A cash advance from a merchant is different from a standard small business loan. Sometimes known as MCAs, they can provide businesses with cash quickly. Many lenders don’t view it as a loan because they offer business guarantees in return for a portion of the business’s future sales. Before you decide if a cash advance from a merchant is right for you, let’s take a look at how they work.
What is a merchant cash advance?
A cash advance from a merchant is not technically a loan. Instead, a lender provides a business with a cash advance, usually in the form of a lump sum, which is deposited into the borrower’s bank account within 24 to 48 hours.
According to GreenStarCashMCAs are similar to personal payday loans in that the money loaned should be repaid when the borrower receives income. In the case of payday loans, it is the borrower’s paycheck; for businesses, it means future sales.
The risk of the loan and the amount the lender will offer is determined differently from how banks or institutions approve small business loans. Usually, before extending a merchant cash advance, the lender will take into account the past and current sales of your business. This will help them assess the likelihood that the advance will be repaid on time. Due to the risk inherent in sales volatility, MCA rates may be higher than other loan options.
How does a merchant cash advance work?
Although merchant cash advances were historically only offered to businesses that relied on debit and credit card sales, the offers have grown. Indeed, MCAs can be structured in two ways.
The first is the most common. A lender evaluates the history, sales and projected income of your business. Based on these numbers, they can determine how likely your business is to repay the advance and how long that will take. Then the lender provides you with an advance or a lump sum of cash based on the future income of your business.
They also set a refund rate that will be taken from your credit or debit card sales. This is called withholding. Hold is the daily or monthly percentage of your business’s credit and debit card sales that will be used to pay off your MCA. This is usually a fixed rate and can range from 10 to 20 percent.
Fees will also be allocated, this is called the factor rate. It is based on the risk and likelihood of repayment of your business. The factor rate is generally between 1.2 and 1.5 percent.
Therefore, the more transactions your business makes, the faster you will be able to repay your advance. If you happen to have a slow period, the money taken as reimbursement will be less. Since the amount you pay on the advance depends on your sales, it may be easier to pay off your debt systematically.
For example, if your business needs $ 20,000 to purchase inventory. The lender will give you a MCA of $ 20,000, but will also give you a 1.4 factor rate. This means that you will have to pay back $ 28,000 in total. They will deduct 10% of your monthly credit and debit sales until you have paid off the loan in full.
The second option is fixed weekly or daily deposits from a bank account. This is called an ACH Merchant Cash Advance. The lender estimates your monthly income and then assigns an amount to be deducted from your account at regular intervals. This type can be ideal for businesses that do not rely heavily on credit or debit transactions. However, the refund amount is unrelated to your sales. The amount deducted will not fluctuate no matter how low last month’s income was.
Why do companies choose an MCA?
They are fast
A cash advance from the merchant can be a great option for some small businesses. They are quick and easy. In most cases, the lender will review your receipts to determine eligibility. The application process is neither complicated nor red tape. You can have the money in your account as early as 24 hours after approval.
The reimbursement amount is variable
A variable repayment amount based on sales is preferred by most small businesses. If you’ve had a lackluster month, you won’t have to worry about raising funds. When your sales go down, your payout goes down as well.
No physical warranty required
Unlike other types of loans, your business won’t have to put up valuable physical assets to secure a cash advance. This means that if you fail to repay your loan, you will not risk taking your assets. However, in some cases a personal guarantee is required. Therefore, if your business cannot repay, you are personally responsible for the remaining debt.
Is an MCA Right for Me?
Whether or not a merchant cash advance is right for you depends on several factors. You know your business better. Funds are generally easy to secure and are deposited quickly. While the refund amount is tied to your sales, the fees and APRs associated with ACMs can be high. Make sure you read the agreement carefully and consider alternatives before making a decision.