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A new small business is always looking for ways to sustain themselves in the short term so that founders can move closer to their long term goals. That’s why a merchant cash advance (MCA) is an option – it allows a business to get cash quickly without going through the more rigorous small business loan application and approval process. Before you go out and get an MCA, it’s important to determine if it is right for your business. Here’s what you need to know.
Note: This article is intended to provide a definition of what an MCA is and what it does, and it should not be taken as financial advice. We encourage small businesses to research all of the loan options available to them before committing.
What is an MCA?
A merchant cash advance comes from a lender and is different from a traditional bank loan. A lender who offers a cash advance to merchants will look at your credit card receipts and assess how much you need and how much you could repay. The contract you sign with the MCA lender will describe the amount you will receive and the amount of interest you will need to repay. Interest rates can vary widely from company to company. The state in which your business is based also plays a role in how much you will ultimately have to pay, as some states place limits on interest rates.
What does an MCA lender buy?
Simply put, the MCA lender buys your future sales transactions. You have a contract with them and MCA lenders will assess your sales to see if you are eligible for them to lend you money, but the importance of an MCA is that it gives you a quick injection of money. .
If you have water damage that you want to fix in your coffee shop, but don’t have the funds to spend on the repair, an MCA could be an effective way to quickly raise funds for those unscheduled repairs.
How does an MCA work?
While obtaining an MCA is not as rigorous as a loan approval process, an MCA is not just a bag of money with no strings attached. There is a contract with stipulations that you should be aware of when looking to get a cash advance from the merchant to help your business.
Amount of advance
In the MCA contract, this is the agreed amount that the lender will give you as a cash advance to the merchant. It is important to assess and ask for exactly what you need, otherwise you will have more to pay back. The advance can be less than, equal to or much greater than your monthly sales. It really depends on how much you need and how long you are comfortable paying your daily sales to your lender.
Amount of reimbursement
This number will be greater than the amount of the advance because an MCA lender charges a fee, known as a factor, in addition to the money they lend you up front. In some cases, this amount can be much higher than the interest rate of other types of loans.
While you are working to pay off your merchant cash advance, there will be a daily amount that you will need to withhold from your credit card transactions. Before getting a merchant cash advance, you need to look at your sales and see how viable it will be during the payback period.
Advantages and disadvantages of an MCA
Need for quick cash is an unfortunate problem for a lot of small businesses. Before taking out a merchant cash advance from a lender, reviewing the pros and cons will give you a better idea of what to expect.
The biggest benefit of an MCA is getting the money you need for your business fast. If you have a project or improvement that you want to make in your small business and need the money to make it happen, a merchant cash advance can be a way to get the money to do it.
Unlike a loan, you don’t need to have collateral to back the loan. You also don’t have to worry too much about your credit score. And although the lender takes your credit score away, MCAs tend to be more lenient on businesses with poor or bad credit.
A lender may also offer you more flexible payment options. If you are going through a period of slow selling, you can also readjust the daily hold on your trades.
Since there is a factor added to the reimbursement amount for a cash advance from a merchant, if you are in a period of declining sales, the higher reimbursement amount could do more harm than good. The additional cost of repaying the merchant’s cash advance could cause them to lose the necessary profits.
Since ACMs are unregulated, the factor in addition to the repayment account tends to be higher than the interest on a traditional bank loan. It can create problems for your business down the road if the amount you owe is more than what you can afford to pay. The repayment period will generally be shorter than a loan.
Who is an MCA for?
A merchant cash advance is the best solution for a small business that needs a little extra cash to make their business more competitive and generally more functional. Not all small businesses can get bank loans to do everything they want to do.
An MCA is not ideal for a business that has suffered a major disaster that has completely shut down operations. Seeking help in the form of a traditional bank loan or grant will be better than an MCA as they don’t expect you to continue with the day-to-day transactions to pay them back.
The MCA is a good idea for a small business that is just starting out and wants to upgrade without interruption. But if you are looking for an alternative means of financing, we recommend that you take a look at our guide to the best merchant account services on the market.
Frequently Asked Questions (FAQ)
What is a merchant cash advance used for?
A business can use its cash advance as it sees fit. It is important for the business to have a plan for their MCA and to use it quickly so that they can start making money to pay off the lender.
Are Merchant Cash Advances Bad?
Like most cash loans, the usefulness of MCAs depends on how you use them. It is important to understand how much you need and how much you will need to pay back so that you don’t lose money or have to pay too much.
What happens if you don’t pay a merchant cash advance?
Since an MCA is a contract between you and the lender, failure to meet the terms can lead to legal action. Instead of missing payments, try to proactively communicate what might be stopping full payments and see if you can renegotiate the payment amounts and schedule.
Are Merchant Cash Advances Legal?
Yes. Although these are not loans, they are considered purchases of your future sales.