What is a merchant cash advance and is it right for your business?

Merchant cash advances (MCAs) have emerged as a popular financing option for businesses seeking quick access to capital.

With the global MCA market expected to reach close to $26.3 billion by 2029, it’s clear that this alternative funding method is gaining traction among entrepreneurs.

But what exactly is a merchant cash advance, and how does it work?

In this comprehensive guide, we’ll dive into the intricacies of MCAs, exploring their benefits, limitations, and how they compare to other financing options.

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What is a Merchant Cash Advance?

A merchant cash advance (MCA) is a form of alternative financing that originated in the United States in the 1990s as a way for businesses to access quick capital without the stringent requirements of traditional loans.

Since then, MCAs have gained popularity among small and medium-sized enterprises (SMEs) across various industries, particularly those with high volumes of credit card sales or consistent revenue streams.

While merchant cash advances are most common in the United States, they have also gained traction in other countries, such as Canada, the United Kingdom, and Australia. In emerging markets like India and Latin America, other products which enable upfront cash have been introduced–for example, revenue-based financing (RBF) and business cash advances–that are personalized to the specific needs and market conditions of each region.

Merchant cash advances are well-suited for businesses with consistent credit or debit card sales or recurring revenue, such as restaurants, retail stores, service providers, and SaaS companies.

This is because one of the primary repayment structures of merchant cash advances is via the card processing facility automatically redirecting payments to the MCA provider - explained further, in the following section. The flexible repayment structure, based on a percentage of daily or weekly sales, makes MCAs attractive for businesses with fluctuating cash flows.

However, MCAs may not be the best fit for all businesses. Compared to traditional startup loans, the higher costs associated with MCAs can make them less suitable for businesses with tight profit margins or those that cannot afford the daily or weekly repayment deductions.

Additionally, businesses without a consistent sales history or a significant portion of their revenue coming from credit or debit card sales may find it challenging to qualify for a merchant cash advance.

Merchant Cash Advance vs Business Cash Advance

Merchant cash advances and business cash advances are often used interchangeably, as they both refer to the same type of financing. However, some providers may use a business cash advance to describe a slightly different product that involves a fixed daily or weekly repayment amount rather than a percentage of card sales.

Merchant Cash Advance Example

Imagine a SaaS company that provides marketing automation software to small businesses. The company is experiencing a surge in demand and needs $100,000 to hire additional developers and expand its infrastructure.

The SaaS company opts for a merchant cash advance, which is approved for the full amount. The MCA provider agrees to purchase $140,000 worth of the company’s future revenue, which will be repaid through a 12% deduction from the company’s daily income.

As the SaaS company generates revenue through subscription fees and other services, the MCA provider automatically collects 12% of each day’s income until the full $140,000 is repaid, in addition to any fee the MCA provider charges. This allows the SaaS company to access the capital it needs–without worrying about fixed monthly payments, as the repayment is directly linked to its revenue stream.

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How Does a Merchant Cash Advance Work?

A merchant cash advance provides businesses with a lump sum of capital upfront in exchange for a portion of their future sales. The MCA provider purchases a specific amount of the business’s future revenue at a discounted rate, which is then repaid through a percentage of the business’s daily or weekly sales.

The repayment process is automated, with the MCA provider collecting a fixed percentage of the business’s credit card sales or revenue until the total purchased amount is repaid. This percentage, known as the holdback rate, typically ranges from 10% to 20% of daily sales.

How MCA Repayment Works

There are two primary ways repayment works:

1. Credit card sales withholding: If most or all of your sales are card-based, the MCA provider works with your payment processor to take a small percentage of your sales. It’s an automatic payment from your processor to the MCA provider.

2. Bank account withdrawals or fixed payments: If you don’t have many credit card sales, the MCA provider might take withdrawals from your bank account. It’s typically a fixed amount every week or day. They also might take “split payments,” which is a fixed part of each sale you make.

Who Can Apply For a Merchant Cash Advance?

Merchant cash advances are designed for businesses that generate a significant portion of their revenue through card sales or otherwise have a consistent revenue stream. That’s why merchant cash advances are a popular option for businesses in retail, restaurant, and service industries, as well as SaaS companies with recurring revenue models.

