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Update Jan. 19, 2021: The latest round of the Paycheck Protection Program is open to small businesses hard hit by the coronavirus pandemic.
The legislation provides more than $284 billion for first and second forgivable coronavirus relief loans, reviving the Paycheck Protection Program that lapsed in the summer. It also widens the kinds of businesses that could seek PPP funding, such as news outlets, and adds funding for smaller, independent entertainment venues and restaurants. For the latest information, read our PPP page.
You’re a small-business owner in need of capital now, and a merchant cash advance looks like a good deal. Before you act, consider this: That quick cash could really cost you.
MCAs have been known to carry annual percentage rates — the total cost of a loan, including all fees — in the triple digits. These costs, as well as the daily repayment schedule, can cause serious cash-flow problems. In some cases, MCAs can lead to a debt trap, where it’s virtually impossible to repay and you must refinance into another — and yet another — MCA or file for bankruptcy.
That’s why many consumer advocates and nonprofit lenders consider MCAs a financing option of last resort. Below, we lay out the pros and cons of merchant cash advances to help you make a wise financing choice.
What is a merchant cash advance?
A merchant cash advance provides alternative financing to a traditional small-business loan. Merchant cash advance providers say their financing product is not technically a loan. An MCA provider gives you an upfront sum of cash in exchange for a slice of your future sales.
How merchant cash advances work
A merchant cash advance has historically been for businesses whose revenue comes primarily from credit and debit card sales, such as restaurants or retail shops. Now, merchant cash advances are available to other businesses that don’t rely heavily on credit card or debit card sales.
Merchant cash advance repayments can be structured in two ways.
You can get an upfront sum of cash in exchange for a slice of your future credit and debit card sales, or you can get upfront cash that is repaid by remitting fixed daily or weekly debits from your bank account, known as ACH, for Automated Clearing House, withdrawals.
This option has become the most common type of merchant cash advance, according to Sean Murray, a former merchant cash advance broker and founder of trade magazine deBanked. They’re referred to as ACH merchant cash advances and allow providers to market to businesses that aren’t primarily tied to credit and debit card sales.
Instead of making one fixed payment every month from a bank account over a set repayment period, with a merchant cash advance you make daily or weekly payments, plus fees, until the advance is paid in full.
How much you’ll pay in fees is determined by your ability to repay the merchant cash advance. The merchant cash advance provider determines a factor rate — typically ranging from 1.2 to 1.5 — based on its risk assessment. The higher the factor rate, the higher the fees you pay. You multiply the cash advance by the factor rate to get your total repayment amount. For example, an advance of $50,000 that carries a factor rate of 1.4 represents a total repayment of $70,000, which includes fees of $20,000.
MCA repayment structures
Here's a more detailed breakdown of how merchant cash advance repayments can be structured:
Percent of credit card sales
The merchant cash advance provider automatically deducts a percentage of your credit or debit card sales until the agreed-upon amount has been repaid in full. Let’s say you need $50,000 to purchase a new oven for your restaurant. You apply and get approved for a merchant cash advance of $50,000. The provider has assigned a factor rate of 1.4 on the contract, so you owe $70,000.
The repayment period typically ranges from three to 12 months; the higher your credit card sales, the faster you’ll repay the merchant cash advance.
In this case, let’s say your merchant cash advance provider deducts 10% of your monthly credit card sales until you’ve repaid the $70,000, and your busy restaurant averages $100,000 in credit card revenue per month. You’d repay $10,000 monthly, with daily payments of $333 in a 30-day month. At this pace, you’d pay off the advance by the seventh month. But if your revenue dropped to $70,000 per month, you wouldn’t repay the merchant cash advance in full until the 10th month, paying $233 daily.
As we explain below, the speed with which you repay your loan is a factor in determining your APR and can help drive it into the triple digits.
The predetermined percentage of sales is an estimate based on your projected monthly revenue. Since your sales can fluctuate, the speed with which the loan is repaid could be longer or shorter than expected, says David Goldin, CEO of Capify, a merchant cash advance provider, and president of the Small Business Finance Association, a trade association that represents merchant cash advance companies. “Eighty percent of the time, it takes longer than the purchaser thought it would take.”
Fixed daily withdrawals
This kind of agreement lists a daily or weekly payment to be withdrawn, based on an estimate of your monthly revenue. For example, a business with $100,000 in monthly revenue would owe $333 per day or $2,331 per week based on a percentage of sales of 10%.
Unlike the repayment structure tied to credit card or debit sales, your payment does not fluctuate with your sales. That means you’ll pay the same amount regardless of whether sales are down or up.
Calculate the cost of a merchant cash advance
Your annual percentage rate represents the total borrowing cost of your merchant cash advance, including all fees and interest. This figure also depends on how long it takes you to repay the advance in full. Use the MCA calculator below to compare the borrowing cost of your merchant cash advance with that of other small-business loans.
Why borrowers opt for MCAs
Although merchant cash advances are a financing option of last resort, they do have their pluses:
They’re quick. You can often get an MCA within a week or so with no heavy paperwork. Providers look at a business’s daily credit card receipts to determine if the owner can repay.
