Merchant Cash Advances (MCAs) are where a business receives an upfront cash advance in exchange for a percentage of their future credit card and debit card sales. It’s easy to implement as payment processing companies automatically send a percentage of a business’s daily sales to MCA lenders, or the lender directly debits the business’s bank account.
Small business lenders and investors offer MCAs because they offer better returns on their investment compared to other types of small business loans. There is potential upside if the business’s sales grow faster than expected so they pay back the MCA faster rather than waiting on term loan payments.
MCAs are similar to business loans because companies get a lump sum of cash, but they’re different because you pay back MCAs based on your daily/weekly/monthly sales and not with set payment amounts in a specific timeframe like business loans. This makes MCAs a good fit for businesses with rapidly growing cash flows that can’t wait for the loan underwriting process or for businesses that can’t get approved for a traditional business loan and need cash fast.
Whether you need financing quickly to restock inventory or are planning for the future, this guide takes you through all you need to know about how MCAs work, when to use them, and how they compare to other types of small business financing.
How Merchant Cash Advances Work
Merchant cash advances work by giving small businesses a lump sum payment in cash in exchange for a percentage of future sales until the advance, and sometimes a bit extra if negotiated, is paid back. The MCA process follows three easy steps:
- A business negotiates contract terms with an MCA lender.
- The MCA lender provides the cash advance, and the borrower begins repaying a percentage of new sales until the debt is paid off.
- Once all debts are paid, the borrower finalizes the payoff and checks that all UCC liens are terminated.
- If the UCC filing or lien is not terminated, the MCA lender may clear it for the borrower, freeing up their collateral for future financing.
Here’s what to expect during each step in the merchant cash advance process.
Negotiate MCA Contract Terms
Merchant cash advances have terms and conditions that you can negotiate including:
- The factor rate/fee.
- Additional administration fees.
- Repayment periods.
- Payment frequencies.
- Payment structures.
- Default remedies.
Factor fees are the main way MCA lenders make money as this is the amount that gets added to the advance for your total owed. It is similar to interest payments on a loan.
You can calculate the factor fee from the factor rate with this formula:
- Advance amount * Factor rate – Advance amount = Factor fee
- If you take a $100,000 advance with a factor rate of 1.2, the factor fee will be $20,000. You’ll have to repay $120,000 plus any additional fees from your contract.
Merchant cash advance companies set the factor rate based on your risk of not paying them back and how long they think you’ll take to pay them back. Riskier borrowers and companies that take longer to repay get higher factor rates since that’s the main way MCA lenders make a return on their investment.
Pro-tip: Watch for additional fees like processing fee, origination fee, ACH fees, wire fees, and others as some may or may not be legitimate depending on your situation. Have a lawyer review the contract to advise which fees make sense and which are simply adding to the lender’s profit.
Most merchant cash advances are marketed as “asset sales” instead of loans, meaning they will have no set repayment period. Instead, you pay more or less as your sales go up and down over time until you’ve repaid the full amount. That’s another reason why lenders use higher factor rates if they think you’ll take longer to repay the advance. Companies with highly seasonal sales and big changes year to year will get higher factor rates than companies with steadily growing revenue.
Payment frequencies are how often you make payments to the lender. Daily, weekly, and monthly are the most common payment frequencies with merchant cash advances. More frequent payments make a huge difference in the true cost of a merchant cash advance, because they can make the annual percentage rate (APR) higher than traditional small business loans over the same period. Here’s an example.
| Merchant Cash Advance | Small Business Loan | |
| Factor rate | 1.2 | N/A |
| Interest rate | N/A | 20% |
| Additional fees | $0 | $0 |
| Payback period | 1 year | 1 year |
| Payment frequency | Daily | Monthly |
| APR | 41.55% | 21.94% |
Payment structure is whether you have a true holdback percentage of sales where you pay the MCA lender 10% each day whether you had $1 or $100,000 in sales. True percentage agreements are rare, and most lenders offer flat daily payments with what’s called “true up.”
