If you own a small business and you need financial support, a merchant cash advance (MCA) may look like a viable option. But keep in mind that this may not be an ideal choice for you in the longterm.
This type of funding can give you a much-needed quick financial fix, but in exchange, you can fall into a debt cycle, have your annual percentage rate tripled, and face other financial issues.
For these reasons, a lot of experts believe that an MCA should be the last funding option. In this article, we will list the pros and cons of a cash advance so that you can decide if this is the right option for you.
What Is a Merchant Cash Advance?
An MCA is a funding option typically used by small businesses that generate revenues from credit and debit card sales and cash transactions., such as restaurants, online shops, retail shops, etc.
An MCA is a specific type of funding in which you don’t borrow money, but instead, you receive a fixed sum upfront for the sale of a percentage of your future receivables. As opposed to paying a fixed amount on a monthly basis, with an MCA, you pay every day until the purchased receivables arepaid to the funder.
The funding provider fixes a factor rate which ranges from 1.1 to 1.5, depending on the provider’s assessment of the risks of your business. Then, you multiply the factor rate by the amount of the cash advance and you get the total amount of the receivables you have sold. For example, if you take a cash advance of $100,000 with a factor rate of 1.2, you’ll need to transferto the funder $120,000 of collections from your future receivables.
There are two ways that you can structure an MCA:
1. Part of Your Credit Card Sales
In this structure, the funder will receive a percentage of your credit card collections until you repay the total amount. Let’s say you need $60,000 to renovate your restaurant. If you make a deal with your MCA provider for this amount, and it assigns a 1.3 factor rate, the funder will receive a total of $78,000 form your credit card collections.
The repayment period spans from 3 months to a year, depending on your credit card collections. If you have high sales, you should be able to repay the advance more quickly and more easily.
So, if your provider takes up 10% of the credit card collections every month, and you have around $70,000 of monthlycollections, you will repay $7,000 monthly. In a 30-day month, this means around $234 daily. But it all depends on your daily collections. Sometimes it may be $350, sometimes $150 per day.
This means that you can repay the full advance in a little more than 11 months. But, if your collectionsincrease, it will take less time because the same percentage of credit card receivables–in this case 10%-is paid to the funder each day.
2. Fixed Daily Withdrawals
With a fixed withdrawal, you will always need to have a predetermined sum available in a designated bank account from which the funder may withdraw a specified amount every business day. The provider determines this fixed amount based on your history of monthly cash collections.
Similar to the previous example, if your business records an average of $70,000 of daily cash collections in the previous three or six months, the MCA provider will fix a daily cash withdrawal of $234.
Unlike the previous option, regardless of your daily cash collections, you will need to pay the fixed sum. This may cause trouble onthe days when your cash collections are significantly less than $70,000.
The daily withdrawals are typically effected by an Automated Clearing House (ACH) debit to your bank account. This structure is generally more popular among businesses that don’t focus solely on credit and debit card sales
The Pros of Merchant Cash Advance
This financing option has a few important upsides. They include:
- Flexible payments:If you can obtaina flexible payment structure, you won’t have to worry about your daily cashcollections. Because the funder always deducts the agreed-upon percentage of credit card payments, when they are down, the provider will deduct a lesser sum, and vice-versa. This is particularly important for seasonal businesses when credit card paymentsskyrocket during certain months and then get significantly lower during others.
- They are much quicker: Unlike some other funding options, you can get an MCA in less than a week. It won’t require too much paperwork eithersince the most important underwriting criteria is your daily credit card or cash collections.
- No collateral: This type of financing is unsecured. This means that you don’t have to put up any collateral such as personal property, business inventory, or other belongings. For example, in the case of repayment failure, the provider won’t be able to seize your home. However, you should keep in mind that some MCA providers will require you to sign an agreement that you will repay the total advance if your company fails to comply with its representations and agreements in the MCA Agreement.
The Cons of Merchant Cash Advance
- Your credit score may be pulled anyway: Even if mostbusinesses with poor credit opt for an MCA, there is a significant chance that the provider will checkyour credit score.
- High annual percentage rate (APR): The total yearly funding cost with all the fees can be at least40%, and could be much higher. Of course, this depends on the provider, credit card and cash collections, repayment period, etc.
- More revenue willspike the APR: If your credit card or cash collections are large and your payments arespread out over a relatively short period oftime period, your APR will be significantly higher than if your payments are made over a longer period of time.Your APR for payments over three months could be more than four times the APR if your payments are made over a year.
- No early-repayment benefits: Unlike some other funding options, you won’t reduce your total costs if you pay off your MCA earlier.
- You can end up in an endless loop of debt: If you aren’t careful, you may end up needing to fund the repayment of an MCA with another financing option.
When Should YouOpt for an MCA?
Overall, opting for an MCA could be the best short-term financing solution. You get the funds quickly and you don’t need to have a good credit score. If you have an online business which generates revenue mostly via credit or debit cards, this might be a better option because flexible payments will be helpful, especially if you have a seasonal business and revenues fluctuate depending on the time of year.
Of course, you should be wary of an extremely high APR and much bigger costs of an MCA funding. As such, you should always consider if your revenue is risk-free and if yourbusiness will be able to sustain the predetermined deductions. If your revenues are insecure or fluctuate widely, you may end in an endless cycle of debt.