Merchant cash advance (MCA) is an alternative to traditional loans in providing spendable cash to businesses. A merchant cash advance company extends funds in exchange for a portion of daily customer credit card purchases. Most MCA companies form a partnership with credit card processors to collect their fees on a percentage basis. These payments are collected from each day’s credit card receipts until the financial obligation is repaid.
Problems with Traditional Funding
Qualifying for traditional bank loans can be difficult for many businesses. If you’ve had previous credit problems, the bank may require some guarantees, such as using your business or personal property as security. In many cases, a traditional loan is dependent on using the money for a specific purpose only, such as buying new delivery vehicles.
These are not loans, but the sale of a portion of future sales. Because it isn’t a loan, some cash advance companies may charge higher rates, as they aren’t bound by usury laws. However, a merchant cash advance does provide some advantages over commercial loans, and competition in the industry has led to a drop in rates.
How it works
Since payments are based on a percentage of sales rather than a fixed amount, fluctuations in daily credit or debit card sales directly affect how much is paid toward the obligation. In times of high volume sales, larger payments are made, and in times of low sales payments remain low.
As one simple example, suppose you own a retail store and are in need of $25,000 for general upgrades and stocking up on holiday inventory. You can sell $30,000 worth of future credit card sales to an MCA company. The finance company offers you a $25,000 lump payment, and then collects 16 percent of every credit card purchase until the $30,000 is repaid.
Terms are usually established to ensure repayment within about 12 months. Depending on the finance company, there may also be different methods by which the obligation is repaid:
The credit card processor splits credit card payments according to the percentage. In the above example, you would get 84 percent and the MCA 16 percent of daily sales.
Often called trust account withholding, in this method all credit card payments you take at your store are deposited to a bank account under control of the finance company, who forwards the agreed-upon portion to you. However, this can create a delay of a day or more before you receive your share of proceeds.
Automated Clearing House (https://www.thebalance.com/how-ach-payments-work-315441) Withholding
The finance company gets a copy of all transactions and is authorized to collect its portion from your checking account. This may be structured more like a loan so that only a fixed amount is taken each day.
Benefits of MCA
MCA funds from a finance company also tend to be quicker to process and receive, sometimes within a few days. Because MCA is not reliant on credit scores, small or new businesses with limited credit that can’t get conventional loans may be able to get cash advances if they have good cash flows.
Because the amount involved is considered a cash payment and not a loan, your company can spend the money any way you like. This offers greater flexibility in meeting various business needs.
Repayment is easier; the sums involved are automatically drawn from batch processing of credit/debit card payments, and automatically delivered to the finance company. Because it’s a percentage rather than a fixed amount, repayment budgets itself, and you don’t have to worry about coming up with additional money if sales slump.
How the payment is determined
Merchants must understand two different rates when seeking MCA funding.
The first is that the finance company figures its profits as a factor rate. Since there’s no fixed timeframe, there’s no interest rate. The factor rate is usually between 1.1 and 1.5. So, if your company borrows $10,000 at a factor of 1.2, you’ll end up paying back $12,000.
The second is the percentage of sales that are paid out. If you agree to 15 percent, and credit card sales on Monday are $2,200, the payment withheld is $330. If credit card sales on Tuesday total $1,400, the payment withheld is $210.
This provides an excellent funding opportunity to business owners who can’t qualify for a bank loan. You many need the money for a variety of minor purposes, such as parking lot repairs, settling bills, or upgrading POS systems, which traditional lenders would refuse. An MCA provides funds faster than traditional lenders, and with automated payments scaled to changes in revenue to make repayment easier.