A true up is where the lender takes the same amount from your bank account each day, then reconciles with your total sales at the end of the week or month. If sales were higher than expected, you could owe them more to true up. If sales were lower, they would owe you a refund.
Having a fixed payment structure and higher frequency gives you much less flexibility to manage cash flow through the month, so forecast your sales to see how cash flow looks. Consider this example comparing a 25% of sales fee versus a flat $250 per day with true up at the end of the week:
| Day | 1 | 2 | 3 | 4 | 5 | 6 | 7 | Week’s Total |
| Sales | $1,000 | $889 | $1,130 | $1,241 | $713 | $610 | $956 | $6,539 |
| Minus 25% | $750 | $667 | $848 | $931 | $535 | $458 | $717 | $4,904 |
| Minus $250 fee | $750 | $639 | $880 | $991 | $463 | $360 | $706 | $4,789 |
| Extra Owed | $115 |
You would owe the company an extra $115 at week’s end to true up to 25% of sales. Missing this payment could trigger a default, forcing you to repay the total balance or trigger legal action. The opposite is also possible where the MCA company owes you cash. In that case, you miss the chance to use the amount you overpaid on other needs for your business.
Default remedies are the terms that allow merchant cash advance lenders to take legal action if you default. Because most MCAs are marketed as asset sales instead of loans, the lenders don’t have the same priority to be paid as business loan lenders if you end up in bankruptcy. This is why they’ll ask you to sign a confession of judgement (COJ).
A COJ gives them the right to immediately start seizing assets the moment you default without having to go through the court system. This is if they are allowed, as they are prohibited in some states, so check the legalities. So, if your agreement treats a single late payment as a default, the MCA lender could start seizing your business assets the next day. Have a lawyer review any COJ before you sign and only agree to it as a last resort.
Cash Advance and Repayment
After you negotiate and sign the agreement, the lender will put the cash advance into your bank account and set up direct payments either from your bank account or via the payment processing companies used in your agreement like Visa, Mastercard, etc. They’ll send a percentage of each day’s sales to the MCA lender and the rest to you.
Finalizing Payoff and Public Records Check
To finalize the payoff, keep detailed records of your payments to the lender and get a payoff statement showing your remaining balance the moment you hit $0. Use that to cancel the debit authorization through your bank if they have been withdrawing directly and terminate the split payment with credit card companies.
Make sure to get an official confirmation of the termination from your bank and/or credit card companies, and double check your statements for the next couple months to make sure you did not send any extra money to the lender.
The final thing to do is make sure any public records related to the MCA are cleared. The lender will likely file a UCC-1 when you take the loan, which is what documents their claim to your assets (the percentage of future sales) in public record. When you pay it off, they should file a UCC-3 termination that documents your payoff and releases their claim in the public record.
Your Secretary of State’s website like this one from Massachusetts will let you search for UCC filings on your company. If the lender hasn’t filed the UCC-3 to terminate their claim, contact your Secretary of State and they’ll walk you through the process to fix the public record yourself.
Situations to Use Merchant Cash Advances
There are 2 main financial situations where merchant cash advances are a good fit:
- You can’t qualify for a small business loan.
- You don’t have time to wait through the business loan approval process.
MCAs can be a fit for new businesses that have trouble qualifying for a small business loan because they don’t have a strong enough business credit score or enough business history to meet a traditional lender’s requirements.
It could also be for established businesses that have enough history but can’t come up with cash for a deposit or enough collateral to secure a loan. For situations like this, an alternative is using invoice factoring where you sell customer invoices to get the cash for a down payment and using a personal guarantee to offset the collateral requirements. Or use specific loan types like inventory financing or equipment financing that use the asset you’re buying as collateral for the loan.
When you need cash immediately because of an emergency or a time-limited business opportunity, MCAs can work because the approval process is quicker than traditional business loans. An additional benefit is that you wouldn’t have to commit to set payment amounts each month with an MCA in case it takes you longer to recover lost revenue, like after a hurricane or flood.
