🎉 Tillful is now part of Nav! Learn more about merchant cash advance at Nav

What is a Merchant Cash Advance?

A merchant cash advance (MCA) is a type of alternative financing that gives you a lump sum to be repaid with either a fixed daily/weekly amount or a percentage of your monthly credit and debit card sales, plus a fee called a “factor rate.” Not a traditional business loan like you would get from a bank, a merchant cash advance is similar to a paycheck advance, except it's for companies rather than individuals. MCA’s can be great, convenient options to immediately improve your cash flow, but they can also be risky, so it’s important to know the pros and cons of taking out this form of financing.

Small businesses have also historically been taken advantage of by bad actors within the industry, which is relatively unregulated. MCA's tend to market themselves as "small business loans" and while they technically are, this can mask the fact that they are not business loans in the traditional sense to unaware borrowers. Many of the small business owners we’ve talked to have been burned by MCA’s, but it doesn’t have to be that way. We’ll talk about what to look out for in order to make sure you don’t get stacked with unreasonable fees, and how to use MCA’s responsibly (and even to your advantage) so that you don’t end up underwater.

How do merchant cash advances work?

Applying for and obtaining a merchant cash advance is generally a pretty fast procedure. As soon as your business entity is approved, it’s often possible to receive your advance within a few business days of applying.

The amount of money a borrower can get from an MCA can range anywhere from a couple thousand dollars to over $150,000. Often, companies are expected to repay the advance within a short period, usually 18 to 24 months or sometimes less. Most of the time, MCA companies will only advance a business an amount that’s relative to their income and calculated through their bank and debit card statements, regardless of how much the company may need. Even so, it’s best not to go entirely off the lender’s judgment of what they think you can afford, and to assess if you will realistically be able to pay back the full cost of the advance within the lender-provided time frame.

The actual cost of merchant cash advances

When calculating the price for an MCA, keep in mind that the fee associated with the advance is not based on an interest rate or annual percentage rate (APR). Instead, it’s based off what’s called a factor rate. This metric can often throw small business owners off, because it’s different from what you’d see on a typical loan or credit card. When converted to an APR, a number like 1.2 can actually translate to 120% interest.

Here’s how to calculate your real cost of borrowing:

Total Repayment Amount = Total Advance x Factor Rate

• Total Advance = $20,000
• Factor Rate = 1.25
• Total Fees (Cost to Borrow) = $5,000
• Total Repayment Amount = $25,000

In the above example, a $20,000 MCA at a factor rate of 1.25 gives an entire repayment loan of $25,000. The cost of the loan would be $5,000.

Calculating MCA repayment: Percent of credit or debit card sales

To calculate MCA repayment for terms that require a percentage of your credit or debit card sales, let’s start by revisiting the example in the previous example.

Total Repayment Amount = Total Advance x Factor Rate

• Total Advance = $20,000
• Factor Rate = 1.25
• Total Fees (Cost to Borrow) = $5,000
• Total Repayment Amount = $25,000

To calculate how much each installment will cost, use the following formula:

Installment Amount = Percent of Sales x Monthly Sales / Payment Frequency (daily or monthly)

Next, you’ll calculate how long it will take to pay back the full amount:

Time to Pay Back MCA = Total Repayment Amount / Installment Amount

When you put it all together, you get:

• Total Advance = $20,000
• Factor Rate = 1.25
• Total Fees (Cost to Borrow) = $5,000
• Total Repayment Amount = $25,000
• Monthly Credit Card Sales = $100,000
• % of Sales (according to terms) = 10%
• Payment Frequency = Daily
• Installment Amount (Daily) = $333.33
• Time to Pay Back MCA = 75 days (2.5 months)*

*The 75 days is starred because, as you’ve probably realized, credit and debit card sales fluctuate. The more sales you make, the less time it will take to pay back the MCA. The less sales you make, the longer it will take. Your installment amount will vary a lot with your sales, which can lead to small business owners becoming stuck with debt that just keeps getting bigger.

We can’t stress this enough: be realistic and conservative with how much you borrow when it comes to a high-cost option like an MCA. While merchant cash advances certainly have their place in providing some extra working capital for covering emergencies, and in serving as much-needed financing for new businesses, it’s better to take out less, pay it back quickly, and borrow again if you need more rather than stretching yourself and running into the possibility of higher and higher APR’s.

