What Is a Merchant Cash Advance?

A merchant cash advance (MCA) is a business financing option in which a company receives money upfront in return for a percentage of its future debit or credit card sales. These are ideal for securing working capital for short-term needs and obtaining funds quickly.

However, it’s important to know how MCAs work before taking one out. If not, you may end up confused, locked into a high-cost agreement, or have a major strain on your cash flow, which could lead to the end of your business altogether.

In our guide, we explore what a merchant cash advance is and help you learn about its pros and cons, how it works, when it’s the right choice, and when you should consider other options.

Key Takeaways

• A merchant cash advance (MCA) gives your company access to funds quickly in exchange for a percentage of your future card sales.
• Some advantages of MCAs include quick approval, flexible automatic repayments, and accessibility. However, the disadvantages include high costs, a negative impact on cash flow, and a lack of regulations.
• To ensure you’re using MCAs responsibly, always read the terms closely and carefully, be aware of any restrictions, plan for repayment, and only use them for short-term needs.

What Makes an MCA Different From a Traditional Loan?

When you get a small business loan, it involves borrowing a certain amount from a lender and paying it back (plus interest) over a specific period of months or years. Instead, an MCA lets you essentially trade a portion of your future sales for upfront funds.

Unlike traditional loans, there’s no fixed repayment schedule or amount with an MCA. Instead, the amount you repay fluctuates with your sales. In some cases, this may be your daily sales, but other agreements may use weekly sales.

MCAs don’t require any collateral, have limited paperwork to fill out, and offer faster approval, typically within a few hours to a few days. It’s also generally easier to qualify for an MCA than a loan.

They’re also much less popular globally than loans. For example, a 2022 report found that 76% of those who sought financing opted for a loan or line of credit, while only 8% chose a merchant cash advance.

How MCAs Work in Practice

While MCAs may seem more complex than loans, their operation is straightforward. Firstly, the size of the advance you get is often based on monthly credit card and debit card sales. The higher your sales, the more you’re able to borrow.

MCAs don’t have a traditional interest rate and instead use a factor rate. A factor rate is a decimal number that shows the cost of borrowing money and is directly applied to the amount you borrow. For example, if you borrow £10,000 at a factor rate of 1.2, the total amount you’ll repay is £12,000.

The money is paid back over time with a percentage of your daily or weekly sales, which is automatically routed via your card processor. According to the British MCA Association, repayment or holdback rates often fluctuate between 10% and 18%, although they may be higher or lower in some cases.

So, if your repayment rate is 13%, your lender will collect 13% of your sales until the amount you borrowed is repaid.

Furthermore, the repayment period depends on your sales. If your sales are high, you’ll pay back the advance faster. However, if sales are low, your repayment amounts will be lower, and you’ll spend more time paying it back.

Key Advantages of MCAs

In the right circumstances, MCAs can offer a number of benefits.

Speed

MCAs are one of the quickest funding options available, as there’s little paperwork to fill out, and you’ll often get the funds anywhere between 24 hours and a few days. This is much faster than many traditional loans, which may take a few days to a few weeks.

Flexible repayments

The flexible nature of MCA repayments is ideal for businesses with fluctuating sales, such as seasonal businesses. During your peak periods when sales are high, your repayments also grow. However, once things slow down and you have fewer sales, your repayments decrease.

Accessibility

With no high credit score requirements or collateral to worry about, MCAs are generally relatively easy to obtain. Many providers even claim approval rates of 90%.

Automatic repayments

Your MCA repayments are generally automatic and done directly through your credit card processor, which also means there’s a much lower chance of late payments occurring.

Major Drawbacks To Consider

Despite some clear advantages, MCAs also come with a handful of disadvantages.

High costs

While these advances don’t have interest rates, the factor rates associated with them may be quite high. They’re typically about 1.1 to 1.5, but some may be even higher. High factor rates often translate to very high APRs. For example, a factor rate of 1.7 is similar to a 70% interest rate.

Negative impact on cash flow

Frequent holdbacks and repayments can reduce your working capital, making it difficult to manage your daily expenses. While some companies can afford to give up a portion of their sales to repay the MCA, others may struggle to stay afloat. In fact, 47% of UK businesses already experience cash flow challenges, and many will struggle to cope with the pressure from daily holdbacks.

Lack of regulation

Unlike traditional loans and other forms of credit, MCAs aren’t highly regulated. As a result, there’s a chance these agreements have a lack of transparency, high costs, and other predatory terms.

Restrictive contract terms

Some terms found in an MCA agreement may be restrictive and limit your business freedom. For example, specific terms may prevent you from switching credit card processors, changing your opening hours, or offering cash discounts.

No benefit for early repayment

When paying back a traditional loan, you can often save on interest and reduce the total cost of the loan by repaying early. However, this doesn’t work with MCAs. Whether you pay the advance off in a week or a year, the amount you pay back is the same.

Is an MCA Right for You? Practical Use Cases

MCAs are generally best suited for smaller, high-turnover businesses that use cards, such as retail shops, small restaurants, cafes, pubs, or service providers. It’s also a solid choice for those with poor credit scores or companies that don’t have the assets required to use as collateral for a traditional loan.

You may consider an MCA when you urgently need cash, need to make crucial seasonal stock purchases, or are experiencing a cash-flow dip and require funds to keep the business operating.

However, you should avoid MCAs if you’ve got thin business margins, consistently slow sales, or if you’ve got access to other types of business financing like loans, lines of credit, or invoice financing.

Before choosing an MCA, compare its terms with those of other options to ensure it’s the right decision. Look at the rates, fine print, repayment periods, and the total amount you’ll need to repay to decide which makes the most sense for your business.

When a Business Loan or Line of Credit Makes More Sense

In many cases, small business loans or a line of credit may be more suitable than an MCA. They’re often cheaper in terms of total cost and have tighter regulations, so there’s a lower chance of being stuck with a predatory lender. The fixed repayments of a standard loan make cash flow forecasting easier, as you always know the amount of each repayment well ahead of time.

They’re also better when your cash flow is predictable over time, or if you have collateral you’re comfortable putting at risk to save money while borrowing.

Other alternatives you may consider include invoice finance and overdrafts. Invoice financing is when you use unpaid invoices as collateral to borrow money, and overdrafts occur when you make a transaction that goes beyond your available balance in the account.

Many banks allow overdrafts and let you borrow small amounts to cover these transactions, and charge you fees and/or interest on what you borrow.

Tips for Using MCAs Responsibly

To ensure you’re using MCAs carefully and properly, follow the recommendations below.

Know the terms

Ensure you’re aware of all terms included in your agreement, such as the advance amount, the factor rate, and the holdback percentage. Never skip over the fine print, either, as you need to check for any penalties and be aware of any restrictions or rules you have to abide by. If you struggle to understand something in the agreement, don’t hesitate to seek professional help.

Have a repayment plan

To plan for your repayment, model your cash flow with the holdbacks in mind. If not, you may end up with much less cash in the bank than you were expecting. So, if you expect to bring in £1,000 each day, and have a 15% holdback percentage, assume you only have £850 coming in when modelling cash flow, so you don’t overestimate what you’ve got available.

Additionally, finding ways to improve your cash flow may help you offset those daily holdbacks and stay afloat as you repay the advance.

Avoid using MCAs for long-term needs

Try to only use these advances for short-term needs if possible. If you’ve got to pay holdbacks for a year or more, it may be debilitating for your organisation, especially if the factor rate and/or repayment percentage is high. Moreover, if you consistently use MCAs and always have debt to pay off, it may potentially hinder your ability to secure traditional types of financing in the future.