Time-limited opportunities could be buying a property you’ve always wanted that will sell at auction in under 24 hours or chasing inventory before a holiday because you sold out and can’t meet customer demand. The best alternative for these types of situations is to plan ahead by getting a line of credit so you have access to capital when you need it and you’ll be able to pay it back fast. Depending on the total amount of money you need, business credit cards could also work.
Here’s a comparison of merchant cash advances with different types of small business funding so you can choose the best option for your situation.
MCAs Versus Other Financing Types
The choice between merchant cash advances versus other types of small business financing comes down to how fast you need the cash, collateral requirement, how you pay it back (if at all), whether it helps build your business credit score, and how much it costs. Check out this table:
| MCA | Revenue Based Financing | Invoice Factoring | Small Business Loan | Line of Credit | Business Credit Card | Equity | |
| Fast Cash | Yes | Yes | Yes | Varies | Yes | Yes | No |
| Requires Collateral | No | No | No | Yes | No | No | No |
| Set payback period | No | No | N/A | Yes | No | No | N/A |
| Set payment schedule | Yes | Yes | N/A | Yes | Yes | Yes | N/A |
| Early payoff | No benefit | No benefit | N/A | Either penalty or benefit | N/A | N/A | N/A |
| Builds your business credit score | No | No | No | Varies | Yes | Yes | No |
| Cost | High | High | Depends | Low | Low | Depends | Depends |
Revenue Based Financing (RBF)
Revenue based financing is almost exactly like a merchant cash advance, but instead of being tied to card sales it often takes a percentage of cash, check, and other non-card payments. The other difference is that RBF funding is usually monthly payments like a small business loan vs more frequent payments like with an MCA.
This often makes it cheaper versus MCAs and it gives you more flexibility to manage monthly cash flows. The drawback is that RBF takes a percentage of all sales making it more difficult to track, pay, and plan for.
Invoice Factoring
Invoice factoring is where you sell invoices or accounts receivable for a discount to get cash and the third party you sell to collects the payment from your customer. That makes it like an MCA where you’re selling future cash flow from sales, but invoice factoring is a true sale where you don’t have anything to pay back. The downside versus an MCA is that factoring will take longer since the factoring company still needs to underwrite the customer’s ability to pay their invoice.
Small Business Loans
Small business loans are cheaper than merchant cash advances, but the approval process takes longer with traditional banks, and there are more requirements to get approved like collateral, good business credit score, and longer business history for your company. Alternative lenders can often provide quicker approvals in most situations, but the interest rates may be higher than those of a traditional bank.
Business loan marketplaces like us have relationships with lenders so we can help you find the best financing solutions for your needs, saving you valuable time.
Line of Credit
Lines of credit give you cash even faster than an MCA when you already have one with an available balance, and they’re cheaper on average than an MCA. They might not get you all the money you need though, and if you don’t already have one approved, then an MCA approval process may be faster.
Business Credit Cards
Business credit cards give you faster access to cash than merchant cash advances as long as you have enough of a credit limit on the card for your needs. Even if you don’t have a credit card for your business yet, getting one approved can be as quick as an MCA, as it can be done online or in person at a bank location, but it might not give you as much cash as you need.
Equity Investment
Equity is where you sell a piece of your company to investors. It’s a completely different type of financing than merchant cash advances and any other funding types, because it’s equity and not debt. You have no obligation to pay back an equity investment even if your company goes bankrupt, but you do have to give investors a share of future profits and a say in how your business is managed and operates.
Merchant cash advances give you an upfront lump sum of cash in exchange for future sales. They’re more expensive than most other funding types, but the speed and simple approvals make them good for companies that can’t qualify for or wait to get approved for a small business loan. Whether an MCA is the right financing type for your situation comes down to how quickly you need cash and whether it’s worth giving up a percentage of future sales to get the cash now.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
