A guide to securing a merchant cash advance

Mitchell Tessier
Mitchell Tessier
An 18th century woman and man cheers each other with glasses of wine.

If you’ve read many of the pieces on the blog lately, you’ll notice a theme here: a lot of them have to do with alternative sources of funding. But trust us, there’s a method to our madness! Many founders struggle with securing that initial funding to start their business, and that’s a barrier we’re working to reduce. So if you’re looking for funding and banks have told you “no”, find out what a merchant cash advance (MCA is and whether it could be right for you. 

What is a merchant cash advance? 

An MCA is an alternative to bank financing in which cash is offered in exchange for a portion of the business’ future income. It’s a system that allows small business founders to receive an advance on credit card payments—so if your business doesn’t take plastic, unfortunately you’re out of luck. An MCA is not a loan, but rather a cash advance that is repaid against future revenues of the business (plus an agreed upon interest rate that’s usually fixed).

Who is involved in a merchant cash advance? 

The key parties involved in a merchant cash advance are as follows: the borrower, the provider, and the processor. Although an MCA isn’t a loan, the easiest way in which to think of the arrangement is to consider the business owner as the borrower. The provider, on the other hand, is the one offering the advance (and, of course, the one who will claim a percentage of the borrower’s future income in exchange). 

You’re probably wondering where the processor comes into all of this, right? The processor is usually an entity with an existing relationship with the borrower that becomes responsible for collecting funds from customers. Their role in the arrangement is to allocate the collected funds appropriately between the borrower and the provider.

 

How does a merchant cash advance work? 

Similar to the three parties involved in a merchant cash advance, there are three key figures needed to create an MCA agreement: an advance amount, a payback amount, and a holdback percentage. Once an agreement is reached, the cash is then transferred to the business’ bank account. Each day following, the agreed upon percentage of daily revenue (or credit card receipts) are then withheld as payment for the MCA. This percentage is called a “holdback”—an MCA’s equivalent to collateral in the case of a traditional small business loan. The holdback payments continue until the entire advance is paid in full, and don’t include the additional interest you have to pay as a fee for the advance in the first place.

Typically, the holdback percentage is based on the following factors:

  • The funds a business is receiving
  • The agreed upon length in which the advance is to be repaid
  • The size of the monthly receivables. 

Generally speaking, holdback rates range from 10 to 20%, although please keep in mind that this can vary greatly depending on the type of business and the provider’s assessment of the risk taken on by the advance. 

What are the advantages of a merchant cash advance? 

There are a number of reasons a small business owner may opt for a merchant cash advance as an alternative source of funding. 

  • Payment is based on daily sales: When business is slow, holdback payments slow down as well relative to their incoming account deposits. 
  • Access to MCAs is timely: While traditional bank loans can take weeks or even months —not to mention small businesses tend to be turned away—MCAs have a comparatively high approval rate. For the most part, you can receive cash in your accounts in a matter of days or even hours. 
  • The application process is simple: Compared to a traditional loan application, MCAs don’t involve lots of paperwork. 

What are the disadvantages of a merchant cash advance?

While you can receive an MCA fairly quickly, it comes at a cost. Merchant cash advances are expensive compared to traditional small business loans. For that reason, high-return, time-sensitive projects tend to be able to take the most advantage of MCAs. It might not make as much sense, for example, to use an MCA to fund operating costs. Generally speaking, you should think of an MCA as a short-term financing option as opposed to a long-term fix to address a need for capital. 

Is a merchant cash advance right for me and my business? 

Merchant cash advances are best suited for small businesses fitting the following profile, although each business should be evaluated on a case-by-case basis:

  • You need access to capital quickly
  • You have adequate cash flow via your merchant account on a daily basis
  • The purpose of the loan (whether it’s for a specific project or related to scaling your business) justifies the high cost of the advance

MCAs tend to have lower credit requirements compared to a small business loan, so keep this in mind if you’re a business with heavy monthly credit card transactions but a fairly weak credit profile. 

Alternatives to a merchant cash advance

Because a merchant cash advance isn’t a loan, it won’t help build business credit. As a result, you may need to turn to other financing options in tandem with an MCA as you scale your business to the next level. Here are a few alternative funding options that may be suitable for you: 

If you’re interested in alternative funding options, we suggest taking a look at this article on creative ways to secure alternative funding. 

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