What is a Merchant Cash Advance?
A merchant cash advance is not a loan. Let’s start there. A merchant cash advance occurs when a merchant (a business) agrees to sell a portion of their future credit card sales in exchange for a certain amount of immediate capital from a funder. When a small business applies for an MCA, if the terms are agreeable, the advance can be (and usually is) deposited into their account pretty quickly.
How does a Merchant Cash Advance Work?
When a merchant applies for a cash advance from a prospective funder they are offering an agreed-upon percentage of their daily credit card sales (a holdback) in exchange for a lump sum from a provider. The provider will continue collecting a holdback until the lump sum is paid back in full. In addition to a holdback, the merchant also agrees to pay a percentage of the lump sum to the funder.
So, for example, if a business receives $100,000 in funding, and they agree to pay 20% repayment of the entire sum, that means they will pay back $120,000. This is different than a holdback percentage which as mentioned earlier, is the portion of credit card sales that will be collected daily until the entire lump sum is paid back. So, if the agreed-upon holdback percentage is 10%, the funder will hold 10% of the merchant’s credit card sales daily until the $120,000 is paid back. So, if a merchant’s daily sales are at about $10,000 and their holdback percentage is 10% and the original lump sum given was $100,000 that means the funder will hold back about 1,000 each day, and the business will be able to pay back the $120,000 in 120 days.
What are the advantages of a Merchant Cash Advance?
Since a Merchant Cash Advance is not a loan, it doesn’t have to abide by all the rules of a traditional business loan, and it is a bit riskier than a traditional loan for all parties involved. MCA’s also provides a larger reward for all parties involved. For the merchant, these types of advances give the merchant access to cash fast, much faster than loan processing, and providers aren’t subject to usury laws, so they can collect higher interest rates than banks can.
MCA is a great option for businesses with bad to no credit. Providers of MCAs give more weight to underlying performance rather than personal credit scores which gives businesses who may not qualify for a business loan access to cash that would not otherwise be offered to them by banks. These are often new businesses and startups, or businesses that process a lot of credit card transactions each day but have less than perfect credit.
Another advantage of an MCA is that they present a solution for businesses experiencing a slow season or an unexpected downturn. Payments to the merchant cash advance company fluctuate directly with the merchant's credit card transactions, which provides flexibility to the merchant in managing their working capital during sudden fluctuations, such as a slow season.