What is a merchant cash advance?
As opposed to a traditional loan where a lender provides funds in exchange for an interest-based repayment plan, a merchant cash advance (or MCA), sometimes called split funding, is a purchase of future credit and/or debit card sales in exchange for a fee.
In addition to this, a MCA is generally much faster than a traditional loan, with the ability to be approved and have your account funded in as little as 24 hours in some cases.
And you can use split funding for virtually anything, including:
- Inventory purchases
- Equipment upgrades
- Hiring and training
- Payroll
- Taxes
For those who need capital fast, who don’t have great credit, or don’t have any applicable collateral that could be placed down to secure a traditional loan, an MCA may be the perfect funding solution.
As small business financing alternatives go, split funding is one of the most convenient when it comes to repayment.
How a merchant cash advance works
An MCA is an advance on future credit card sales. Therefore, it’s best for businesses who function mostly off credit and debit card sales.
What is convenient about split funding is the advance is repaid, typically via an ACH or automatic withdrawal, based on a percentage of those daily sales. The amount which is automatically paid towards the loan is typically called the “holdback” amount.
That means if you have a dip in regular sales, the amount taken out for those days will also be reduced, making it easier to pay back the advance when business is down.
The most unique aspect of an MCA is that it doesn’t use a typical APR interest fee but rather what is typically called a factor rate.
Click here to apply for a merchant cash advance and find out what your options are:
What is a factor rate?
The factor rate, which takes the place of interest as the primary fee associated with MCA’s, typically ranges from anywhere between 1.14 and 1.48.
By multiplying your loan amount by the factor rate, you’ll have a rough estimate of the total amount you’re expected to pay once you’re done repaying your MCA.
For example, if you get an advance of $25,000, and your factor rate is 1.3, you’ll pay $32,500 before paying off the advance.
The factor rate associated with split funding is generally considered to be steep compared to the interest on something such as an unsecured business loan.
However, it trades increased fees (in some but not all cases, and depending on the lender) for hyper-convenience, speed, and reduced credit requirements.
Example of a Merchant Cash Advance
Let’s take a closer look at how an MCA works with an example:
Jerrett, the owner of a local cafe, needs $20,000 for the purchase of new high-grade barista equipment and a few additional hires to meet a recent increase to traffic at his location.
Jerrett doesn’t have much business credit history, only having been in business at his location for about a year. So, he can’t depend on a bank loan to get him out of his pinch.
Instead, he decides to apply for a merchant cash advance. Because he has the necessary credit card sales, so he’s approved for the $20,000 advance and is off to the races. He gets all the equipment he needs and gets some help around the cafe. Business is booming.
Now that the advance has been issued, he can begin paying it back with a percentage of his regular credit card sales.
If his factor rate is 1.25, on $20,000 he’ll be paying back a total of $25,000. The repayment period on an MCA is typically between 3 and 12 months, all depending on how high your regular credit card sales are.
However, because the repayment period is based on the volume of credit card sales, it doesn’t affect how much you pay. Instead, your regular holdback amount is based on a set percentage decided by the lender.
Let’s say your holdback percentage is 10%. If you average $20,000 in monthly credit card sales, you’d pay about $65 a day ($2,000 total over a month) on average based on that day’s sales towards the advance and have it paid back in full within about 10 months.
The exact method which is used to repay an MCA varies, so in the next section, we’ll quickly cover each of them.
Ways to set up a merchant cash advance
There are 3 ways that repayment on a merchant cash advance can be set up. Here’s a rundown on the 3 methods:
1. Direct split
With this method, the lender uses one of several trusted credit card processors to place a “split” on your credit card sales (hence why it’s sometimes referred to as split funding), directing the percentage notated in your agreement from your credit card sales.
Each time you batch out, that percentage is automatically removed behind the scenes and you receive your deposit in exactly the same way as you usually would with zero delays.
2. Lockbox
If you’d prefer to not change your payment processor, or your merchant processor has early termination fees you’d prefer to avoid, this may be a more preferable method.
With lockbox funding, instead of switching merchant accounts a lockbox account, also known as a bridge account, is set up to split your credit and debit batches.