Physical collateral isn't required. MCAs are unsecured, so you don't need to provide physical collateral. This means you don’t have to supply business assets upfront to back your financing — and risk losing those assets if you can't afford to repay. However, the MCA provider will likely require a personal guarantee, which is a written agreement that makes you personally responsible for repaying the advance. If this is the case, the MCA provider can recoup any losses in the event that you can't pay.
When sales are down, your payment may be too. When the repayment schedule is based on a fixed percentage of your sales, repayments adjust based on how well your business is doing.
Still, MCAs are far from a perfect borrowing option, and you can get some of these advantages with other types of financing products.
Reasons to be wary of MCAs
Your APR could be in the triple digits. The annual percentage rate, or total annual borrowing cost with all fees and interest included, typically ranges from about 40% to 350%, depending on the lender, the size of the advance, any extra fees, how long it takes to repay the advance in full and the strength of the business’s credit card sales. This is far more expensive than traditional bank loans, whose APRs are typically 10% or less; online small-business loans, with APRs from 8% to 99%; and business credit cards, with APRs from 12.9% to 29.9%.
Higher sales mean a higher APR. For MCAs repaid with a percentage of your credit card sales, the APR depends not just on the total fees paid but also on how fast you repay the loan. If your sales are weak, your payments spread out over a greater length of time and your APR drops. If you’re raking in the credit card sales, you repay the MCA faster — and, subsequently, APR goes up. For example, the company might offer you a $100,000 advance with a factor rate of 1.3, for a total repayment of $130,000. If you repay it in just six months, the APR would be a minimum of 60%. If you repay it in 12 months, the APR would be a minimum of 30%.
There’s no benefit to repaying early. Since you have to repay a fixed amount of fees no matter what, you get no interest savings from early repayment. This differs from a traditional “amortizing” small-business loan, in which early repayment would result in less interest paid. It also means that if you decide to refinance, you’ll still have to pay all of the agreed-upon fees, and you may also get hit with an early repayment penalty.
There’s no federal oversight. The merchant cash advance industry is not subject to federal regulation because MCAs are structured as commercial transactions, not loans. Instead, they are regulated by the Uniform Commercial Code in each state, as opposed to banking laws such as the Truth in Lending Act, according to a report by First Data.
Your credit score may be pulled. Although MCAs typically are an option for business owners with bad credit, that doesn’t mean the MCA provider won’t at least check your credit score during the application process. Background credit checks are a common requirement for MCA providers, Goldin says — but if the provider's credit inquiry results in a hard credit check, it can hurt your credit score.
There's a debt-cycle danger. The speed and ease of MCAs can put you into a debt cycle, especially if you don’t qualify for other types of financing. Borrowers may find themselves in need of another advance soon after taking on their first one due to the extremely high costs and frequency of repayments of MCAs, which can cause cash-flow problems. A daily payment of hundreds of dollars, for example, could put a strain on the cash flow of many small businesses and put them at risk of default.
Contracts can be confusing. The costs and repayment structure of MCAs can make them difficult to understand. Contracts are often loaded with unfamiliar terms, such as specified percentage (the percent you repay out of credit card sales), purchase price (the amount you receive) and receipts purchased amount (total payback amount). MCA providers do not provide APRs, which makes it impossible to compare with other financing products. You may also be required to sign a legal document called a confession of judgment, which forfeits your right to defend yourself if the company takes you to court.
Alternatives to MCAs
Before turning to a merchant cash advance, small-business owners should seek out alternatives. If lack of collateral or a need for speed make getting a traditional loan difficult, online lenders offer small-business loans with competitive APRs and repayment terms.
For businesses with poor credit
Business owners with poor personal credit can try online lenders OnDeck and Kabbage for financing. The upper end of APRs for these lenders is 99%. But for borrowers with a narrow range of choices, they offer some advantages over MCAs.
OnDeck’s business term loans are a less pricey and more flexible alternative to MCAs. Unlike MCA providers, the company reports your payment activity to the business credit bureaus, so it gives you the opportunity to build strong business credit, which can help you get a lower-cost business loan in the future.
With access to up to $500,000, repayment periods stretching to three years and repayments made daily or weekly, loans from OnDeck are best used for expansion, such as equipment purchases or hiring new employees. Besides meeting the minimum qualifications, borrowers cannot be on the company’s restricted industries list.
Kabbage is among the options for business loans for bad credit, as the lender requires a minimum credit score of 560 to qualify. Kabbage provides $2,000 to $250,000 with shorter repayment terms than OnDeck. It's a better option for short-term working capital needs than for an expansion.
You repay each individual draw, with its own fee structure, monthly over six, 12 or 18 months. With APRs of 24% to 99%, Kabbage is pricey but still likely to be cheaper than an MCA.
For businesses that have unpaid invoices
For businesses that have unpaid customer invoices, BlueVine gives you 85% to 90% of the invoice amount upfront and the rest when your customer pays, minus fees. Borrowers can obtain up to $5 million within 24 hours at an APR of 15% to 68%.
Qualifying can be difficult. BlueVine requires a minimum personal credit score of 530 and annual revenue of at least $100,000.