A merchant cash advance (also known as a business cash advance) is one of many alternatives available to small business owners in need of capital quickly. But what exactly is a merchant cash advance – and is it right for your business? Read on as we break down and weigh the pros and cons of merchant cash advances for small businesses.
What is a Merchant Cash Advance?
In simple terms, a merchant cash advance (MCA) is a lump sum of cash paid upfront in exchange for a percentage of future credit card or debit card sales. Business owners may turn to a MCA when they need access to funds quickly and are not aware of other alternatives, or if they believe their credit isn’t strong enough for them to be eligible for a loan. While in some situations a merchant cash advance may be a good option, it is important to keep in mind the risks and fees associated with this unregulated segment of the lending industry.
Are Merchant Cash Advances Considered Loans?
There is a common misconception that a merchant advance is a type of loan, when in fact it is actually a form of a sale. The confusion is understandable since there are similarities. Like a loan, a merchant cash advance is a financing option that small business owners can put towards costs such as rent, payroll, equipment or marketing efforts. However, merchant cash advances are not repaid in the same way as a loan. Instead of making regular payments, the business makes payments every time they receive card payments from customers. Since MCA repayments are based on credit card sales, the payments ebb and flow with your business. Some businesses find this method more manageable, while others find the constant payments difficult to manage.
Unlike loans, merchant cash advance approval rates are very high, as they don’t evaluate credit scores or require collateral. Instead, recent sales and credit card transactions are used to determine eligibility.
Factor Rates and Fees
While interest rates are used to describe the cost of loans, MCAs use a “factor rate”, which is simply a multiplier of the amount borrowed. Factor rates (also known as “buy rates”) are a multiplier of the amount borrowed and typically fall between 1.1 and 1.5. But don’t be fooled – do the math first because the true cost of this type of financing is often much higher than the alternatives. For example, a factor rate of 1.35 means the borrower will have to pay 35% in interest on the entire lump sum. Keep in mind that with most loans you are only paying interest on the outstanding principle, which goes down over the term as you repay your loan. As such, merchant cash advances can be deceptively more expensive than a loan.
Industry Regulation – Know the Risks
Because merchant cash advances are not considered actual loans, MCA providers don’t have to abide by the laws that limit reputable loan providers (such as banks or online lenders like Lendified) from charging astronomical interest rates. The key is to do you homework on each financing provider to verify their legitimacy and true costs.
Alternatives to a Merchant Advance
Approval rates for traditional bank loans are notoriously low, so obtaining a loan if your credit isn’t perfect can be difficult. But before considering a merchant cash advance, research other small business financing options. Many new fintech companies offer fast and affordable online loans with more flexible eligibility criteria. Lendified helps many businesses who currently are unable to obtain financing and don’t want to utilize expensive merchant advance financing. If you are interested in obtaining a no-obligation offer from Lendified you can start your application now. Until then, best of luck securing the capital you need to grow your business!