Merchant Cash Advance: Find a Better Alternative

Is a merchant cash advance right for your business?

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 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.

IN THIS ARTICLE

How MCAs work

Why borrowers opt for them

Reasons to be wary

Find alternatives to MCAs

How a merchant cash advance works

A merchant cash advance is for businesses whose revenue comes primarily from credit and debit card sales, such as restaurants or retail shops. MCA 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.

Instead of making one fixed payment every month from a bank account over a set repayment period, with an MCA you pay an agreed-upon percentage of your credit and/or debit card sales daily, plus fees, until the cash advance is paid in full.

How much you’ll pay in fees is determined by your ability to repay the MCA. The MCA 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.

Total advanceFactoring rateTotal feesTotal repayment
$50,0001.4$20,000$70,000

There are two ways that merchant cash advance repayments can be structured:

Percent of credit card sales: The MCA 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 an MCA 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 MCA.

In this case, let’s say your MCA 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 repayments 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 MCA 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 pre-determined 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, an MCA provider, and president of the Small Business Finance Association, a trade association that represents MCA companies. “Eighty percent of the time, it takes longer than the purchaser thought it would take.”

Fixed daily withdrawals: You can also make MCA repayments via daily ACH debits from a bank account. This kind of agreement lists a daily payment or “specified daily amount” 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 based on a percentage of sales of 10%.


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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.
  • You won’t lose your home. MCAs are unsecured, so you don’t need collateral. This means you don’t have to forfeit any personal or business assets if your sales plunge and you fail to repay. “If the company goes out of business, I’m out of luck since it’s nonrecourse,” Goldin says. “There’s no absolute repayment in a correctly structured merchant cash advance.” However, the MCA provider may 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 may still try to recoup any losses.
  • 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. Here are some downsides:

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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 70% to 350% or even higher, 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 7% to 108%; 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. As you can tell from the above examples, the costs and repayment structure of MCAs can make them difficult to understand. In addition, the 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 also do not provide APRs. That makes it impossible to compare an MCA with other financing products, which is crucial to smart shopping.


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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 often have 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 can be high — near or above 100%. But for borrowers with a narrow range of choices, they offer some advantages over MCAs.

OnDeck
  • Loan amount: $5,000 to $500,000.
  • APR: 16% to 98%.
  • Loan term: Repaid daily or weekly for three to 36 months.
  • Funding time: As fast as 24 hours but typically a few days.
  • Read our OnDeck review.
Get started at OnDeck

 

Before you apply for an OnDeck loan, find out whether you meet the lender’s minimum qualifications.

  • 500+ personal credit score.
  • 1+ year in business.
  • $100,000+ in annual revenue.
  • No bankruptcies in the last two years.
  • Personal guarantee required.
Do I qualify?

OnDeck’s business term loans are a less pricey and more flexible alternative to MCAs. The loans also get cheaper for repeat customers, as OnDeck’s one-time origination fee drops from 2.5% on your first loan to 1.25% on your second loan and to between 0% and 1.25% on all subsequent loans. 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, real estate renovation or hiring new employees. Besides meeting the minimum qualifications, borrowers cannot be on the company’s restricted industries list.

Kabbage
  • Loan amount: $2,000 to $100,000.
  • APR: 32% to 108%.
  • Loan term: Six or 12 months.
  • Funding time: A few minutes to several days.
  • Read our Kabbage review.
Get started at Kabbage

Before you apply for a Kabbage loan, find out whether you meet the minimum qualifications.

  • No minimum personal credit score required.
  • 1+ year in business.
  • $50,000+ in annual revenue.
  • A business checking or online payment platform required.
Do I qualify?

Kabbage is among the options for business loans for bad credit as the company doesn’t require a minimum credit score to qualify. Kabbage provides $2,000 to $100,000 in the form of a business line of credit that you can borrow from and repay on an as-needed basis, making it better for short-term working capital needs than for an expansion.

You repay each individual draw, with its own fee structure, monthly over six or 12 months. With APRs of 32% to 108%, Kabbage is pricey but still likely to be cheaper than an MCA.

