What Is a Merchant Cash Advance (MCA)?
⏰ Estimated read time: 9 minutes
Key takeaways
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Merchant cash advances are one of the most expensive types of business financing.
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MCAs are not federally regulated, which can result in misleading marketing and confusing contracts, and lead borrowers to predatory lenders.
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MCAs typically fund faster and more easily, with less qualification requirements, than other types of financing.
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What is a merchant cash advance?
How does a merchant cash advance work?
Merchant cash advance repayments can be structured in two ways:
Percentage of debit/credit card sales
This is the traditional way an MCA is structured, in which a merchant cash advance provider automatically deducts a daily (or weekly) percentage of your debit and credit card sales until the advance is repaid in full.
Fixed withdrawals from a bank account
This type of MCA repayment structure allows you to calculate exactly how long it will take to pay the advance back based on the amount borrowed and can be better suited for businesses that don’t rely heavily on debit and credit cards sales.
Did you know…
Merchant cash advance rates and fees
Your industry, years in operation, business financials, debit and credit card transactions and personal credit score may all play a role in determining the factor rate you receive. Businesses whose ability to repay looks riskier will likely receive higher factor rates — and pay higher fees as a result.
The factor rate also does not include any additional fees the merchant cash advance company may charge you, such as administrative fees or underwriting fees, which will increase the total cost of your financing.
Calculate the cost of a merchant cash advance
To calculate the cost of a merchant cash advance, multiply the amount received by the factor rate. For example, if you are approved for an advance of $50,000 at a factor rate of 1.4, your total repayment amount will be $70,000, which means you’ll be paying $20,000 in fees.
But to understand the total borrowing cost of a merchant cash advance, you should always calculate the factor rate and additional fees into an APR. This will also help you determine how long it will take to repay the advance in full.
Let’s break down what this MCA looks like if the provider deducted 10% of your monthly credit card sales until you repaid the full $70,000 based on different revenue amounts:
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MCA details |
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If your monthly credit card sales are $100,000 |
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If your monthly credit card sales are $70,000 |
In this example, paying off the debt faster actually leads to a higher APR. If your sales are lower, your APR decreases — but it takes longer to pay off the debt. In either instance, you’ll still pay the same in fees. However, the different APRs show how expensive a merchant cash advance can be regardless of the terms.
Pros and cons of merchant cash advances
Pros
✅ Repayment based on your sales. Unlike other types of business financing, your repayment schedule is based on a fixed percentage of your sales, so payments adjust based on how well your business is performing.
Cons
❌ Frequent repayment and debt cycle danger. Merchant cash advances are repaid daily (sometimes weekly) and payments are deducted directly from your incoming sales, which can seriously impact your cash flow. The high cost, coupled with frequent repayments, can easily trap you in a cycle of debt that’s hard to break, especially if one advance is not enough and you can’t qualify for other types of financing.
❌ No benefit to repaying early. Since you have to repay a fixed amount of fees no matter what, you can’t save on interest by repaying early, unlike traditional amortizing loans.
❌ Confusing contracts. Merchant cash advance contracts can be confusing, especially considering the nature of factor rates and repayment schedules that are based on percentages of your daily sales. MCA providers also don’t typically provide APRs in their agreements, which makes it difficult to compare these products with other types of financing. Although some states have moved to force transparency among MCA companies in recent years, providers have historically been criticized for agreements that are unclear and hard to understand.
❌ No federal regulation. Unlike traditional loans, merchant cash advances, which are structured as commercial transactions, are not subject to federal regulation. Instead, MCAs are regulated by the Uniform Commercial Code in each state. This limited regulation has often led businesses to fall victim to predatory companies that use misleading marketing and sales tactics, offering instant approvals and funding.
What happens if you default on a merchant cash advance?
If you are in danger of defaulting on an MCA, you may be able to restructure your agreement with the company or put payments on temporary hold if you reach out to your MCA company directly. Another option is to try refinancing your MCA with a traditional loan. This will also likely save your business money in the long run.
Alternatives to merchant cash advances
Before turning to a merchant cash advance, you should seek out alternative financing options.
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Traditional loans with collateral or a cosigner. You may consider using collateral or adding a cosigner to your business loan to improve your chances of getting approved. If you have time to plan for your financing, working to improve your credit score can also help.
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Online business loans. Loans from online lenders may overlook barriers such as length of time in business, personal credit score or revenue requirements. Although they can come with higher interest rates and shorter terms than traditional loans, they may still be a more affordable and better long term option than MCAs.
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Friends and family loans. If you have friends or family members who are willing and able to loan you money for your business, it may be a good idea to seek their help before turning to an MCA. Make sure you are clear on some written terms of any agreement you come to in order to avoid personal disputes.
Steve Nicastro, a former NerdWallet writer, contributed to this article.
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