Traditional bank loans are a common source of financing for most businesses, but they come with many restrictions. For instance, a “use of proceeds” clause may limit the money borrowed to only certain things approved by the bank, like buying specific inventory or equipment. Merchant cash advances (“MCAs”), on the other hand, have less restrictions. The money can be used for whatever purpose the business owners think is in the best interests of their business.
MCAs might be an interesting option for some businesses, especially ones that need capital quickly. Unlike bank loans, which can take weeks or even months to get approved, MCAs can be approved and deposited into business accounts in a matter of days or even hours.
In this article, we’ll go over various matters relating to MCAs, including what MCAs are, how they work, and the benefits they offer to businesses.
What is a merchant cash advance?
MCAs are a type of financing that businesses can use to get quick access to capital. As an alternative to traditional bank loans, MCAs offer businesses an upfront lump sum of cash in exchange for a portion of their future sales.
Many business owners seeking traditional bank financing quickly realize that traditional banks are designed to loan money to large businesses – like Ford, GM, Haliburton and Bechtel. Most banks would prefer not to work with Bob’s Wheel Alignment or John’s Trucking and Transportation. In addition, traditional banks often look for any reason to tell a small business owner “no.” Whether it’s personal credit history, lack of a reasonable amount of time in business or failure to articulate a five-year business plan, banks will point to a number of factors in order to deem a particular applicant not credit worthy. As a result, a business owner often needs to look to alternative financing sources for their capital needs.
How does an MCA work?
MCAs often get confused with loans, but they work quite differently. With a loan, companies receive an upfront sum of cash that they then have to pay back over time, plus interest. MCAs, on the other hand, require a business to sell a portion of their future sales for an upfront lump sum of cash. MCA funders usually charge fees based on a factor rate instead of a traditional interest rate. Factor rates typically range from 1.1 to 1.5 based on numerous factors.
As an example, a store that has consistent debit and credit card payments may request an MCA by exchanging a portion of future credit and debit card sales for a lump sum of cash today. Then, every time a sale is made using credit or debit cards, the business will reserve a portion of the sale for the MCA provider until the total agreed upon amount is paid. This repayment is based on a percentage of sales, rather than a fixed amount (like a traditional loan), so if sales go up, the MCA is paid down faster. Alternatively, if sales decline, repayment is delayed. This makes merchant cash advances an interesting option for new business owners that don’t have much collateral or have personal bad credit.
Merchant cash advances can also be fixed withdrawals from a business bank account. These fixed payments can be made weekly or daily regardless of how much the company may have in sales. The fixed repayment amount is determined based on historical monthly revenues. This type of repayment structure allows businesses who do not use credit/debit card sales to easily calculate how long it will take to pay back a MCA. For example, a trucking company may need $10,000 to repair trucks around a busy season like Christmas. An MCA lender will quickly give the company $10,000 and charge a factor rate of 1.3 to get $13,000 with 16 weekly payments of $812.5. The trucking company is able to repair its trucks quickly and earn $20,000 or more and efficiently cover the repayment and factor rate fee of the MCA.
What are the benefits of merchant cash advances?
Now that we know what merchant cash advances are and how they work, let’s take a look at some of the benefits they offer businesses and why more should consider getting one over a traditional bank loan.
- Quicker access to capital
One of the most significant advantages of MCAs is that they offer quick access to capital. Businesses can apply for and receive the funds in as little as 24 hours, whereas it can take weeks or even months to get approved for a bank loan. MCAs are an interesting option if funds are needed quickly to cover an unexpected expense or take advantage of a business opportunity.
- No hard credit check
Another advantage of MCAs is that the funders don’t require a hard credit check. This means that even if someone has bad credit, they may still be able to get approved for an MCA. This is because the approval process for MCAs is based on sales history rather than credit score. Businesses will not qualify for a bank loan if they or their owners have bad credit, so an MCA could be a good choice for new and small businesses that may not have established credit yet.
- There is no set amount to repay each month
A bank loan works by agreeing to repay a set amount of money each month, regardless of how much revenue a business generate. This can be difficult for businesses that have seasonal sales or unpredictable income. With a merchant cash advance, the amount repaid is based on a percentage of sales, so if sales are slow, companies do not have to worry about making a large payment that it cannot afford.
- No restrictions on use of funds
When it comes to bank loans, businesses might have to show the purpose of how they’ll be using the borrowed money. Loans might not get approved if it’s for something other than business expenses. That’s not the case with merchant cash advances, as there are limited restrictions on how funds are used. Business owners can use the money for anything they consider is in the best interests of their business, whether it’s to buy new equipment, cover unexpected expenses, or even employee bonuses.
- Do not need collateral
One of the best things about MCAs is that most businesses do not need to put up any collateral. This is unlike bank loans where there is a need to offer some form of collateral, such as a home, car or business property, to secure the loan. For businesses with little to no assets, trading future receivables for money today is a viable option with an MCA.
- Lower impact on credit score
Failing to make payments of a fixed amount on a traditional bank loan will damage the credit score for a business (and its owner), making it difficult to get approved for loans in the future. Since MCAs are structured so that a business only pays a percentage of its future sales, there is less of an impact to the business credit score because the business is only paying back what it can afford.
MCAs can be an expensive form of financing and may not be right for all business, but business owners who need money fast, want flexibility in use of proceeds or worry about being approved for a traditional bank loan may choose to a merchant cash advance as an alternative to traditional bank financing.