August 27, 2024

What is a Merchant Cash Advance & Is it right for you?

01 - Will a Merchant Cash Advance Help or Hurt Your Business@1.5x
Starting and sustaining a small business is costly. Many don’t even turn a profit until they’ve been up and running for years.
If your company’s struggling to stay afloat or needs a quick cash infusion to get off the ground, a merchant cash advance (MCA) is one option — especially if you don’t yet have enough assets to secure a traditional business loan.
But what is a merchant cash advance? And more importantly, will getting one help or hurt your business in the long run?

What is a merchant cash advance (MCA)?

An MCA lets you borrow against your company’s future credit and debit card sales. You inquire with an MCA lender, get a lump sum of cash upfront, and repay it with a percentage of your daily (or weekly) sales.

How do merchant cash advances work?

An MCA isn’t technically a loan, which means the total repayment cost and timeline are hard to predict. Instead of borrowing money and paying it back with interest over a set period, you essentially sell a chunk of your future income in exchange for immediate cash. How long your repayment period lasts depends entirely on your card sales.
Here’s the basic process for getting an MCA:
1. Apply. Put in an application with an MCA lender like Fora Financial or Libertas. The requirements are usually less strict than a traditional loan. You have to submit credit card statements, invoices, or other proof of income.
2. Receive funds. Once approved, the funds should hit your business account pretty quickly — often within a day or two.
3. Repay. Instead of making payments to the lender, they automatically take a portion of your card sales until you’ve repaid the advance, plus fees.
Not every business sees a lot of credit and debit card sales. If that’s true for your company, an MCA could still be an option. You’d estimate your monthly revenue and set up fixed repayments, which the MCA lender withdraws from your business bank account daily or weekly, even if your estimated revenue doesn’t wind up being accurate. For example, if you estimate that you’ll be able to pay back $1,000 per week but don’t make enough, you still have to pay $1,000 per month.
This process sounds pretty straightforward so far. But things get a little more complicated when you try to figure out exactly how much an MCA will cost your business.

Understanding merchant cash advance rates and fees

Unlike the interest rates of traditional loans, MCAs use factor rates. A factor rate is a multiplier (like 1.2 or 1.4) applied to the amount you borrow. The higher the factor rate, the more expensive the MCA. For example, you’d repay $14,000 for a $10,000 advance with a 1.4 factor rate. That same advance would cost $2,000 less if your factor rate were 1.2 ($10,000 x 1.2 = $12,000).
The factor rate isn’t usually the only cost associated with an MCA, though. Other fees might include:
It’s important to note that MCAs often lack traditional business loans’ strong regulations. This means you have less protection as a borrower, so do your homework to find a reputable MCA lender and protect yourself from unfair practices.
Unfortunately, the lack of regulation means doing your homework is much easier said than done. MCA providers have the flexibility to set high factor rates and layer on fees, which makes it difficult to compare true costs across lenders. And if your business winds up going deeper underwater than you were before taking out the advance, you may have fewer legal options available than you would with a conventional loan. While MCAs are helpful, they’re a slippery slope.

The pros and cons of merchant cash advances

MCAs are generally riskier than traditional business loans. But that’s not to say they don’t have any benefits. Here’s a list of pros and cons to help you decide if an MCA is right for you:

Pros

Cons

5 merchant cash advance alternatives to consider

Before pulling the trigger on an MCA, explore other financing options. You’re always better off going for a traditional business loan before opting for high-cost alternatives like MCAs.
If a traditional loan isn’t an option for your business, here are a few other paths to explore:

1. Business term loan

With this loan type, your business borrows a fixed amount and repays it over a set period with regular monthly payments. Interest rates are typically lower than MCAs, but you need to have good credit.

2. Business credit card

If you need money for small and mid-sized purchases, get a business credit card. You can spend what you need up to the limit, then pay the provider back with interest. Just watch out for potentially high interest rates if you’ll be carrying a balance from month to month.

3. Business line of credit

A business line of credit provides access to a pool of funds you can draw upon as needed, and you only pay interest on the borrowed amount. Think of it like a credit card. You can use it for short-term cash flow needs or fluctuating expenses.

4. Equipment financing

If you’re purchasing business equipment, you may be able to finance it directly with the vendor. The equipment usually serves as collateral to secure the financing, so if you can’t pay the installments, the vendor takes the equipment back. This is a good option if you need essential equipment but can’t pay the full amount upfront.

5. Small Business Association loan

The Small Business Association (SBA) provides government-backed loans, often through partner banks, with favorable terms and lower interest rates. The application process is longer, but small business loans from the SBA are usually the most affordable financing option for businesses that qualify.

Build better credit with EarnIn Credit Monitoring

Regularly checking your business credit score is key to staying on top of your company’s financial standing and spotting red flags before they turn into major problems.
EarnIn’s Credit Monitoring tool lets you keep a close eye on your personal credit score at any time, for free. You’ll see a clear view of the main factors impacting your score and get Credit Monitoring alerts so you can act fast if anything suspicious pops up.
Download EarnIn today to see where your credit stands — and gain confidence in where you and your business are headed.
Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.

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