Home

Product and service reviews are conducted independently by our editorial team, but we sometimes make money when you click on links. Learn more.

Pros and Cons of Merchant Cash Advance Loans

Katharine Paljug
Katharine Paljug

Merchant cash advances can be risky, but if used correctly, they can be a useful tool. Are they right for your business?

Running a successful business requires regular cash flow and working capital. Every business goes through periods when sales are down and money is tight. When this happens, many business owners look for outside sources of funding. One type of funding is a merchant cash advance. 

In this article, we explain what merchant cash advance loans are, their typical requirements and what their advantages and disadvantages are.

What is a cash advance loan?

A cash advance allows you to borrow an immediate amount against your future income – the lender is "advancing" you the cash before you are paid, hence the name. Technically, you are selling your future revenue in exchange for cash today, so a cash advance is different than a typical loan. 

Personal cash advance loans are borrowed against your next payday, when the lender debits your checking account for the amount that you borrowed plus additional fees. Sometimes, lenders have borrowers write a check for the amount of the loan plus fees, then cash the check after the date the borrower receives the money. 

The fees for these loans are often very high and can leave borrowers saddled with significant debt. Cash advance loans are sometimes considered predatory. However, they can provide vital cash flow to people without credit cards. 

For retailers and other businesses in need of immediate funding, there is a specific type of cash advance available called a merchant cash advance loan.

What is a merchant cash advance?

Merchant cash advance loans are a source of short-term business funding for owners who are unable to obtain financing from a bank or other source. These advances are borrowed against future credit card sales, and most of them are repaid – plus the associated fees – within six to 12 months.

To obtain a merchant cash advance, your business must have daily credit card transactions and proof of at least four months of credit sales. Many merchant cash advance companies require that your monthly credit card sales be between $2,500 and $5,000, depending on the amount of the advance. This allows the lender to confirm that you can repay the advance.

How do merchant cash advances work?

Merchant cash advance companies have traditionally worked with businesses that rely primarily on debit and credit card sales, such as retail, service shops and restaurants. However, there are two different structures to how these advances work that allow businesses that don't have high debit or credit sales to get an advance. 

  1. Traditional merchant cash advance: Businesses get an upfront sum. To repay it, a set percentage of daily or weekly sales is debited back to the merchant cash advance company (known as the "holdback") until the advance, plus fees, is repaid. The higher the business's sales are, the faster the advance is repaid. Encouraging your customers to pay in cash to avoid a percentage of their sales going to repayment is considered a breach of contract and could result in litigation. 

  2. ACH merchant cash advance: Businesses get an upfront sum, then repay it through debits from their checking account. A fixed daily or weekly sum is transferred from the checking account through an automated clearing house (ACH) withdrawal until the advance, plus fees, is repaid. Unlike a traditional merchant cash advance, the debited amount remains the same, regardless of the business's volume of sales. These advances can be paid off more quickly than an advance that is debited against sales, unless your business runs out of available cash, in which case, you may be unable to make your daily or weekly payment. 

How much you will pay in fees depends on how much risk the merchant cash advance company feels it is taking on. Generally, the factor rate will be between 1.2 and 1.5%. If you take out a $40,000 advance with a 1.5% factor rate, your total payment will be $60,000: your $40,000 advance plus $20,000 in fees.

A merchant cash advance is considerably more costly than traditional financing. It can also create a debt cycle in which business owners must take out a second advance in order to pay back the first, resulting in additional fees.

Merchant cash advances are legal because they are not considered loans. Instead, they involve the purchase and sale of future income. Because the advance never lasts more than a year, the firms putting up the financing don't have to follow regulations that traditional lenders are required to follow.

The fees paid with merchant cash advances are not technically considered an interest rate. If compared to one, however, the rate paid for a merchant cash advance is significantly higher than it would be for a bank loan. The equivalent annual percentage rate (APR) for a merchant cash advance fee can be up to 200% of the advance.

One reason the APR equivalent is so much higher than with traditional financing is that a bank receives a monthly percentage on the balance your business owes, not the full amount of the loan. As the loan is paid off and the balance reduced, the interest paid per month decreases.

However, a merchant cash advance fee is a fixed charge for providing the advance. The amount that you owe does not change, even as you pay back the advance.

Banks are regulated by federal and state laws intended to protect consumers against lending practices that are considered predatory. Merchant cash advance companies are not similarly regulated because they are technically buying future receivables, not providing a loan. As a result, they are exempt from state usury laws that would otherwise prohibit charging fees so much higher than standard interest rates.

This lack of regulation means that if you work with a merchant cash advance company, you need to scrutinize your contract, carefully looking for

  • The size of your advance: Some companies will advance more than a business can be reasonably expected to repay.

