Introduction
If you are a small business looking for fast and flexible funding, a merchant cash advance (MCA) may be right for you. However, it’s important to understand how they work before making a decision for your business.
Read on for a borrower’s guide to merchant funding. This article outlines how MCAs work, their many uses and benefits for business owners, things to consider before applying for one, and their eligibility requirements.
Terms You Should Know
Here’s a quick look at some financial terms you will come across while reading, and their definitions.
Accounts receivable
Funds owed to a business by customers in return for products or services that have been invoiced.
Confession of Judgment (COJ)
A written agreement, signed by the borrower, that states that they accept full liability for the loan. Once signed, a COJ waives the borrower’s right to a legal defense if they default on repayment.
Credit history
A record of how a person or business has managed their credit in the past. Credit history takes into account debt, timeliness of payments and number of credit lines, and can be used to determine the terms of a loan.
Defaulting
Failing to repay a loan or advance.
Factor rate
A tool used to determine the additional amount owed to a lender upon repayment of a loan. Unlike interest rates, factor rates are expressed as a decimal between 1.1 and 1.5.
What Is A Merchant Cash Advance?
An MCA is a type of business funding that allows businesses to get the cash they need with flexible methods.
In the case of MCAs, the lender gives the company an advance which it repays through a card terminal using a percentage of its customer’s credit card payments. While it’s fast and flexible, it is important to understand how an MCA works and whether it is the right choice for your business. Other types of cash advances are credit card cash advances and payday loans.
Unlike traditional loans from banks and credit unions, MCAs are well suited to small businesses that require funding quickly, but have less-than-perfect credit scores and few assets to pledge as physical collateral. With MCAs, businesses receive a lump sum upfront in exchange for a percentage of its daily credit card sales until the advance has been repaid in full.
Here is what you need to know about how MCAs work.
How Does A Merchant Cash Advance Work?
MCAs aren’t loans. This means you do not need to worry about being charged interest. Repayment is calculated using a factor rate based on the financial state your business is in. The factor rate represents the additional percentage of the loan owed to the lender, and generally falls between 1.1 and 1.5.
The following formula can help you determine the total repayment owed with MCAs:
Advance Amount X Factor Rate = Total Repayment Owed
When determining factor rates, lenders take several factors into consideration:
Industry
Some industries are cyclical with sales being dependent on season or demand. These types of industries tend to carry more risk.
Length of time in business
For example, Business Capital Providers require applicants to have been in business for at least 6 months in order to qualify for an MCA. Other online lenders often have more strict requirements.
Growth
Months of bank statements are often needed for lenders to gauge a business’s ability to pay back the advance.
Monthly credit card sales
Proof of consistently well-performing sales can indicate a business’s ability to repay the advance through a percentage of daily sales.
Credit history
Lenders use your business’s credit score to assess its creditworthiness. They may also consider your personal creditworthiness as an indicator of your ability to pay back the advance.
In short, factor rates determine the total cost of receiving funding. Since MCAs are often granted without need for collateral or a personal guarantee, it is at significant risk to the lender. As a result, they typically cost more than other types of funding. It is important to speak with a business advisor before deciding to apply for an MCA, to make sure that it is feasible for your business.
How Can Your Business Use A Merchant Cash Advance?
MCAs are useful for small businesses across different industries. Capital is flexible and not restricted to a particular purpose, this helps to create opportunities for growth and expansion by supporting the following activities:
01. Consistent Cash Flow
Economic instability brought on by the pandemic, for example, can tighten cash flow and disrupt operations. This can cause delays in accounts receivable, fluctuations in sales and revenue, and employee turnover. An MCA can help to fill the gaps in cash flow by providing the working capital needed to keep your business running smoothly during difficult times.
02. Team Expansion
According to the Small Business Administration (SBA), there are 30.2 million small businesses in the United States, and this accounts for 99.9% of all U.S. businesses. Small businesses of less than 100 employees hire the biggest share of American workers. MCAs are useful for businesses looking to grow their teams, and are especially useful in cyclical industries, like hospitality and retail, where businesses might need to hire more staff to meet a seasonal demand.
