A Look at How Merchant Cash Advances Work
Merchant cash advances (MCAs) are not loans. They are advance payments to your business in exchange for a portion of your future sales. This upfront amount comes at a rate – factor rate – determined by the merchant cash advance provider. The factor rate which generally ranges from 1.1 to 1.5 is based on ability to repay and risk assessment. A higher factor rate translates to higher fees. To get the total amount to be repaid, you just need to multiply the cash advance by the factor rate. For example, an advance of $100,000 at a factor rate of 1.3 will translate to a total repayment of $130,000.
Merchant cash advance payments can be structured in the following ways:
Fixed deductible percentage on credit card sales
Here, a percentage of your credit card sales is automatically deducted by the merchant cash provider until the full amount has been repaid. The repayment period may vary with this method. If your sales go below projections, the duration will be longer and vice-versa.
A predetermined amount based on revenue projections is repaid periodically. It may be daily, weekly or monthly. For this payment plan, the amount to be paid is not affected by sales. The amount due remains constant regardless of increased or reduced sales.
Advantages of merchant cash advances
These funds can be approved within the same day and get to you in a few days. They offer a good solution to emergency cash needs
You don’t need a perfect credit rating
Most providers do not even check your personal or business credit score. The most important thing to merchant cash advance lenders is the consistency of your credit card sales. They also, however, won’t help you build your credit score as most do not report to credit bureaus.
No security is needed
You do not need to put any personal or business assets on the line to secure the cash advance as with loans.
The fixed percentage payment plan allows for flexible payment. Payments made are proportionate to the sales generated. This therefore means, there is no unnecessary pressure to pay a certain amount.
Disadvantages of Merchant Cash Advances
Even though this form of financing is convenient and easy to access, it has its drawbacks. The following are some of them:
Your annual percentage rate (APR) could be very high
If sales go better than expected on the fixed percentage plan, you can repay the advance in a shorter period. Having repaid the principal amount advanced to you plus interest in a shorter period, the annual percentage rate would significantly be higher.
No benefits for early repayment
Unlike bank loans, merchant cash providers offer no exemptions on interest for early repayments.
No federal oversight
Merchant cash advances are structured like commercial transactions and not loans exempting them from federal scrutiny. According to a report by First Data, they are regulated by the uniform commercial code in each state, as opposed to banking laws such as the Truth in Lending Act.
Vicious debt cycle risk
The high cost and frequency of payments can cause cash-flow issues in the business. A borrower may find themselves in need of additional funds soon after taking the first advance. The risk is even greater for borrowers who do not have access to other forms of financing. The borrower may end up taking another merchant cash advance initiating a vicious cycle of debt.
Merchant cash advances can be a great way to meet emergency financial needs. They, however, require caution. Also, note that not all businesses may do well with such plans.