  • What credit card processing company you can use: Most cash advance contracts prohibit switching credit card processors. If for some reason you are dissatisfied with your credit card processor, you are stuck with them until the advance is repaid. Your contract may also require you to switch to using a specific credit card processing company before you can receive your advance.

  • Billing practices: Some cash advance companies change billing practices without notifying the merchant borrowers, which can impact your ability to repay the advance.

  • Holdback terms: The holdback is the daily or weekly amount that is repaid to the merchant cash advance company. If this amount is too high, your business may struggle with cash flow while you pay back your advance.

Why use a merchant cash advance?

Though the steep fees of merchant cash advances mean that many financial experts discourage them, business owners may find that there are good reasons to consider a cash advance over financing from a bank or other lender, including:

  • You have almost instantaneous access to funding; advances are typically made within 24 to 48 hours.

  • There is no collateral requirement. If the business fails and the cash advance is not fully repaid, there is no legal liability. The business owner's assets are not at risk, as they would be with a bank loan.

  • Repayment is performed automatically so there is no possibility of late charges from overlooked due dates that frequently occur with bank loans.

  • With a traditional merchant cash advance, there is no minimum payment required. A month with slow sales means you pay less to the merchant cash advance company.

  • Applications require minimal paperwork.

  • Merchant cash advances are available to businesses that need cash quickly, don't qualify for a traditional bank loan or can't wait for a loan decision/release of funds.

Merchant cash advances are a workaround to unavailable bank lending, particularly for businesses that have poor credit or are otherwise unable to obtain a traditional loan.

Do merchant cash advances hurt your credit score?

Merchant cash advances are typically available for businesses with poor or no credit, but that doesn't mean the company will ignore your credit report. Merchant cash advance providers will generally do a background credit check as part of the application. This will generally not impact your credit score. 

Some providers may do a hard credit check before issuing you an advance. This type of check can potentially hurt your credit score. You may be able to find out what kind of credit check companies perform before you apply in order to work with a cash advance company that won't impact your credit score.

How do you apply for a merchant cash advance?

Applying for a merchant cash advance is generally a quick process, which is part of why they are appealing to business owners who need immediate access to cash. There are merchant cash advance companies that accept applications both online and in person, but the information they ask for on your application will be similar in either case. 

A typical application is one or two pages, but you will need to provide: 

  • Basic information and contact information for your business
  • Your name and Social Security number
  • Tax ID number for your business
  • Several months of your credit card processing history and bank statements
  • Copy of the lease for where your business is located
  • Proof of citizenship
  • Blank check/checking account number and routing number 

Applying is quick; generally, you're approved in a matter of hours or days. Once you are approved, you will need to sign a contract agreeing to the advance amount, payback amount, holdback, repayment period and other terms. Once this agreement is signed, the advance is transferred to your bank account.

Alternatives to a merchant cash advance

If you need extra cash for your business but are wary of the disadvantages that come with a merchant cash advance, there are other financing solutions that provide working capital to small businesses. 

  1. Business line of credit: A line of credit (LOC) is similar to a credit card. You can apply for and be approved for a set amount, which you can borrow against for the term of the LOC. You can never owe more than the upper limit of your line of credit, but you can repay the amount you owe and borrow again as many times as you need. A business can open a line of credit for any amount, often ranging from $2,000 on up to $500,000. Funding is generally approved in less than a week, and repayment terms range from six to 12 months.

  2. Short-term loan: A short-term loan is an unsecured business loan that is offered by a private lender rather than a bank. These loans have lower interest rates and more transparency than a merchant cash advance, though lenders look at credit history when considering an application. Short-term loans generally offer up to $500,000 in one-time financing, are approved in less than a week and have repayment terms of three months to three years.

  3. Payment processor financing: If you use a credit card processing company like Square or PayPal, you may be immediately eligible for financing they offer. These loans, which are generally under $100,000, can be applied for through your online account. They usually come with a factor rate of 1.1% to 1.16%, which is lower than a merchant cash advance. 

A merchant cash advance is a quick financing option for businesses with an immediate need for funding. However, the repayment terms can often be expensive and cause additional cash flow problems. Before choosing an advance or any other form of business funding, understand the details of your contract and the long-term impact it can have on the financial well-being of your business.

Katharine Paljug
Katharine Paljug,
business.com Writer
Katharine Paljug is a freelance content creator and editor who writes for and about small businesses. In addition to Business News Daily, her articles can be found on Your Care Everywhere, She Knows, and YFS Magazine. Visit her website to access her free library of resources for small business owners.