Pre-Funding
September 3, 2020

How should founders think about using Merchant Cash Advances

What are merchant cash advances?


A merchant cash advance (MCA) is an alternative form of funding in the realm of debt financing. Unlike your standard bank loan, MCAs allow businesses to receive a lump sum upfront, or a cash advance, based on credit card sales as a quick way to receive funding.

 

How do repayments work?

The repayment works in two different ways. You can get a cash advance upfront in exchange for a percentage of your future credit card sales, or you can repay with a daily or weekly fixed amount from your bank account. Either way you decide to structure the repayment, you will also pay fees based on a factor rate. The factor rate is a risk assessment based on your sales performance, similar to an interest rate on a loan. It’s not uncommon to see a factor rate between 1.2 to 1.5. 


So, what type of businesses would be a good fit for MCAs? 


Typically, businesses who are in a bind for quick cash opt for MCAs, because the requirements to qualify are not as strict as getting other types of financing. 


What are some advantages of MCAs?

MCAs have flexible repayment terms, are unsecured, and can be used in any way you want. Once you’re approved, you can see the cash as early as a day to a week. 

What are some disadvantages of MCAs?

Although they’re quick, MCAs are very expensive. While the factor rates are fixed, you could see an APR upwards of 350% depending on the provider. Since their repayment structures are based on credit card sales, you must accept credit cards. Lastly, minimum daily payments hurts cash flow, and this type of financing doesn’t help your credit score.


Many of these disadvantages could be deal breakers for some companies. A good alternative could be a short-term loan from online lenders if you can hold off on cash for a few months. Factoring is another alternative if you often have unpaid invoices and not the best credit, since factoring is mainly depending on your customer’s ability to pay.


Like any form of debt financing, choosing to fund your business with your merchant cash advance isn’t a decision to take lightly. It can be a great form of bridge funding in the short run, but fully understanding the contract for an MCA is key to avoid the risk of being in a worse position than you started. 


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