Taking out smaller amounts doesn't just come with the benefit of a lower cost to borrow — some lenders will even reward you for early payments by knocking a little extra off your payback amount. This runs counter to some bank and other loan types, which can sometimes come with prepayment penalties. It’s important to do your calculations here to check what your full cost to borrow actually is. Finally, building up a payment history also helps build your relationship with the MCA provider, which over time can often result in better payment terms with subsequent MCA’s. Do note, however, that many MCA's don't report to credit bureaus, so taking out an MCA product won't necessarily help you build business credit.

Calculating MCA repayment: Fixed daily payments

In a second type of MCA scenario, you would pay back the lump sum in daily (sometimes weekly) payments that are determined by your monthly revenue. Instead of calculating your installment amount by a percentage of sales, this number would be replaced by a percentage of your estimated monthly revenue.

To calculate how much each installment will cost based on fixed payments, use the following formula:

Installment Amount = Percent of Monthly Revenue x Monthly Revenue / Payment Frequency (daily or monthly)

Your time to pay back the MCA in this case is fixed.

To update our example:

• Total Advance = $20,000
• Factor Rate = 1.25
• Total Fees (Cost to Borrow) = $5,000
• Total Repayment Amount = $25,000
• Monthly Credit Card Sales = $100,000
• % of Sales (according to terms) = 10%
• Payment Frequency = Daily
• Installment Amount (Daily) = $333.33
• Time to Pay Back MCA = 75 days (2.5 months)

In this case, unlike with the repayment being calculated based on credit or debit card sales, the time to pay back the advance is fixed (assuming you pay everything on time).

Since many MCAs are short-term loans, the cost to borrow is more significant than a conventional long-term loan. Though MCA’s can fill urgent cash flow needs for small business owners, especially those with a short time in business or poor credit, they are a more expensive form of financing than other options such as lines of credit or traditional bank loans. Depending on the situation, they can even be more expensive than credit cards.

The pros and cons of merchant cash advances

Though MCA’s can be expensive, they can also be very useful forms of financing. It may well be the case that a merchant cash advance is exactly the kind of product that your small business needs at this stage in its existence. Like anything in life, and especially when it comes to funding options for small businesses, MCA’s have both advantages and drawbacks.

The pros of merchant cash advances for small business

Pros:

• Unlike bank loans, the application process for MCA’s tends to be fairly quick, and funds are often released quickly, making them ideal for emergencies or any other situation where you need cash in a pinch.
• The requirements for the application are usually pretty simple, and minimize complicated paperwork.
• Usually, there is no collateral required.
• Payment amounts are flexible when based off credit and debit card sales; they rise and fall with sales fluctuations within your business.
• Typically, businesses with no credit history and/or poor credit are able to get access to this form of business financing.
• Businesses may use the funds as they desire once they acquire them; there are no special requirements or proof of use necessary.

The cons of merchant cash advances for small business

Cons:

• Due to the lack of regulation, they have very high interest rates, sometimes even higher than credit cards.
• Repaying the loan quickly under the agreed time does not minimize interest payments like some other business financing options.
• There are some regulatory loopholes, which means you need to be educated when shopping around.

Overall, if you’re a small business who needs a little extra cash to get you through a big unexpected expense, or if you’re still establishing business credit, then an MCA can be a good option for you. So long as you calculate the real cost of the loan and avoid potential pitfalls, a merchant cash advance can help you invest in the success of your business.

How to get a merchant cash advance

So we’ve gone through the pros and cons of MCA’s, and you’ve decided to go for it. Congrats! The next steps are to find a lender and to apply. Though no MCA application is exactly the same, there are a few documents that are typically required to prove your identity and that of your business. They include:

• Proof of identity such as government-issued ID
• Business type
• Bank statements as well as credit card processing statements
• Business tax returns (in some cases)

Merchant cash advance lenders for small business

Credibly

The Merchant Cash Advance product from Credibly is transparent and up front about both its costs and what documentation you will need in order to apply. Their MCA product offers up to $400,000, with a payback period of anywhere from three to eighteen months. Again, your payback period will be determined by how much you can pay back per month based on your credit card sales, meaning that this period is not a hard and fast rule.

