Is a merchant cash advance right for your business needs?

The merchant cash advance (MCA) market is expected to experience significant growth between 2023 and 2030, according to Absolute Reports. This expansion is driven by the rising demand for funding across a spectrum of businesses, from smaller ventures seeking under $250,000 to established companies requiring over $500,000. 

Several factors contribute to this upward trajectory, including the size and specific market segment, emerging industry trends, overall sales volume, and the dynamic interplay between supply and demand.

Running a small or medium-sized business (SMB) can be exciting, but it also presents unique financial challenges. Whether it's maintaining smooth operations, investing in growth, or managing unexpected expenses, access to capital is crucial. 

In these scenarios, the promise of quick capital through a merchant cash advance can seem appealing. However, while MCAs offer rapid access to funds, you must first fully understand how they work and carefully consider if they are the right fit for your business needs.

What is a merchant cash advance?

A merchant cash advance is a type of financing that provides businesses with a lump sum of cash upfront in exchange for a percentage of their future sales revenue. Unlike traditional loans, MCAs don't legally qualify as loans because the funding essentially represents an advance on future sales.

An MCA is straightforward: a lender provides a company with a lump sum. Repayment occurs through a predetermined percentage of the business's daily or weekly credit card and debit card sales. This arrangement continues until the entire advance and any associated fees are repaid.

Key concepts of a merchant cash advance include:

• Factor rate: This is the primary way MCA providers determine the cost of the advance. It's expressed as a decimal (e.g., 1.2) and is multiplied by the advance amount to calculate the total repayment. For instance, a $10,000 advance with a 1.2 factor rate means you'll repay $12,000 in total
• Holdback percentage: This refers to the percentage of the daily or weekly credit card sales that the MCA provider automatically deducts to repay the advance. The holdback percentage is determined based on the business's sales volume and risk profile
• Repayment period: MCA repayment periods are flexible and depend on the sales volume. Faster sales generally lead to quicker settlement, while slower sales can extend its duration

How does a merchant cash advance work?

Applying for a merchant cash advance is relatively simple compared to traditional lending. Businesses can complete much of the process online, minimizing paperwork. 

The Federal Reserve’s 2024 Report on Employer Firms reveals that 82% of small businesses seeking MCA funding received either full or partial approval in 2023, underscoring their accessibility compared to traditional lending.

Keep in mind, though, that the exact merchant cash advance requirements can vary depending on the provider, so it's always a good idea to check their specific criteria. Nevertheless, there are a few documents that you’ll typically need to provide:

• Business plan: Objectives, strategies, and potential for growth
• Financial statements: A detailed overview of the financial situation through balance sheets, income statements, and cashflow statements
• Business banking information: Bank account number and routing number to set up the repayment process
• Bank statements: Most MCA providers will request at least three months' worth of bank statements from the business to assess its financial health and revenue trends
• Credit card processing statements: If the MCA is to be repaid through a percentage of credit card sales, the provider will typically request at least three months' worth of credit card processing statements from the company to determine its average credit card sales and set an appropriate repayment percentage
• Tax returns: The provider may request to see the business's tax returns for additional insight into its financial situation
• Identification: A valid form of identification, such as a driver's license or passport
• Other legal documents: Depending on the nature of the firm and the MCA, the provider may request additional legal documents

Upon approval, the company receives a lump sum advance payment within a few days. The advance amount depends on monthly card revenues but often ranges from $5,000 to $500,000.

The way an MCA is repaid can vary, with two main structures being used:

• Sales-based repayment: In this structure, the MCA provider takes a percentage of the business's daily (or weekly) debit and credit card sales. This continues until the full amount of the advance, along with the provider's fees, has been repaid
• Fixed-amount repayment: The MCA provider can also take a fixed amount from the firm's bank account on a daily or weekly basis. This amount is determined based on the business's average monthly revenue

Merchant cash advances pros and cons

Merchant cash advances can be a lifeline for businesses in need of quick cash, but they also come with potential drawbacks. Understanding both sides of the coin is essential before diving into this type of financing. 

Let's take a closer look at merchant cash advances pros and cons:

Pros

• Speed and efficiency: MCAs stand out for their fast approval and funding speed, often providing access to capital within a few days, sometimes even within 24 hours
• Flexible requirements: Compared to traditional loans, MCAs often have more lenient eligibility criteria, making them accessible to businesses with less-than-perfect credit histories or those who might not qualify for conventional financing
• Automated repayments: The automated deduction from your sales revenue simplifies the process and eliminates the need for manual payments. This structure also means your settlement amounts fluctuate with your sales, offering flexibility during slower periods

Cons

• High costs: MCAs typically come with higher costs than traditional loans, reflected in their factor rates, which can translate to a significant annual percentage rate (APR)
• Potential for debt cycle: The quick access to cash and relatively easy approval process, while beneficial in certain situations, can lead to over-reliance on MCAs, potentially trapping companies in a cycle of debt if not managed carefully
• Impact on cashflow: The daily or weekly deductions from your sales revenue, while designed to be manageable, can impact your cashflow, particularly during slower business periods

Alternatives to merchant cash advances

While MCAs can be a viable option for short-term needs, exploring alternative financing options is crucial to make better decisions for your business's financial health.