Merchant Cash Advance Eligibility

To be eligible for a merchant cash advance, businesses typically need to meet the following criteria:

• Have been in operation for at least 6 months
• Generate a minimum monthly revenue of $10,000
• Have a consistent history of credit card sales or revenue
• Have no open bankruptcies or serious tax liens

Compared to traditional loans, MCAs often have more lenient eligibility requirements, making them accessible to businesses that may not qualify for other forms of financing.

Merchant Cash Advance Rates and Fees

The cost of a merchant cash advance is determined by a factor rate, which typically ranges from 1.2 to 1.5. To calculate the total repayment amount, multiply the cash advance amount by the factor rate. For example, if a business receives a $100,000 cash advance with a factor rate of 1.4, the total repayment amount would be $140,000. For businesses looking for lower rates, they might consider an alternative financing option like revenue-based finance with a 1.1x rate.

In addition to the factor rate, merchant cash advances may also come with additional fees, such as origination fees, underwriting fees, and closing costs. These fees can vary depending on the provider and the specific terms of the cash advance.

It’s essential for businesses to carefully review the rates and fees associated with an MCA before accepting the financing, as the total cost can be higher than traditional loans.

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Pros and Cons of MCAs

Here are some factors on whether or not you should consider merchant cash advances.

Benefits of Merchant Cash Advance

• MCAs provide fast access to capital, with funding often available within a few days of application
• The flexible repayment terms of MCAs allow businesses to repay the cash advance via a percentage of their daily or weekly sales, which can be beneficial for those with seasonal or fluctuating revenue
• MCAs do not require collateral, making them an attractive option for businesses that do not have valuable assets to secure financing.
• Compared to traditional loans, MCAs have more lenient eligibility requirements, making them accessible to businesses with less-than-perfect credit scores or limited operating history
• MCA financing can be used for a wide range of business purposes, such as purchasing inventory, hiring staff, expanding marketing efforts, or investing in new equipment

Merchant Cash Advance Limitations

• MCAs have a higher cost of capital compared to traditional loans because of factor rates
• The daily or weekly repayment deductions associated with MCAs can strain cash flow, particularly for businesses with tight profit margins or inconsistent sales
• MCAs are not subject to the same level of federal regulation as traditional loans, which can lead to less transparency and potential for predatory lending practices
• Businesses that take on MCAs without carefully considering their ability to repay may find themselves in a cycle of debt, constantly seeking new advances to cover the repayment of previous ones
• Most MCA providers do not report payment history to credit bureaus, so successfully repaying an MCA may not help improve a business’s credit score

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Alternatives to Merchant Cash Advances

Merchant cash advances aren’t the right fit for every business. If you’re looking for funding options without factor rates or repayment deductions, here are some great alternatives for financing your startup.

1. Revenue-based Financing

Revenue-based financing is a form of financing where companies receive a capital infusion with a fixed repayment period and then make smaller payments over time, typically over 12-24 months. For example, an RBF company could offer a startup $500,000. The startup would pay back $500,000 as well as the predetermined fee through periodic installments - for example, the startup may pay a flat 10% fee of $50,000 alongside the principal $500,000.

Pros:

• No equity dilution or loss of control
• Faster application process compared to traditional loans
• Flexible use of funds
• No warrants or collateral required
• Generally cheaper than Merchant Cash Advances

Cons:

• Requires consistent revenue streams
• May have shorter repayment terms than some financing options like bank loans and venture debt

With Efficient Capital Labs’ revenue-based financing, there are no hidden fees–just fixed monthly payments depending on your annual recurring revenue that follow a clear fee structure of either 10–12% (if accessing a financing in US Dollars) or 12–15% (if accessing a financing in Indian Rupees). Startups can access funding in 72 hours–without giving up equity or control.

Merchant Cash Advance vs Revenue-based Financing

MCAs typically have higher factor rates and daily repayment obligations, which can strain cash flow. In contrast, RBF providers like ECL offer fixed repayment terms based on an estimate of future revenue, providing more predictability for businesses.

ECL’s RBF model synergizes perfectly with SaaS companies and businesses with recurring revenue streams. With funding available in as little as three days and zero hidden fees, ECL allows your company to scale at an affordable price—without losing equity or control.

Apply here to get up to $1.5 million in funding

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2. Small Business Loan

Small business loans are a traditional form of financing offered by banks and financial institutions. These loans provide businesses with a lump sum of capital that is repaid over a fixed term with interest.