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For businesses looking to buy inventory

Dealstruck
  • Loan amount: Up to $500,000 for inventory and asset-based line of credit.
  • APR: 22% plus prime rate.
  • Loan term: Six months per draw for lines of credit.
  • Funding time: Average of 10 days.
  • Read our Dealstruck review.
Get started at Dealstruck

Before you apply for a Dealstruck loan, find out whether you meet the lender’s minimum qualifications.

  • 600+ personal credit score.
  • 1+ year in business.
  • $150,000+ in annual revenue.
  • Breaking even or profitable.
  • Personal guarantee and a lien on business assets required.
Do I qualify?

Dealstruck is an option for businesses thinking of using an MCA to buy inventory. Its line of credit lets you finance 100% of your inventory purchases up to $500,000. You make repayments weekly over six months, with least four weeks of interest-only payments. With an APR of 11% to 22% plus the prime rate (3.5%), it’s much more affordable than an MCA.

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For businesses that have unpaid invoices

Businesses that have unpaid customer invoices have multiple financing options.

fundbox
  • Loan amount: $500 to $100,000.
  • APR: 13% to 68%.
  • Loan term: Equal repayments over 12 weeks.
  • Funding time: One to three business days.
  • Read our Fundbox review.
Get started at Fundbox

Before you apply for Fundbox’s invoice financing, find out whether you meet the lender’s minimum qualifications.

  • No minimum personal credit score required.
  • No minimum annual revenue required.
  • Must use online accounting software that can link to Fundbox (such as Quickbooks, FreshBooks, Harvest).
Do I qualify?

Fundbox is the best option for business owners with bad credit, as the company does not require a minimum credit score to qualify. It’s also a good option for businesses that need cash right away. You can borrow up to $100,000 and receive 100% of the invoice value upfront, repaid weekly over 12 weeks. However, this speed and convenience carry a cost; Fundbox’s APRs range from 13% to 68%.

bluevine
  • Loan amount: $20,000 to $500,000.
  • APR: 17% to 60%.
  • Loan term: One to 12 weeks
  • Funding time: One to three days.
  • Read our BlueVine review.
Get started at BlueVine

Before you apply for BlueVine’s invoice factoring, find out whether you meet the minimum qualifications.

  • 530+ personal credit score.
  • 3+ months in business.
  • $120,000+ in annual revenue.
Do I qualify?

BlueVine gives you 85% of the invoice amount upfront and the rest when your customer pays, minus fees. Borrowers can obtain up to $500,000 within 24 hours at an APR of 17% to 60%.

However, qualifying is a bit tougher than with Fundbox. BlueVine requires a minimum personal credit score of 530 and annual revenue of $120,000.

Dealstruck
  • Loan amount: Up to $500,000 for inventory and asset-based line of credit.
  • APR: 22% plus prime rate.
  • Loan term: 6 months per draw for lines of credit.
  • Funding time: Average of 10 days.
  • Read our Dealstruck review.
Get started at Dealstruck

Before you apply for a Dealstruck loan, find out whether you meet the lender’s minimum qualifications.

  • 600+ personal credit score.
  • 1+ year in business.
  • $150,000+ in annual revenue.
  • Breaking even or profitable.
  • Personal guarantee and a lien on business assets required.
Do I qualify?

If you can wait a bit longer to get funded and want the cheapest invoice financing option, Dealstruck’s asset-based line of credit is your best bet. Businesses with unpaid invoices can borrow up to 85% of the amount of their outstanding invoices, up to $500,000, with an APR of 22% plus the prime rate. As with the inventory line of credit, you repay weekly over six months.
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To find other alternatives to MCAs, compare options here:

Compare business loans
This article was updated on July 14, 2016.

Steve Nicastro is a staff writer at NerdWallet, a personal finance website. Email: Steven.N@nerdwallet.com. Twitter: @StevenNicastro.

To get more information about funding options and compare them for your small business, visit NerdWallet’s small-business loans page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.