You’re probably already familiar with the concept of a cash advance from your credit card. You pay a set percentage fee (around 3-10 percent) to your credit card provider for the privilege of withdrawing cash from an ATM. Alternately, some providers might send you a check instead.
A merchant cash advance is a different sort of transaction. Although the names are similar, merchant cash advances have little in common with consumer cash advances. In this post, we’ll cover everything you need to know about merchant cash advances.
What is a Merchant Cash Advance?
Merchant cash advances (or MCAs) are sometimes referred to as cash advance loans. But actually, this is not technically an accurate term. Merchant cash advance providers are usually very careful to describe the product as not a loan. This is because they operate according to different set rules and are not subject to business loan regulations.
In a merchant advance, your business is given an advance of cash for a set amount. The agreement will stipulate that you repay a higher amount within a certain time frame. Think of the transaction as pre-selling a portion of your future credit and debit transaction revenue.
How Does a Merchant Cash Advance Work?
Say you run a small restaurant that’s been open for 18 months in a busy downtown area. Your customer traffic has been steady, and you believe your business might be ready to expand and serve more diners. Then you get news that the retail store next-door is closing down, and you’re offered to lease the space.
Expanding into your neighbor’s space would be a great way to accommodate more customers. There’s only one problem. Your cash-flow isn’t strong enough to support the remodeling necessary to convert the retail space into a restaurant dining room.
So what do you do?
For an established business, the typical answer would be to seek a small business loan. Indeed, the SBA is a government organization set up to do exactly this. However, SBA lenders are not eager to approve funding for newly launched endeavors. The SBA and most other small business lenders often require you to be in business for at least two years.
Merchant cash advances were conceived specifically to address when a company requires cash but doesn’t have the type of bookkeeping metrics that traditional lenders look for.
In this example, your business could work with a cash advance provider to receive $20,000 to fund your expansion and renovation. In a typical arrangement, you might agree to repay $25,000 by the end of the advance term— usually 6 months, but sometimes 12 or more.
How Are Cash Advances Repaid?
In most cases, merchant advances operate on a daily remittance schedule. This means a portion of your credit card revenue is remitted directly to the cash advance provider on your behalf.
There are three typical remittance methods
- Split: In a split withholding arrangement, your merchant services provider splits your daily credit card proceeds according to your MCA agreement. Typically, around 10% of your daily proceeds will be remitted to the cash advance provider, although rates of 20% or more are also common.
- Trust: With lock box or bank trust withholding, the full portion of your debit and credit transactions is deposited into a trust bank account each day. A percentage of your cash advance payment is then removed from that account to pay the provider, and the remainder goes into your business account. This arrangement usually leads to a one- to two-day delay before you receive the funds from the relevant transactions.
- ACH: For ACH withholding, you receive the full amount of your card processing revenue deposited to your account as normal. Then the percentage used to pay the cash advance provider is automatically withdrawn via an ACH transaction.
Advantages and Disadvantages
Merchant cash advances are often the only reasonable alternative if you can’t quality for small business loans. Their main advantage is that they’re usually easier to qualify for. As long as you can demonstrate a reliable level of debit and credit transactions each day, you can usually find a merchant cash advance provider who’s willing to work with you. The other major advantage of MCAs is that they’re speedy to apply for, and you can count on funding in a matter of days.
The number one disadvantage of a merchant cash advance is a much shorter repayment period than a standard loan. Plus, the effective cost of an MCA can be higher than what you’d see with a standard loan interest rate.
If you can’t qualify for traditional business financing and need cash quick, a merchant cash advance may be the answer. As long as you’re sure you can afford the repayment terms and are confident in your daily cash flows, it’s usually worth considering.