Understand the business of selling merchant cash advances


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Ask a Lender
November 2, 2017 | Updated November 6, 2017


Merchant-selling-shawls-and-clothing-in-shop

Key Points

How merchant cash advances sell and profit

  • Merchant cash advances involve little paperwork and are usually funded in much less time than traditional loans.
  • MCAs use factor rates to derive the total costs of the transaction.
  • MCA providers may require a business to have a large amount of income from credit-card sales.
  • MCAs are more lenient about credit scores and don’t require collateral.
  • The actual costs of a cash advance can be deceiving, so it’s important to do the math.

Business owners may not understand how a merchant cash advance works, but it might be important to know the basics of the MCA industry, regardless of whether you ever utilize one.

Merchant cash advances are not loans — they are commercial transactions based on a business’s future credit-card and debit-card income. Since they aren’t business loans, they aren’t governed by the same laws, making them a bit murky for some business owners to grasp.

Entrepreneurs can benefit by knowing how MCA providers operate and make money, as well as the process of applying for, receiving and repaying a cash advance.

MCA fundamentals

Merchant cash advances are available to a variety of businesses, although retailers, restaurants and smaller manufacturers are the most common recipients. They can be attractive to a business owner because they can provide a large chunk of cash in a short amount of time. Traditional bank loans may take 60 to 90 days from application to approval, but MCAs are typically funded in as little as three to five days.

Unlike loans or lines of credit, MCAs do not use an interest rate or annual percentage rate (APR) to calculate total costs. Instead, a factor rate is used to multiply the cash advance. For example, a cash advance of $10,000 with a factor rate of 1.5 means the total cost is $15,000. Factor rates between 1.2 and 1.5 are common.

A business owner repays the advance through a specified amount of credit- and debit-card sales. Some MCA providers use a holdback percentage, meaning the daily, weekly or monthly payments will vary based the business’s sales. For example, if the holdback percentage is 15 percent, the business would pay $1,500 during a month with $10,000 in sales, but only $750 in a month with $5,000 in sales.

Application process

MCAs require less paperwork than bank loans. A business owner may need to provide several months of credit-card and bank statements, as well as some basic information about their business. Often, the entire application process can be done online.

Also, MCA providers are typically less concerned with credit scores, existing debt or repayment history. They may require the business to have been operating for at least a year, or they may require substantial credit-card revenue of $5,000 a month or more.

MCAs are unsecured transactions, meaning the merchant doesn’t need collateral to qualify. Once the advance is approved, the parties sign a contract with several stipulations, such as the amount of future credit-card receipts that will be sold to the MCA provider; the amount of cash the business will receive up front; the percentage of daily or weekly sales that are sold to the provider; and any recourse or penalties if the contract is violated.

Profit motivation

MCA providers look to sell business owners on their product by talking about opportunities for growth through a quick cash infusion. They approach a large number of merchants, knowing that only a small percentage are likely to want or need their product. They may also offer a free credit-card processing machine, or an advance with lower costs than the merchant’s existing lines of credit.

Providers may partner with independent brokers, who approach business owners with offers. Brokers looking to work for everyone’s benefit may try to generate enough capital that a cash advance will more than pay for itself. For example, a business may use a cash advance to buy an expensive piece of equipment that will create a large amount of revenue in a short time. If the revenue is substantially more than the cost of the equipment, plus the cost of a cash advance, the transaction makes sense.

Cash advance providers bank on the broker’s ability to provide quality service during the sales and repayment periods, since they have a stake in the transaction. Brokers are typically paid commissions ranging from 3 to 8 percent of the total transaction.

When considering a cash advance, business owners should understand that providers don’t usually report to credit bureaus, meaning a good repayment history won’t positively impact their credit report.

Also, the costs of a cash advance can be deceiving since the factor rate doesn’t always match up with the holdback percentage. For example, a 12-month cash advance of $50,000 with a factor rate of 1.2 equates to a repayment of $60,000 and an APR of 20 percent. But if you generate $40,000 a month in sales and your daily holdback percentage is 15 percent, you’ll repay the loan in 300 days at an equivalent APR of 45.68 percent, or more than twice what was advertised.

In essence, business owners can be penalized for making more money than projected. Negotiating a lower holdback percentage to minimize the cost of the transaction is something to consider.  


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