rate, meaning your daily or weekly fees will also be higher.

In addition to the factor rate, the merchant may charge additional fees, so it’s important to carefully review the terms of your agreement before taking out an MCA loan. 

How is a merchant cash advance different from factoring? 

One of the best ways to explore the question, “What is a merchant cash advance” is to compare it to another popular financial tool for small businesses, invoice factoring. 

Merchant cash advances involve borrowing money based on estimated future sales. To put it another way, you’re betting on your business, which can be risky if you’re already struggling to generate cash flow.

When you engage in factoring, you’re selling off accounts receivable (unpaid invoices). Since factoring isn’t a type of loan, you won’t owe any interest. Instead, you’ll forfeit a portion of the invoice’s value.

For instance, let’s say you sell off $10,000 of unpaid invoices and the factoring company charges a fee of 7%. In this scenario, you’d receive $9,300 and the company that bought your invoices would get the full $10,000 from your clients.

Benefits of a merchant cash advance

Receiving a merchant cash advance offers several benefits, including:

• Fast funding
• Flexible requirements 
• Payments based on a set percentage of your sales 

If you’re confident in the trajectory of your business and expect to experience high sales volume in the near future, an MCA loan may be more advantageous than factoring. 

Disadvantages of a merchant cash advance

There are some disadvantages to a merchant cash advance. For example:

• MCAs can be expensive, especially if a merchant cash advance company deems your business high risk
• You’ll have to make payments daily or weekly
• You can’t save money by repaying the loan early
• Contracts may be confusing
• Some providers and their agents may use abusive collection practices

Because of these concerns, it’s vital that you carefully research the fees and terms associated with any MCA loan before accepting funding. Otherwise, you might end up paying exorbitant factoring fees that hinder your company’s long-term growth. 

Is MCA financing right for your business?

While there are many benefits to a merchant cash advance, it isn’t the only way you can bolster your cash flow. We recommend researching a few of the best factoring companies as well. Doing so lets you weigh all your options and identify the best strategy for obtaining additional resources for your growing business.

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