⏰ Estimated read time: 9 minutes
Merchant cash advances are a type of financing best for small businesses that need capital immediately to cover cash-flow shortages or short-term expenses. This type of financing can be very expensive, carrying annual percentage rates in the triple digits and potentially creating a difficult cycle of debt. Generally, you should consider all other small-business loan options before a merchant cash advance.
Here’s what to know about merchant cash advances, how they work and what to keep in mind before choosing one for your business.
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What is a merchant cash advance?
A merchant cash advance, or MCA, is an alternative type of business financing, and is not a traditional small-business loan. With an MCA, a company gives you an upfront sum of cash that you repay using a percentage of your debit and credit card sales, plus a fee.
How does a merchant cash advance work?
A merchant cash advance company provides your business with a lump sum of capital. But an MCA isn't a loan. Instead, that provider is purchasing your future sales, and you’ll use those sales to repay the funds — plus fees. MCAs work similarly to invoice financing, when you borrow against future invoices in exchange for cash.
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.
Unlike other types of business loans, merchant cash advances don’t have typical repayment terms. Repayment periods are based on your sales and can range anywhere from three to 18 months; the higher your credit card sales, the faster you’ll repay the advance.
Fixed withdrawals from a bank account
Merchant cash advance companies can also withdraw funds directly from your business bank account. In this case, fixed repayments are made daily or weekly from your account regardless of how much you earn in sales, and the fixed repayment amount is determined based on an estimate of your monthly revenue.
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.
Merchant cash advance rates and fees
Instead of a traditional interest rate, merchant cash advance companies charge their fees as a factor rate. Factor rates typically range from 1.1 to 1.5, varying based on the provider’s assessment of your business.
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:
If your monthly credit card sales are $100,000
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.
Use our MCA calculator below to compare the cost of a merchant cash advance with that of other business loans.
Pros and cons of merchant cash advances
Fast to fund. You can apply for a merchant cash advance online — and get approved quickly — usually with minimal documentation required. Many MCA providers offer funding within 24 hours. Flexible requirements. Merchant cash advance companies may work with businesses facing credit challenges, startups and those with previous financial difficulties. Plus, MCAs don’t typically require physical collateral. Providers will likely consider traditional business loan requirements but may focus on your debit and credit card transactions or business revenue. Of course, the better your qualifications, the better factor rate you can receive.
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.
Expensive. Compared with other types of business loans, like online term loans or business lines of credit, whose APRs typically range from 9% to 99%, MCAs are one of the most expensive forms of financing. APRs on merchant cash advances can reach 350%, depending on factors such as the lender, size of the advance, fees, time it takes to repay and business revenue. Plus, unlike traditional interest rates, factor rates can make it more difficult to determine exactly how much an MCA will cost you. 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?
Generally speaking, defaulting on a loan means that you have stopped making payments on it, and a lender can take recourse specific to your type of debt and loan agreement. Because MCA companies are not subject to federal regulations, defaulting on a merchant cash advance can often be more detrimental than defaulting on a traditional loan. Many MCA companies will require you to sign a confession of judgment at closing, an agreement that essentially waives your right to dispute or defend yourself in court if they decide to file a judgment against you.
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 MCAs
Before turning to a merchant cash advance, you should seek out alternative financing options. You may also consider using other forms of 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. If you’re a new business, have bad credit or need funding quickly, some online lenders may still offer small-business loans that are worth considering. For example, OnDeck offers online term loans for businesses with at least one year in business, a minimum credit score of 625 and at least $100,000 in annual revenue. These loans are available in amounts up to $250,000 with terms up to 24 months. Repayment can be daily or weekly and APRs range from
99.9% (based on loans originated in the half-year ending March 31, 2023; minimums provided are rates that at least 5% of customers received).
Startup businesses, on the other hand, might look into Fundbox, which offers business lines of credit up to $150,000. To qualify, you’ll need a minimum credit score of 600, at least six months in business and at least $100,000 in annual revenue. Fundbox lines of credit require weekly repayments and have terms of 12 or 24 weeks. APRs range from 10.1% to 79.8%.
With both of these lenders, you can apply for financing online and receive funds as soon as the next business day. And, although the qualification requirements may be higher than some MCA providers, the cost of borrowing will likely be much lower.