Pros and Cons of Merchant Cash Advance Loans

What is a cash advance loan?

A cash advance allows you to borrow against your future income — the lender is “advancing” you the cash before you are paid. Technically, you are selling your future revenue in exchange for money today, so a cash advance is different from a typical loan. Cash advances are offered by a variety of lenders, including banks and credit unions, online lenders, and alternative lenders.

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

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The fees for these loans are often very high and can leave you saddled with significant debt. Cash advance loans are sometimes considered predatory. However, they can provide vital cash flow if you don’t own a credit card.

There is a specific type of cash advance available for businesses, which is called a “merchant cash advance (MCA) loan.”

What is an MCA?

MCA loans are a source of short-term funding if you cannot obtain financing from a bank or other source. These advances are borrowed against future credit card sales, and most are repaid — plus the associated fees — within 6 to 12 months.

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

How does an MCA work?

MCA companies will most likely work with your business if you rely primarily on debit and credit card sales, which includes retail, service shops and the restaurant industries. However, these are two structures that would allow your company to get an advance if you don’t have high debit or credit sales:

1. Traditional MCA: Your businesses would gain an upfront sum with a traditional MCA. To repay the loan, a set percentage of daily or weekly sales is debited back to the cash advance firm until the advance is repaid with interest. This is also known as a “holdback.” The higher your company’s sales are, the faster the advance is repaid. However, do not encourage your customers to pay in cash to avoid a percentage of their sales going to repayment, as this is a breach of contract and could result in litigation.
2. ACH MCA: With an ACH (Automated Clearing House) MCA, you would receive a sum upfront and then repay the advance through your company’s checking account. A fixed daily or weekly sum is transferred from your business checking account through an ACH withdrawal until the advance is repaid plus interest. Unlike a traditional MCA, the debited amount remains the same regardless of your company’s 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 pay in fees depends on how much risk the MCA firm is taking. Generally, the factor rate will be 1.1 to 1.5. The decimal indicates the repayment percentage on the loan; for example, a factor rate of 1.1 means you’ll repay the principal plus 10%.

So, if you take out a $40,000 advance with a 1.5 factor rate, your total repayment will be the principal plus 50% of the borrowed funds for a total $60,000 (your $40,000 advance with $20,000).

An MCA is considerably more costly than traditional financing. It can also create a debt cycle that would force you to take out a second advance to pay back the first — resulting in additional fees.

MCA rates and fees

MCAs tend to come with rates and fees that are substantially higher than traditional loans. Here’s an overview of what you can expect to pay:

• Factor rates: MCAs tend to come with a factor rate instead of a traditional interest rate. Factor rates can vary between 1.1 and 1.5, depending on your lender and your company’s credit profile.
• Holdback: When you qualify, you’ll agree to set aside a percentage of your credit card sales to repay the MCA. This is known as the holdback, and it usually ranges between 10% and 20% of your daily or weekly sales.
• Additional fees: MCAs may come with additional fees, like origination, administrative or prepayment penalties. Make sure to read your loan documents so you understand any additional fees you’ll have to pay.

MCA pros and cons

Taking out an MCA has many advantages and risks compared to other small business loans. According to Chad Cohen, VP of sales at Credibly, a business financing company, the ease of use and lack of documentation are two of the biggest benefits.

“Merchants of all financial profiles can qualify for an MCA, and the documentation requirements are much lower,” he explained. “The speed of the transaction is another benefit — you can apply and be funded within the next day, which is faster than any other lending product.”

Cohen warned that MCAs come with significant drawbacks to consider. “The cost is higher than most financial products and the terms are shorter, which leads to larger monthly payments,” he said.

The following chart provides an overview of the biggest MCA pros and cons:

Alternatives to an MCA

Cohen said that MCAs are best for businesses that can’t qualify for traditional financing, like a bank or SBA loan. “They do require established revenue, so startups aren’t the best fit for an MCA,” he added.

If you need extra cash but are wary of a merchant cash advance, consider other financing solutions that provide working capital for your small business. There are a variety of small business loan types to choose from. Lines of credit, term loans and payment processor financing are just some of the options.

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. You can open an LOC for your company for any amount, often ranging from $2,000 to $500,000. Funding is generally approved in less than a week, and repayment terms are 3 to 12 months.

Fundbox is one lender that provides business LOCs. Fundbox’s fast, transparent application, pricing and approval processes can offer up to $150,000 over 3 to 6 months. Fundbox is known for its direct communication regarding how much you’ll pay per week for its services, and it will automatically withdraw these fees from your bank account. Learn more in our review of Fundbox.

Short-term loan

A short-term loan is an unsecured business loan offered by a private lender rather than a bank. These loans have lower interest rates and more transparency than an MCA, though lenders will review your credit history. 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 3 months to 3 years.

Fora Financial is a top lender for short-term small business loans. With Fora, your repayment period will be at most 15 months, and you can obtain a loan of up to $500,000. You can set your payment schedule to fit whatever terms work for you, and you won’t have to put up any collateral. Plus, the approval process takes just 24 hours, with funding of the loan as quick as 72 hours. You can learn more in our review of Fora Financial.

Payment processor financing

If you use a credit card processing company like Square or PayPal, you may be eligible for the financing these companies offer. You can apply for the loans, which are generally under $100,000, through your online account. They usually come with a factor rate of 1.1% to 1.16%, which is lower than an MCA.