A merchant cash advance (MCA) provides businesses with quick access to capital, but it is not technically considered a loan. While MCAs share some similarities with loans, there are important differences that business owners should understand before getting one. This article will examine what an MCA is, how it works, the pros and cons, and whether it should be considered a loan.

What is a Merchant Cash Advance?

A merchant cash advance is a form of alternative business financing where a company provides a business with an upfront sum of cash in exchange for a percentage of future credit card sales. The key aspects of an MCA include:

• Upfront sum of cash – The MCA provider gives the business a lump sum of capital upfront. This amount can range from a few thousand dollars to over $200,000.
• Repaid from credit card sales – The business repays the MCA provider by allowing them to take a percentage of future credit card sales. This percentage is called the holdback rate and is usually between 10-20% .
• Short repayment term – MCAs typically have to be repaid quickly, often within 6-18 months. The repayment period depends on the volume of credit card sales.
• Expensive – MCAs are a very expensive form of financing, with equivalent APRs frequently over 100%. Fees are charged as a factor rate, usually 1.1-1.5 times the amount advanced.

How Does a Merchant Cash Advance Work?

The process of getting a merchant cash advance is relatively simple:

1. Apply – The business applies with an MCA provider, submitting information like monthly credit card sales.
2. Get approved – The MCA provider assesses eligibility based on credit card volume and approves a lump sum.
3. Receive funds – Once approved, the lump sum is deposited into the business’s bank account, minus any fees.
4. Make repayments – The MCA provider takes a fixed percentage of daily credit card sales from the business’s account until the advance is repaid.

Unlike a term loan, the repayment period of an MCA fluctuates based on the volume of credit card transactions. The higher the sales, the faster the advance is repaid. This structure makes MCA repayments more flexible and manageable for the business.

Is a Merchant Cash Advance a Loan?

While an MCA shares some similarities with a loan, it is not considered a loan under the law. Here are some key differences:

• Not debt – With a loan, the borrower takes on debt that must be repaid with interest. But with an MCA, the provider purchases a percentage of future sales.
• No interest – MCAs charge fees, not interest. So usury laws that cap interest rates do not apply to them.
• No credit reporting – MCA providers do not report payment history to credit bureaus, so MCAs do not help build business credit
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• Less regulation – MCAs are not subject to the same regulations as bank loans, such as disclosure requirements.
• No collateral – Loans often require collateral, but MCA providers secure repayments through credit card sales.

So while an MCA provides upfront capital like a loan, it is technically considered the purchase and sale of future receivables between a business and provider. The different legal structure allows MCA providers to operate outside many state lending laws.

Pros of Merchant Cash Advances

Despite their high costs, merchant cash advances do offer some benefits for small businesses:

• Quick funding – MCA providers can fund in as little as 24-48 hours, much faster than a bank loan.
• Easy to qualify – MCA qualification is based on credit card sales, so bad credit is not necessarily a dealbreaker.
• Flexible repayments – Repayments only come from credit card sales revenue, so they adjust with seasonal business fluctuations.
• No collateral required – MCA providers do not require any business assets or owner guarantees as security.
• Funds usable for any purpose – MCA money can be used for any business need, not a specified purpose like with some loans.

For businesses turned down by traditional lenders or needing fast working capital, an MCA can provide a much-needed infusion of funds. The flexible repayments help businesses manage cash flow crunches.

Cons of Merchant Cash Advances

However, merchant cash advances also come with some significant drawbacks:

• Very expensive – The equivalent APR is typically over 100% and can exceed 200%. Much pricier than conventional financing.
• Risk of debt cycle – If the MCA is not enough, taking a second advance can lead to an unaffordable debt cycle.
• Daily repayments – The daily payments make it hard to retain profits until repaid in full.
• Confusing contracts – MCA contracts do not disclose APRs, making it hard to compare costs vs other financing.
• No credit building – MCAs do not help improve business credit scores.
• Aggressive collections – Some MCA providers use aggressive collections tactics for late or missed payments.

While MCAs provide fast access to capital, the extremely high costs and potential debt cycle make them a very risky financing option. They should generally be considered a method of last resort for businesses unable to secure funding elsewhere.

Alternatives to Merchant Cash Advances

Before resorting to an MCA, businesses should explore some alternative funding options:

• Business term loans – Offer lump sums and predictable repayment schedules like MCAs but at much lower rates.
• Business lines of credit – Revolve as needed instead of a lump sum, more flexibility than an MCA.
• Invoice factoring – Sell unpaid invoices to a provider for immediate capital.
• Equipment financing – Funding to purchase equipment that serves as collateral.
• SBA loans – Government-backed loans with long terms and reasonable rates.
• Friends/family loans – Borrow from people you know who may offer reasonable terms.
• Business credit cards – Use cards with 0% intro APR offers and rewards programs.

While these options may take longer or have more requirements, they provide affordable financing that builds business credit. MCAs should not be the first choice for funding working capital or growth.

The Bottom Line

Merchant cash advances provide a useful source of capital for businesses that cannot secure funding elsewhere and need money quickly. However, the extremely high costs and risky debt cycles mean MCAs likely do more harm than good over the long term for most businesses. They also do nothing to help build business credit.Business owners should consider MCAs as an absolute last resort form of financing rather than a go-to option. Conventional loans, lines of credit, and other funding sources should be explored first. While MCAs have a place in providing emergency capital, their lack of regulation allows providers to take advantage of desperate businesses through confusing terms and exorbitant fees.

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