Are you a small business owner in need of cash right now? Consider a merchant cash advance. MCA’s can be a lifeline for businesses but before obtaining one, educate yourself on what they are and their pros and cons.
What is a Merchant Cash Advance?
An MCA is a cash advance from a creditor based upon a merchant’s credit card sales. MCA’s aren’t loans, so they operate differently. Let’s say Phil’s Pizza does $10,000 in credit and debit card sales each month, and Phil’s Pizza and a merchant cash advance provider agree to an MCA.
The lender will determine Phil’s ability to pay back the advance using a factor score. The score ranges between 1.1 and 1.5, the higher the risk, the higher the factor score. Phil and the provider agree to a cash advance of $10,000. If Phil’s factoring rate is 1.3, then the lender will charge him $3,000 in fees. Phil’s Pizza is obligated to repay $13,000 to the lender, but how Phil repays them differs from a loan. Since MCA’s are not loans, they are subject to different regulations and their terms differ from traditional loans. Understanding what MCA’s are is key to determining which provider may be the right option for a small business.
Important Terms to Know
- Holdback: Unlike a traditional loan where a recipient agrees to pay back the loan in fixed amounts, credit card sales are the basis for MCA’s. The recipient agrees to pay back the lender based upon a percentage of credit card sales. The recipient agrees to “holdback” a percentage of the business’s credit card sales each month. In our example, Phil agrees to pay back the advance by giving his lender 17% of his monthly credit card sales. At this rate, Phil would pay back the advance in six months. If Phil’s credit card sales total more than his usual $10,000, he still repays on the agreed upon 17%. Thus, Phil would pay back the advance sooner, but Phil pays less if his credit card sales fall below $10,000.
- Factor rate: Factor rates are based upon industry, time in business, and especially credit card receipts. MCA’s carry high risk for the provider, so the rates are much higher than for traditional loans. The cash advance isn’t based on an interest rate. However, the annual percentage rate or APR includes interest and fees, so the APR can be calculated for MCA’s. APR’s will be in the double or triple digits, higher than traditional business loans. Factor rates aren’t amortized either.
Benefits of a Merchant Cash Advance
- Available to those with bad credit. If Phil’s Pizza’s oven breaks, he can’t afford to work with one less oven until he saves up enough funds to buy another. Phil could apply for a small business loan, but what if he doesn’t qualify because of a poor credit score? Anyone with a credit score below 670 is defined as a subprime borrower. Subprime borrowers will find it almost impossible to get lending from traditional outlets like banks. But many online merchant cash advance providers don’t require minimum credit scores to qualify.
- Simple application and speedy approval. In our example, Phil needs a new oven now! National Pizza Day is coming next week, and his restaurant will be packed with pizza enthusiasts. MCA’s don’t require a lot of paperwork. MCA approval leans heavily on credit card sales. Once approved, consumers can get access to cash in less than 24 hours.
- No collateral required: Since MCA’s aren’t loans, applicants don’t have to put up collateral to obtain one. However, recipients might be personally liable for the advance. Some lenders require personal guarantees, allowing them to pursue individuals if a business fails. Discuss this with your lender before signing the dotted line.
- When sales are down, so are payments: Unlike loans, consumers aren’t required to pay a fixed amount if revenue is down. Missing payments, underpayments, or late loan payments usually results in added fees in addition to accumulating interest. MCA recipients may pay less one month without penalty.
How to Apply
- Gather necessary documents: While the required paperwork for an MCA is less onerous than a loan, applicants will still need to provide their Social Security number or tax ID, and credit card sales.
- Apply: Applying and approval can happen in a manner of hours, not days. ROK Financials’ merchant cash advance application takes 15 seconds, provides up to $5 million in funding, and offers same day funding.
- Finalize the details: Once a small business has access to this cash advance, the operator has to pay back the advance plus fees. Work with the provider to determine your cash advance and the amount “held back” each month (payment options may vary between daily, weekly and monthly).
Since MCA’s are not loans, the regulations vary state by state, and terms vary depending on lender. Lenders don’t provide payment history for cash advances to credit agencies. Consumers won’t build up their credit scores by meeting the terms of the advance. However, there are some cash advance options that may help you build your business credit.
Since MCA’s are a non-traditional form of lending you may have more questions. You can speak with ROK Financial advisor for assistance to better understand these financing options.
About the Author, Madison Taylor
Madison Taylor is the Brand Ambassador at ROK Financial. She is responsible for raising brand awareness and business relationships with business owners across the country. Madison loves that she plays a small role in getting Business Back To Business Through Simple Business Financing and looks forward to hearing what you think about the blogs she creates!Madison has been working in the financial space for six years, and loves it! When she is not at work, you will find her at home learning a new recipe to test out on her family or going on new adventures with her friends.