I had a new reader writing in with a question the other day and it put me in mind of this topic. She is a restaurant owner who took a merchant cash advance and has since seen her sales slow. She now discovered that the MCA company has been in contact with the company that processes her card payments. She is understandably concerned about why they’re talking and what it means. The answer to her questions depends on how she set up the MCA in the first place. It can feel intimidating, but the issue is usually the financing structure, not a conspiracy.
The Merchant Account Sits at the Center of a Traditional MCA
Back before fixed-payment business loans were around, the traditional merchant cash advance was the only option. That meant tying a business’s need for working capital to its merchant account. They did it through a split-funding process or by setting up a lockbox account. And the merchant account was the foundation of the MCA approval.
Your processor talks to the MCA company every day. And no, there’s nothing weird about that. Split-funding is the direct method. That means the merchant converts his merchant account to an ISO (independent sales organization, sometimes called a merchant service provider (MSP)) selected by the MCA company. Then the MCA company has a contract with the ISO. The ISO will process all daily credit card volume and will withhold a percentage and forward it to the buyer of the receivables (the MCA company). So the processor and the MCA company are always talking. It’s efficient, but it means a lot of back-channel communication that you can’t see from your dashboard.
A lockbox is a separate, FDIC-insured bank account that receives every credit card receipt. (It’s called the “indirect method.”) All your card receipts settle there first. From there, a percentage of your settlement is transferred to the MCA company and the remainder is swept into your normal operating account. The lockbox adds about one or two business days to the settlement for you and the buyer. For split funding deposits, funds arrive in your account as usual.
So whether direct or indirect, the merchant account sits at the center of a traditional MCA. If your processor hears from the MCA company, that is usually just the plumbing of your deal working. First job is to figure out which arrangement you signed up for. Did you switch processors when you got the advance (split-funding) or did a new side account appear (lockbox)?
You Pay Less When Sales Dip
A traditional MCA doesn’t have a fixed term or a fixed payment. The amount is more in a busy period, less when you’re slower. That’s why they take it through your card processor. A fixed-payment business loan isn’t the same. There’s no conversion of your merchant account, a percentage of the gross revenue is approved, the loan has fixed terms up to 36 months, payments are daily or weekly. The advantage is that you know in advance what the payment is and how frequently.
An MCA does give you more flexibility than a traditional fixed-payment loan because you pay less when sales dip. The trade-off is that, by tying it to your credit card processor, the MCA company gets a front-row seat to your daily card sales. It’s part of the deal, and it means they’ll know your numbers better than you want them to.
Card Processing
Let’s clear up a few things about card processing. First, Visa and MasterCard are card brands that manage member banks. Issuing banks are the banks that give cards and credit limits to the folks using them. On the other side of things, ISOs (also called MSPs) and their sponsor bank approve merchants for an account, authorize payments through a front-end network and settle them through a back-end network. That ISO is your processor. The issuing banks are paid through interchange, those wholesale prices for every card type. New interchange charts come out in April and October.
Here’s the thing nobody tells you: you’re not just a customer of a payment processor, you’re a borrower. The processor cares about the business, because your merchant account is really an unsecured line of credit from the ISO to the merchant. It may sound odd, but you can visualize it this way: if a customer charges a $500 purchase on their card, but the business owner doesn’t want to wait for the cardholder to pay off their card over the next few years, the processor will deposit the money within 48 hours.
If a customer disputes a $500 sale and the merchant loses that chargeback, the merchant not only refunds the $500, the merchant also pays a chargeback fee and a retrieval fee. And if the processor has to chase it and the merchant has closed up shop, suddenly the ISO that underwrote the account is the one on the hook. A processor that’s been watching a struggling merchant isn’t just worried about the customer dispute; it has its own cash in the game.
The processor is not your neutral friend in an MCA, either. They make money by marking up interchange, the wholesale fee paid to the card-issuing banks, and by charging things like annual fees and statement fees and batch fees. MCA brokers are incentivized to push you to the ISO their MCA firm split-funds with, so they collect long-term processing residuals plus commissions on future MCA renewals. That’s a business relationship between the MCA company and your processor.
If you’re under water, but the MCA company is calling your processor, here’s your first move: sit down with your MCA agreement and your processing statements. Check whether you’re on split-funding or a lockbox. Know that the percentage is taken off the top before you see a dime. Don’t renew just to breathe. Get help from a debt settlement firm before it’s too late. Get out in front of this.