To apply, you will need at least 6 months in business, a 500 personal credit score, and $15,000 or more in average monthly bank deposits (in a business bank account). In addition to the terms set out by the MCA, fees include a one-time underwriting fee of 2.5% of the total advance amount, as well as a monthly admin fee of $50.

One last thing to note on Credibly is that they do provide other financing options. When you apply, you may find out that you can qualify for a different funding option with more favorable terms.

Bitty Advance

Bitty only provides merchant cash advances with their Bitty Advance product, providing anywhere from $2,000-$25,000. Bitty typically requires at least 6 months in business, as well as an average of $5,000 in monthly revenue. The payback term is typically 110 days, or about 4 months.

Everest Funding

If you’re a small business currently bringing in at least $4,000 in monthly revenue, then you may be eligible for an advance through Everest Funding. Everest claims to approve 95% of businesses and to release funds upon approval within 24 hours. Their advances range from $5,000 to $1,000,000 (though if you are a business who could qualify for up to $1,000,000, then you may have cheaper options such as traditional bank loans).

Lendini

Lendini provides both a Business Cash Advance and a Merchant Cash Advance ranging from $1,000 to $250,000. Lendini’s Merchant Cash Advance product is based off future credit card receivables, and paid back based on a percentage of credit card sales. Their Business Cash Advance product works very similarly to an MCA, but is based on your account receivables, and paid back in daily withdrawals from your business bank account.

Merchant cash advance alternatives

If you decide an MCA isn’t right for your business, or if you think you may be able to qualify for a lending product with better terms, then here are a few options to look into, from short term loans to business credit cards.

OnDeck Short Term Business Loan

OnDeck provides a short term loan option that can serve a similar purpose as an MCA would. The caveat, of course, is that it’s a bit harder to qualify for than an MCA: you’ll need at least one year in business, a personal FICO score of at least 600, and an annual gross revenue of $10,000.

Their term loan product comes with same-day funding, and extends $5,000 up to $250,000, with 2 years being the longest payback term. Similarly to an MCA, it’s paid back in daily/weekly or monthly payments, but unlike an MCA, this repayment amount is not based on a factor rate. Instead, OnDeck uses APR. Even with a pricey APR that starts at 35%, that’s still significantly lower than a 100% plus APR equivalent factor rate.

American Express Blue Business Cash™ Card

Though business credit cards are pricey forms of small business funding, the APR’s that they carry can still be lower than those of merchant cash advances. We chose the American Express Blue Business Cash Card for its 0% intro APR rate (available for the first 12 months after account opening). The other benefit of going with American Express if you need a little extra cash is that their cards come with Expanded Buying Power. This means that you can spend more than your credit card limit.

Do note that Expanded Buying Power is not unlimited, and should you choose to spend over your limit, your minimum monthly payment will go up. Plus, if you don’t pay the minimum, the penalty rate will apply to your entire balance, including any amount above the credit limit. Of course, the penalty rate is currently 29.24% (Prime Rate + 25.99%), which could still make this card a cheaper alternative than an MCA.

Last word on merchant cash advances for small business

There are many cheaper alternatives to MCA’s, and we recommend looking into other forms of financing, such as short term lines of credit, first. That said, sometimes an MCA is all a business can qualify for, or presents quick access to cash that other funding options can’t provide. If you decide that an MCA is right for your business, be sure to do your due diligence when shopping around for offers. Here are some quick tips:

• Do not sign a confession of judgment. This allows lenders to collect directly from your bank account.
• Read up on the state that the MCA is registered in and the governing laws in the agreement. For example, if they are registered in New York, the court would be more favorable to these MCA's confession practices.
• Make sure you understand what the repayment terms actually are, and if you can afford them.
• Do your research! Check Trustpilot and Better Business Bureau (BBB).
• Proceed with caution when it comes to very small MCA companies. While some may simply be new startups, some can be bad actors. Keep your wits about you!

MCA’s can help small businesses stay afloat during tough times. Just be sure to fully understand the requirements and operation of such loans before signing any contracts. Being informed and financially savvy when borrowing is always a good idea, no matter what kind of financing product you’re applying for.