The Pros and Cons of Merchant Cash Advances: How They Work and Who Can Benefit

As a small business owner, finding the right funding option to keep your business afloat or to expand can be a daunting task. Whether you’re trying to cover unexpected expenses, invest in new equipment, or take advantage of growth opportunities, access to fast capital is crucial. One option that many small business owners turn to is a Merchant Cash Advance (MCA). But is it the right choice for you? In this blog post, we will walk you through everything you need to know about Merchant Cash Advances, including their pros and cons, who can benefit from them, and the process of obtaining funds quickly.

What Is a Merchant Cash Advance?

A Merchant Cash Advance (MCA) is a type of alternative financing where a lender provides a lump sum of money to a business in exchange for a percentage of the business’s future daily credit card sales or revenue. Unlike traditional business loans, MCAs are not repaid through fixed monthly payments. Instead, repayments are made daily or weekly as a percentage of your daily credit card sales, making it more flexible for businesses with fluctuating income.

How Does a Merchant Cash Advance Work?

Here’s how the process generally works:

1. Application: The business owner applies for an MCA with a lender, typically providing details about the business, including monthly revenue, the industry, and how long the business has been operating.
2. Approval: The lender reviews the application and the business’s cash flow, often considering the business’s credit card sales as the key factor. This means that businesses that process credit card payments regularly may have a better chance of being approved.
3. Funding: If approved, the lender provides a lump sum, which can range anywhere from $5,000 to $500,000, depending on the business’s needs and revenue.
4. Repayment: The lender collects a percentage of the business’s daily credit card sales until the loan is repaid. Typically, the repayment amount is between 5% to 20% of the daily credit card sales.

Example: Let’s say you own a coffee shop, and you receive an MCA of $50,000. You would then repay the lender by giving them a percentage of your daily credit card sales. If your daily sales are $1,000 and the agreed percentage is 10%, you would pay the lender $100 per day until the full amount is repaid.

Who Can Benefit From a Merchant Cash Advance?

While MCAs can be beneficial, they aren’t for everyone. Here’s a breakdown of businesses that are more likely to benefit from this financing option:

1. Businesses with High Daily Sales

Businesses that process daily credit card transactions, such as retail shops, restaurants, and service providers, are more likely to qualify for an MCA. These businesses have consistent sales patterns that lenders can use to determine the repayment schedule.

Example: A clothing store that processes hundreds of credit card transactions daily can secure an MCA quickly. The daily repayments will be based on their daily sales, making the repayment process flexible.

2. Small Businesses with Bad Credit

Traditional loans often require good credit scores, and many small businesses may not qualify due to poor credit. MCAs are less concerned with your credit score and more focused on your business’s daily credit card sales. This makes them an attractive option for businesses that may have been turned down by traditional lenders.

Example: A small bakery with a history of inconsistent credit scores but a steady flow of daily sales may find it easier to secure an MCA than a traditional loan from a bank.

3. Businesses in Need of Quick Access to Funds

Merchant Cash Advances are known for their fast approval and funding times. While traditional loans might take weeks to process, MCAs can be approved and funded in as little as 1 to 3 business days. This can be ideal for business owners who need funds quickly to address urgent expenses.

Example: Suppose you’re a salon owner and your equipment breaks down unexpectedly, and you need immediate funds to replace it. An MCA could provide the cash you need within days, while a bank loan might take much longer.

4. Businesses with Fluctuating Cash Flow

If your business experiences seasonal sales or irregular cash flow, an MCA can help manage periods of low income because repayments are tied to your sales. During slow periods, you will pay less, and during peak periods, you will pay more.

Example: A landscaping business might experience a surge in sales during the spring and summer months but see a drop-off during the winter. With an MCA, repayments adjust based on the business’s revenue, making it easier to manage expenses during the off-season.

The Pros of Merchant Cash Advances

1. Quick Access to Funds

The most significant advantage of an MCA is the speed of funding. If you need money urgently, you can receive funds in a matter of days. Traditional bank loans or lines of credit can take weeks or even months, which isn’t always practical for time-sensitive situations.