A lockbox account is a typical bank account which you’re given credentials to, however, with your lockbox account, each time a batch is settled the account automatically “splits” the amount by sending the designated repayment percentage via ACH to the corresponding account and deposits the rest of your amount into the account for your use.
The only drawback with this method vs. a direct split through a credit card processor is that there is typically a 24-48-hour delay in the typical amount of time it takes for you to receive your deposit after batching.
To set up a lockbox account, you’ll be asked to sign the lockbox form given by your MCA provider. Once your bank letter arrives in the mail for the lockbox account, the only thing left to do is call your card provider to have your deposits redirected to the lockbox account (which typically takes up to 48 hours).
3. Variable ACH
The final way to set up an MCA is as a variable ACH.
This is ideal when your merchant processor isn’t already one of the provider’s friendly accounts (i.e. a direct split won’t work) and you as the business owner don’t want to deal with the 24-48-hour delay between when your batches are settled and when the MCA holdback percentage is removed (as in a lockbox account).
A variable ACH requires your MCA provider’s collections department to have access to your merchant processor’s login portal. Your provider will log in to your processor’s portal each to check your batch amount and then issue an ACH transfer for the holdback amount.
This method of repayment requires that your provider always has access to your merchant processor portal, otherwise the account is considered to be in default.
It’s generally harder to be approved for a variable ACH as, unlike when using split funding or a lockbox account, variable ACH approval is dependent largely upon your average ledger balance.
In other words, while you can be approved for both split funding and the lockbox method with a high number of non-sufficient funds (NSF’s) or overdrafts, with a variable ACH your average balance must be high to ensure that the full holdback amount can be collected regularly.
Click here to apply for a merchant cash advance and find out what your options are:
Pros and cons of business merchant cash advances
Here are the primary benefits, and drawbacks, of a split funding:
As a merchant cash advance is a unique small business financing solution, it has a unique collection of pros and cons which are important to review before deciding if it’s the ideal solution for your needs.
Pros
- Get funds fast: An MCA is a good idea if you need cash fast as you can have the funds within your account within 1-2 business days. As opposed to a traditional loan, this makes an MCA lightning fast.
- No collateral: They don’t require traditional collateral, instead using your future credit card sales as a kind of “soft” collateral. That means you don’t have to risk losing something valuable such as your property or important equipment in the case of defaulting on the loan.
- Good credit not required: Depending on the lender, fair or even bad credit is acceptable for an MCA. This makes it an invaluable funding solution for business owners who don’t have the credit to be approved for any kind of business loan.
- Repayment terms fluctuate with business: If business is down, your payment goes down with it. This makes split funding one of the most flexible and convenient small business funding solutions available.
Con: The factor rate can be high
An MCA offers several significant benefits. However, every funding solution has both pros and cons, and a merchant cash advance is no exception.
However, while many funding solutions have several different drawbacks, an MCA really only has one, though it can be a big one.
The factor rate on split funding can be very high, as low as an equivalent 15% interest in some cases, but as high as triple digits in others depending on various factors.
For that reason, it’s important to know what the terms are of your advance going in, how much you’re paying and are able to pay, and whether it’s worth it for you.
It may be the perfect vehicle to get you out of a tough spot, help you buy new equipment that can drive sales, or help you hire the seasonal assistance you need to make full use of a busy season. Whatever the case, weigh the cost and benefits to decide if an MCA or another funding vehicle is the ideal fit for you.
Who is a merchant cash advance best for?
Still wondering if a merchant cash advance is the right funding solution for you and your business.
Consider these factors when deciding whether an MCA is a good fit. It’s ideal for those who:
- Accept credit card sales: If you accept credit and/or debit card sales, split funding may offer a more convenient repayment plan than a traditional loan.
- Need a fast funding solution: If your funding needs are an emergency, an MCA is one of the best.
- Don’t have great credit or enough credit history: Split funding doesn’t require great or even good credit, making it accessible to many who otherwise wouldn’t be able to qualify for a traditional business loan.
- Don’t have available collateral to offer: Similarly, if you don’t have collateral to offer for a traditional bank loan, you won’t be able to qualify for a typical bank loan. However, an MCA doesn’t require typical hard collateral such as property or liquid cash.