Pros:

• Longer repayment terms, often several years
• Builds business credit history
• Fixed monthly payments for easier budgeting

Cons:

• Stringent eligibility requirements, including credit scores and collateral
• Longer application and approval process
• May require personal guarantees
• Less flexibility in the use of funds

Merchant Cash Advance vs Small Business Loan

MCAs are often easier to qualify for than small business loans and provide faster access to capital. However, small business loans typically have lower interest rates and longer repayment terms. Businesses with strong credit profiles and collateral may find small business loans to be a more cost-effective option in the long run.

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3. Invoice Factoring

Invoice factoring is a financing solution where businesses sell their outstanding invoices to a factoring company at a discount in exchange for immediate cash. The factoring company then collects payment directly from the business’s customers.

Pros:

• Fast access to cash tied up in unpaid invoices
• No debt or loans to repay
• Flexible funding that grows with your sales

Cons:

• Higher fees compared to traditional loans
• Limited to businesses with invoiced sales to creditworthy customers
• May impact customer relationships if not managed properly - this is because the invoice factoring company may become involved in the collection of customer payment

Merchant Cash Advance vs Invoice Factoring

While both MCAs and invoice factoring provide fast access to capital, invoice factoring is limited to businesses with outstanding invoices. MCAs, on the other hand, can be used by businesses with consistent card sales or revenue streams.

However, invoice factoring may be a more cost-effective option for businesses with a high volume of invoiced sales to reliable customers.

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More About MCAs

Let’s take a look at some of the most common questions about merchant cash advances.

Does a merchant cash advance affect your credit?

Merchant cash advances generally do not impact your credit score, as most MCA providers do not report to credit bureaus. However, some providers may conduct a soft credit check during the application process, which does not affect your credit score.

Can you get a merchant cash advance with low credit?

Yes, it’s possible to obtain a merchant cash advance with low credit. MCAs typically have more lenient eligibility requirements compared to traditional loans, focusing more on the business’s sales and revenue rather than the owner’s personal credit score.

How do you get out of a merchant cash advance?

To get out of a merchant cash advance, you can either pay off the remaining balance in full or attempt to negotiate a settlement with the MCA provider. However, you should carefully review the terms of your agreement, as some providers may impose prepayment penalties or other fees for early repayment.

Is a merchant cash advance a loan?

No, a merchant cash advance is not technically a loan. Instead, it is a commercial transaction in which a business sells a portion of its future sales or revenue to the MCA provider in exchange for upfront capital.

What happens if you default on a merchant cash advance?

If you default on a merchant cash advance, the consequences can potentially be severe. MCA providers may take legal action to recover the funds, which can result in judgments, liens on your business assets, or even forced bankruptcy. It’s crucial to carefully assess your ability to repay an MCA before entering into an agreement.

Are merchant cash advances a good idea?

Whether a merchant cash advance is a good idea depends on your business’s specific needs and financial situation. MCAs can provide fast access to capital and have flexible eligibility requirements, making them a viable option for some businesses. However, the high costs might lead to startups to consider a more affordable funding alternative, like revenue-based financing.

Are merchant cash advances legal?

Yes, merchant cash advances are legal in most countries, including the United States. However, the regulatory oversight of MCAs varies by jurisdiction, and some states have implemented additional regulations to protect businesses from predatory lending practices.

Are merchant cash advances tax deductible?

In most cases, the fees associated with a merchant cash advance are tax-deductible as a business expense. However, you should consult with a tax professional to determine the specific tax implications for your business and ensure proper documentation of the expenses.

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Is a Merchant Cash Advance Right For Your Business?

Merchant cash advances can provide fast capital and have flexible eligibility requirements, but they come with high costs and risks that may not suit every business. When exploring financing options, consider alternatives like revenue-based financing that offer a more cost-effective solution for businesses with consistent revenue.

Efficient Capital Labs provides non-dilutive RBF to SaaS companies and businesses with recurring revenue. You can access funding in just three days, maintain equity, and benefit from financing without the hassle of credit checks, interest rates, or lengthy applications.

With a 75%+ repeat customer rate, you can join over 100 global SaaS founders who’ve found success with ECL.

Apply here in under 10 minutes to see how much capital you can access and get funding in less than 72 hours.

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