2. No Collateral Required

Unlike traditional loans, which may require assets like property or inventory to secure the loan, an MCA does not require collateral. This makes it a low-risk option for businesses that don’t have valuable assets to pledge.

3. Flexible Repayments

Since MCA repayments are based on a percentage of daily credit card sales, the amount you pay fluctuates according to your business’s income. During slower periods, repayments will be lower, which can help reduce the financial strain on the business.

4. Easier Approval Process

Unlike traditional loans, which often require a solid credit score, MCAs focus on your business’s cash flow and sales. This makes it an attractive option for businesses with poor or no credit history.

5. No Restrictions on Usage

The money you receive from an MCA is typically not restricted. You can use the funds for any purpose, such as covering operational costs, hiring additional staff, investing in marketing, or purchasing equipment.

Example: A restaurant could use the MCA funds to upgrade its kitchen equipment or invest in a marketing campaign to attract more customers.

The Cons of Merchant Cash Advances

While there are significant benefits to an MCA, there are also some drawbacks that you should consider before moving forward.

1. High Cost of Borrowing

The most notable disadvantage of an MCA is the high cost. Due to the flexibility and quick access to funds, the interest rates can be significantly higher than traditional loans. The total cost of borrowing can sometimes exceed 30% or more, depending on the terms.

Example: If you borrow $50,000 with an MCA and repay it over a year, the total repayment amount could end up being much higher than the initial loan, due to the high fees and daily repayment structure.

2. Daily Repayments Can Be Straining

Although the daily repayments are flexible, they can still be burdensome for some businesses. If you have a slow sales day, you still have to make the agreed-upon repayment, which could create cash flow challenges.

3. Not Suitable for Long-Term Funding

MCAs are designed for short-term financing needs. If you need long-term capital for expansion, it’s not the right option, as the repayments are structured based on daily sales, which can lead to higher overall costs.

4. Potential for Debt Cycle

Since MCA repayments are tied to sales, there is a risk of getting caught in a cycle of borrowing if the repayments are too high. This is especially true if your business is not able to generate enough sales to meet the daily payments, leading to further borrowing and increased debt.

5. Lack of Regulation

The MCA industry is less regulated than traditional banking, which can lead to less transparency in terms and higher fees. Some MCA providers might charge hidden fees or engage in predatory lending practices, so it’s essential to work with reputable lenders.

The Process of Obtaining a Merchant Cash Advance

If you decide that an MCA is the right choice for your business, here’s a step-by-step breakdown of how to apply:

1. Research Lenders: Look for reputable MCA providers. Some well-known ones include OnDeck, Credibly, and BlueVine. Read customer reviews and ensure the lender is transparent about their fees and terms.
2. Submit an Application: Fill out the application form, providing information about your business, monthly revenue, and credit card sales history. Most lenders require that your business has been in operation for at least 6 months and processes a minimum amount in credit card sales.
3. Review Terms: Once the lender evaluates your application, they will present you with an offer. Review the terms carefully, including the factor rate (the cost of borrowing), the percentage of daily sales, and any additional fees.
4. Sign Agreement and Receive Funds: After agreeing to the terms, you’ll sign a contract, and the funds will be deposited into your account, often within a few days.
5. Repayment: The lender will begin withdrawing payments based on your daily credit card sales. If you experience fluctuations in sales, your repayments will adjust accordingly.

Conclusion: Is a Merchant Cash Advance Right for Your Business?

A Merchant Cash Advance offers fast access to capital, especially for businesses that experience fluctuating sales or have trouble qualifying for traditional loans. While they come with high costs and daily repayments, they can be a lifeline for businesses that need immediate funds for growth or urgent expenses.

However, it’s crucial to carefully weigh the pros and cons and understand the full cost of borrowing before committing. If you’re considering an MCA, make sure to choose a reputable lender and ensure that the repayment terms are manageable for your business. If your business can handle the daily repayments and you need funds quickly,

an MCA might be a suitable option.

For more information on business funding options, be sure to check out other financing solutions like business lines of credit, SBA loans, or invoice factoring. Always compare your options to find the best fit for your business’s needs.