How to apply for a merchant cash advance
Because a merchant cash advance doesn’t require good credit or a hard form of collateral, it’s generally easier to be approved for one vs. a typical loan which requires sufficient proof that you’ll be able to repay the debt.
However, there are still qualification requirements and an application process you should be aware of. The more you know, the more likely you’ll be to get approved and the better terms you’ll be able to get.
How to qualify
The first and most basic eligibility requirement of an MCA is which has been mentioned already: a large portion of your revenue must come from credit card sales.
Additional qualification requirements include:
- In business at least two months
- $7,500 or more in monthly credit card sales
- $10,000 or more in gross monthly sales
- No open bankruptcies
Merchant cash advance: Good or bad credit vs. credit card sales volume: Which is more important?
We touched on an MCA’s credit card sales volume requirements in this and previous sections as well as its credit requirements.
However, if you’re already convinced an MCA is the ideal financing option for your business and you skipped to this section to see how to qualify, keep this in mind:
Credit is not the most important factor, your credit card sales volume is.
With a merchant cash advance, your credit card sales volume triples as:
- The primary qualification factor
- The main factor which decides how much you can be approved for, and
- Your estimated future credit card sales volume serves as a kind of soft collateral that guarantees to a lender that they’ll be able to collect on the advance
All of this taken together makes your credit card sales volume by far the most important factor for approval.
How to apply
If you’ve been operating in business for more than two months and meet the monthly sales requirements, acquiring a merchant cash advance is a simple matter of being approved.
To be approved for split funding, you’ll simply need to submit an application along with four months of bank and credit card processing statements.
However, in addition to this, you’ll want to gather several documents that may be requested after applying for approval.
A lender will review your credit card processing and bank statements to see that you fulfill the minimum monthly sales numbers. If you qualify, they’ll typically request additional documentation to finalize the approval.
Documents you’ll want to have in order to streamline approval include:
- Driver’s license
- Voided business check
- Credit score
- Business tax returns
Merchant cash advance alternatives
As we’ve reviewed throughout this guide, a merchant cash advance has several notable benefits.
However, if the tradeoff isn’t to your liking, it’s worth considering an alternative funding method. No matter what it is you need to pay for, the options below are fast and allow approval without perfect credit.
Term loan
Short-term and medium-term loans are closest to a traditional bank loan in that you receive a lump sum in exchange for repayment with interest. The repayment term on short-term loans is typically between 3 months and 2 years and medium-term loans up 5 years.
Business line of credit
With a business line of credit, you get access to a pool of funds which you can tap into whenever the need arises. And, provided you pay back what you borrow, you can then tap into that line of credit again.
Get the funds your business needs– fast– with a merchant cash advance
A merchant cash advance is both a fast and convenient funding solution.
In addition to this, it’s an ideal source of extra capital for business owners who either don’t have stellar credit or any form of hard collateral to offer and therefore wouldn’t be approved for a bank loan.
Traditional bank financing takes months for approval. So, whether you need funding fast or need access to capital and don’t qualify for a traditional bank loan, an MCA is an effective source of additional capital worth considering.
Click here to apply for a merchant cash advance and find out what your options are:
Frequently Asked Questions
Before signing a contract with an MCA provider, it’s important to first make sure that an MCA is the right funding method for you and your situation.
An MCA is based on your business’s regular flow of income, so if your business income is in a volatile period, a loan would likely be a better option for you.
However, if your business income is consistent, even growing, then an MCA may be a good option for you and your business.
If you find yourself in a position where you can’t pay back your MCA, start by looking at your contract to see what options are available to you in default as it all depends on the advance, provider, and your particular situation.
MCAs are considered a purchase agreement, not a loan, so they’re not subject to the same usury laws as typical business loans. Depending on your provider, they’ll have various options and actions they may take if you breach your contract and go into default.
For example, your provider may sue for breach of contract, though defaulting doesn’t necessarily mean you breached your contract. For example, if you defaulted because your business closed down, that isn’t a breach of contract and there would be no recourse whatsoever.
If you’re having trouble paying your MCA, give your provider a call to ask what your options are for setting up a revised repayment plan and getting back to current.