1. Revenue-based financing 

Revenue-based financing (RBF) is a type of funding where investors inject capital into a business in exchange for a percentage of its ongoing gross revenues. This percentage is paid until the investor recoups a predetermined amount, typically a multiple of their original investment.

Unlike traditional equity financing, RBF does not dilute ownership, and it provides more flexibility than a bank loan. It's attractive for businesses seeking growth and control.

💡 Key difference to merchant cash advance: 

• Lower costs: RBF generally has lower costs compared to MCAs, making it a more affordable option
• Repayment flexibility: Like MCAs, repayments adjust based on revenue, but RBF terms might be more favorable

Are you an eCommerce or SaaS business looking for a financing alternative? Revenue-based financing may be a perfect fit for you.

2. Invoice financing

Invoice financing (IF), also known as factoring, is a way for businesses to borrow money against the amounts due from customers. It can be a useful option for operations that have a lot of money tied up in outstanding invoices.

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There are different types of invoice financing, such as recourse and non-recourse. With recourse factoring, the business is responsible for repaying the lender if the customer doesn't pay. With non-recourse factoring, the lender takes on this risk.

💡 Key difference to merchant cash advance: 

• Repayment mechanism: Instead of deducting a percentage of daily sales, invoice financing provides funds based on outstanding invoices
• Cost and terms: IF typically has clearer terms and potentially lower costs compared to the high factor rates of MCAs
• Focus on B2B: Invoice financing is primarily geared towards B2B businesses and have longer invoice cycles

3. Term loans

A term loan is a loan option that has a fixed amortization schedule and a specified maturity date. The borrower receives a lump sum of money upfront and repays it, with interest, over a set period.

Term loans can be a good option for businesses that need to finance a specific project or purchase and can afford to make regular repayments. They can be secured or unsecured, and the interest rate can be fixed or variable.

💡 Key difference to merchant cash advance: 

• Predictable payments: Term loans offer fixed monthly payments, making it easier to budget and manage the cashflow
• More stringent requirements: These loans have stricter eligibility requirements, including a good credit history and strong financials

4. Business lines of credit

A business line of credit is a flexible financing option that allows organizations to borrow up to a certain limit, as and when they need it. It's similar to a credit card because businesses only pay interest on the amount they borrow, not on the full limit.

Lines of credit can be a useful option for managing cashflow, financing short-term projects, or dealing with unexpected expenses. They can be secured or unsecured, and the interest rate can be fixed or variable.

💡 Key difference to merchant cash advance: 

• Lower costs for short-term needs: Lines of credit can be more cost-effective than MCAs for short-term financing needs
• Requires good credit: Qualifying for a business line of credit usually requires a good credit history and a solid financial track record

5. Asset-based loans

Asset-based loans are a type of financing where businesses can borrow money against the value of their assets. These can include property, equipment, or inventory. Stock financing, for example, can be a good option for those who have significant assets but may struggle to secure a traditional loan. 

💡 Key difference to merchant cash advance: 

• Potentially lower costs: Securing the loan with collateral can result in lower interest rates or factor rates
• Requires appraisal: Lenders will typically require an appraisal of your assets to determine their value and your borrowing capacity

Learn more about asset-based lending and how it works.

Frequently asked questions about merchant cash advance

What happens if you can't pay back a merchant cash advance?

Failing to repay a merchant cash advance can lead to additional fees, legal action, and potential damage to your credit score. It’s crucial to communicate with the lender and explore potential solutions if repayment becomes challenging.

Is a merchant cash advance bad?

Merchant cash advance is not inherently bad, but it can be costly and may not suit every need. High factor rates and frequent repayments can strain cashflow. Businesses should carefully evaluate their financial situation and consider their options before opting for an MCA.

What is the difference between an MCA and a loan?

Merchant cash advances are not technically loans, as they involve an advance on future sales rather than a traditional loan agreement. MCAs also have different repayment structures, qualification criteria, and regulations than traditional loans.

How to calculate the cost of a merchant cash advance?

To calculate the total cost of a merchant cash advance, consider the advance amount, factor rate, and any additional fees. Multiply the advance amount by the factor rate to determine your total repayment amount. For example, a $10,000 advance with a 1.3 factor rate results in a total of $13,000 ($10,000 x 1.3).

Are merchant cash advances a good idea?

For businesses facing urgent capital shortfalls or temporary slow periods, quick access to funds from MCAs can be invaluable. But you need to read the agreements carefully, consult professionals, and compare alternative financing options first.

Before you sign on the dotted line, remember that MCAs come with their own set of rules – and those rules aren't always playing on your team. It's crucial to read those terms with a fine-tooth comb and understand exactly what you're signing up for.

Here's the thing, though: you deserve better than a financial band-aid. You need a funding solution that fuels sustainable growth, not just a temporary fix.

That's where Stenn comes in. We're all about providing flexible financing options like revenue-based financing and invoice factoring – designed to give you the capital you need with terms that support your long-term success.

Ready to explore financing that's built for your success? Let's talk.