03. Inventory Purchasing
MCAs enable businesses to buy inventory in bulk and reduce cost through efficient and cost-advantageous purchases. This is especially useful when preparing for a seasonal demand or promotional period. Some lenders provide dedicated financing options for inventory purchasing, where the advance would be specific to the type of inventory needed.
04. Marketing & Promotions
MCAs can also be used to grow your business through marketing and advertising efforts. Typically, new businesses lack the capital required to invest in these areas, so an MCA can help to fill this gap.
05. Equipment Funding
An MCA can fund the replacement or reparation of old or faulty equipment that is essential to business operations. This is useful for construction and manufacturing businesses that rely heavily on machinery. Equipment funding also extends to digital growth, such as the implementation of new softwares, website development and transaction technologies.
Is A Merchant Cash Advance Right For Your Business?
Every type of funding comes with its own list of pros and cons and it’s important to consider all factors before committing to a funding program.
Advantages |
Disadvantages |
|---|---|
Fast FundingIf eligible, your business can receive approval for an MCA in 2-4 hours and gain access to working capital in as little as 24 hours. |
Confusing ContractsFirst-time borrowers may find it difficult to understand the terms of the advance, so it’s necessary to consult with an advisor before committing or signing any legal documents, such as a confession of judgment, for example. |
Funding EligibilityApproval for an MCA is less reliant on credit scores and more so on business sales and revenue. |
High Risk For LendersThe cost of acquiring funding through an MCA is typically higher, as lenders assume more risk by tying repayment to the business’s sales. |
No Collateral NeededAs an MCA is a type of unsecured funding, borrowers need not offer assets as collateral and risk losing them in case the business defaults on the advance. Instead, they sign a personal guarantee that they will repay the advance in place of their business. |
Unregulated FundingMCAs are not federally regulated. Instead, they are regulated by each state’s Uniform Commercial Code and don’t adhere to national banking laws. |
Flexible & Easy RepaymentSince repayments are agreed as a percentage of sales volume, repayments can fluctuate over the agreed period. As such, borrowers can make up repayments at a later time if their business is experiencing poor sales. Since MCAs are repaid automatically through a credit card portal, the borrower need not worry about missing payments. |
High Factor RatesFactor rates are determined by sales performance. Therefore, low sales turnover can increase the cost of repayment which can eat into profits. |
If you have decided that an MCA is what your business needs, it is important to be aware of the eligibility requirements expected by lenders to know which funding your business qualifies for.
How To Qualify For A Merchant Cash Advance?
Eligibility requirements may differ across lenders, but most lenders of MCAs will require the following information.
Time spent in business (usually at least 6-12 months)
Average of $2,500-$5,000 in monthly credit card sales
No open bankruptcies
A personal credit score of at least 500
At least $50,000 in annual revenue
Form of identification
Voided business check
Business bank statements of the last 3-6 months
Good credit score
Business tax returns
Credit card processing statements
Business bank account number and routing number for deposit
Last three credit card processing statements
Some lenders may ask for all of the above documents, while others may ask for only a few.
How Can Business Capital Providers Help You Get Funded?
The process of receiving your funds is straightforward and simple. Our process works in three steps:
Understanding your business needs
No two businesses are the same. Consult with a dedicated account manager who will provide you with a tailored financial plan and find the right funding option for your business.
Apply and get approval in less than 4 hours
Our process is streamlined and convenient, allowing you to focus on running your business while we take care of the rest.
Get funded in as little as 24 hours
Our pre-application step simplifies the process, so you can receive funding in under 48 hours.
Now that you understand what an MCA is and how it works, it’s time to decide what your business needs funding for and how best to utilize those funds. Business Capital Providers can help you gain access to fast and flexible funding in a safe and secure manner.
Speak with one of our advisors to create a personalized funding plan for your business!
