Merchant Cash Advance Reduced By $92,000 (Bizfi)[yoast-breadcrumb]
Merchant Cash Advances – A Viable Option for Small Businesses Seeking Fast Financing
Getting access to capital quickly is often a challenge for small businesses and startups. Unlike large, established companies, smaller firms usually don’t have deep cash reserves or easy access to traditional bank loans. This is where alternative financing options like merchant cash advances (MCAs) can provide a lifeline.In this article, we’ll take an in-depth look at merchant cash advances – how they work, costs and considerations, and whether they may be a good solution for your business’s short-term financing needs.
What is a Merchant Cash Advance?
A merchant cash advance provides an upfront lump sum of capital to a business in exchange for a percentage of its future credit card and debit card sales. It is not technically considered a loan, since the business is selling a portion of its future receivables rather than borrowing money.With an MCA, a financing company provides a business with a set amount of capital upfront – say $50,000. In exchange, the business agrees to pay back the advance through daily or weekly deductions from its credit/debit card sales over a period of months.The amount deducted is typically 10-20% of daily sales, until the full advance amount plus fees is repaid. There are no set repayment terms – the payback period depends on the business’s sales volumes. Higher sales volumes enable faster payback.
How Do Merchant Cash Advances Work?
There are two main ways MCA repayments are structured:
- Percentage of credit/debit card sales – This is the more common structure. A set percentage – usually 10-20% – of daily or weekly card sales is automatically deducted and paid to the MCA provider until the advance is fully repaid. Repayment periods typically range from 3-18 months depending on sales volumes.
- Fixed withdrawals from a business bank account – With this method, the MCA provider withdraws a fixed amount from the business’s bank account each day or week. The fixed amount is determined based on estimated monthly revenue. This structure allows exact repayment periods to be calculated.
Under both structures, the business repays the advance from its incoming cash flow. No fixed repayment terms or schedules exist.This flexibility can be beneficial for seasonal businesses or those with fluctuating revenues. Payments scale up and down with sales volumes. However, fluctuating payments can also make cash flow management challenging.
Costs and Fees of Merchant Cash Advances
Merchant cash advances do not have interest rates. Rather, the fee charged is represented as a “factor rate” – usually between 1.1 and 1.5.For example, if a business receives an advance of $50,000 with a factor rate of 1.4, the total repayment amount will be $70,000. The $20,000 difference represents the fee paid for the financing.To determine the true cost of an MCA, you should calculate the factor rate and fees into an Annual Percentage Rate (APR) for comparison purposes. APRs on merchant cash advances often fall between 60-300%.Here’s an example calculating APR on a $50,000 MCA with a 1.4 factor rate and 10% of monthly sales deductions:
- Advance amount: $50,000
- Factor rate: 1.4
- Total repayment: $70,000
- Monthly credit card sales: $100,000
- Monthly deduction percentage: 10% = $10,000
- Repayment period at this sales rate: ~7 months
$20,000 in fees / 7 months = ~$2457 in monthly interest$2457 monthly interest x 12 months = $29,484 annual interest$29,484 annual interest / $50,000 advance amount = 59% APRAs you can see, the equivalent APR is very high compared to other financing options. The APR varies depending on the payback period.
Pros of Merchant Cash Advances
Merchant cash advances offer some potential benefits for businesses who need quick financing and can’t qualify for traditional loans:
- Fast funding – MCAs can provide funding in as little as 24-48 hours. The application process is simple and funding decisions are quick.
- Flexible qualifications – MCA providers generally have less stringent approval requirements compared to banks. Startups and smaller businesses are often eligible.
- Payments scale with sales – Repayments fluctuate based on your sales volumes, helping match cash outflows to inflows.
- No collateral required – MCAs do not require any business assets or owner guarantees as security.
Cons and Risks of Merchant Cash Advances
While MCAs offer quick and accessible financing, there are some significant downsides to consider:
- Very high cost – The equivalent APRs are typically double or triple that of other financing options.
- Frequent payments – Daily or weekly payments directly from sales can seriously impact cash flow.
- Risk of debt cycle – The high cost and frequent payments make it easy to get trapped in a cycle of debt.
- Confusing contracts – MCA contracts do not provide APRs or total repayment costs, making comparisons difficult.
- Aggressive collections – Some MCA providers use aggressive tactics like filing confessions of judgement if repayments are missed.
- Difficult early payoff – Paying MCAs off early often involves extra fees and penalties.
For businesses already struggling with cash flow, merchant cash advances can exacerbate problems rather than solve them. The risk of entering a debt cycle is high.
Alternatives to Merchant Cash Advances
Due to the high costs and risks, most businesses should consider MCAs as an absolute last resort for financing. Some alternatives to consider first include:
- Business credit cards – Cards like Chase Ink or Amex Blue Business Plus offer 0% intro APR periods for purchases.
- Business lines of credit – Lines of credit provide revolving access to capital with interest charged only on amounts used.
- Invoice factoring – Selling unpaid invoices to a factoring company can provide immediate working capital.
- Short-term business loans – Online lenders like Kabbage offer installment loans with set repayment periods.
- SBA loans – Government small business loans offer long terms and reasonable interest rates.
- Crowdfunding – Raising capital from customers or supporters can provide startup funding.
- Angel investors – Wealthy individuals sometimes provide capital to startups in exchange for equity.
While these options may take longer or have more requirements than MCAs, they provide affordable long-term financing without the predatory risks.
Is a Merchant Cash Advance Right for Your Business?
In limited circumstances, a merchant cash advance may make sense for a business. Situations where an MCA could be appropriate include:
- You need a very small amount of capital for a short period.
- You have a clear, near-term plan to increase sales and cash flow.
- You have an urgent, unexpected expense and no other options.
- You can qualify for an MCA with a competitive factor rate.
However, it’s essential to read the fine print carefully, consult professionals, and have a solid repayment plan before obtaining a merchant cash advance.The bottom line is MCAs are very high-risk financing and should only be used as an absolute last resort. Weigh all alternatives first, and have a plan to pay off the advance quickly. With the right approach, MCAs can serve as a temporary bridge to get past an unexpected cash crunch.At Delancey Street, our goal is to help businesses find the most affordable financing options for their situation. Our team is always available to provide free consultations and advice. If an MCA seems like your only option, please contact us first so we can explore alternatives. With the right guidance, your business can establish a healthy financial foundation for long-term growth and success.