Merchant Cash Advance: How It Works and When to Use It

Merchant Cash Advance loans (MCA) are a form of revenue based financing. Unlike traditional loans, MCAs offer a unique approach to borrowing that’s linked with your business’s future sales, providing cash to help fluctuating revenue streams but without the time or credit score needed for conventional financing.

An MCA involves an upfront lump sum payment to your business in exchange for a percentage of future credit and debit card sales. This alternative financing method can help you with urgent needs for cash. However, the convenience of fast access to cash comes with its own set of complexities, including higher costs and special terms.

This article provides a comprehensive overview of merchant cash advance loans, exploring their benefits and drawbacks beyond a simple cost analysis. We’ll dive into key terminologies, evaluate typical repayment structures, and provide insights on mitigating risks associated with this high-cost source of funding. Whether you’re considering an MCA or seeking ways to manage an existing one, this guide will give you the knowledge to make informed decisions and leverage merchant cash advances as part of your business strategy.

What Is a Merchant Cash Advance?

An MCA is a short-term financial strategy that businesses may use to obtain quick funding in exchange for a share of future profits over a set time frame. When you choose an MCA, you’re essentially selling future profits for upfront cash.

An MCA is not a loan. You’re not borrowing money when you take out an MCA. Instead, you’re allowing the MCA provider to take a cut of your future revenue to pay back the cash that they advanced you.

MCAs are only applicable for businesses that use debit or credit cards as their primary means of transacting business. If your business primarily transacts using other means, you will not be eligible for a merchant cash advance.

Before we go too much deeper into the details of MCAs, let’s look at a few important terms that should make our discussion of MCAs clearer.

Important Merchant Cash Advance Terms

Holdback: A holdback is a fixed percentage of future credit/debit sales that the MCA provider will collect directly from your business account to repay the MCA. It usually ranges between 10% and 20% of daily sales.

Annual Percentage Rate (APR): Though APR is irrelevant to an MCA, it’s the yearly percentage you pay to borrow money using things like small business loans or credit cards. MCAs don’t use APRs—instead, they use factor rates to determine how much the cash advance will cost you.

Factor Rate: The factor rate is a multiplier that determines how much you’ll need to pay back to access an MCA. As a simple example, if you borrow $10,000 at a factor rate of 1.5, you’ll end up paying $15,000 total to pay off the MCA.

Daily Draw (or Daily Debit): The daily draw (or daily debit) is the amount of cash that an MCA provider will take from your business account every day as repayment for the MCA. This number is based on four factors: (1) the amount of cash you were advanced, (2) your daily credit/debit sales, (3) your factor rate, and (4) your holdback percentage.

Collateral: Collateral is something that you promise to a lender in case you can’t make payments on money you borrowed. Collateral is generally irrelevant to MCAs, since most MCAs don’t require you to put up collateral, such as property, equipment, or inventory.

Risk Assessment: A risk assessment is a financial strategy that lenders use to determine the likelihood that a person or business can pay off a loan. Generally, the higher the risk, the higher the cost of the loan.

UCC-1 Lien: A UCC-1 lien is a financing statement that a lender (in this case, an MCA provider) uses to settle debts.

We’ll be using these terms throughout this article and will dive into them in more detail throughout. However, it’s good to have a sense for what these terms mean as reference points to our discussion.

Pros of a Merchant Cash Advance

• Convenience: MCAs are almost always quicker and easier to obtain than conventional loans. In some cases, you can receive the money you request within 2 to 3 business days, as opposed to weeks or months for conventional loans.
• Available to Businesses With Bad or No Credit: Unlike conventional loans, your credit score isn’t a factor in your eligibility for an MCA.
• No Collateral Required to Apply: Most MCAs require no collateral to apply (other than the holdback rate from your future sales).
• Minimal Limits on Use of Funds: Once you obtain MCA funds, you can use them practically however you want. This is different from many conventional loans, which limit how you can use the funds related to your loan.

Cons of an MCA

• Expensive: The cost of an MCA is generally more expensive than a conventional loan. In some cases, the cost of an MCA would be the equivalent of paying an APR of over 300% or equivalent interest rates of over 100%.
• Don’t Build Credit: While MCAs don’t require good credit to access, they also don’t help you build credit. This is another reason why you should leverage MCAs strictly as a short-term strategy.
• Requires Credit / Debit Payments: Your business must transact using credit or debit to be eligible for an MCA. Additionally, some MCA providers are picky about the terminals they require businesses to use. So, if you don’t use a preferred terminal, you may not be eligible.
• Could Harm Customer and Vendor Relationships: If you’re unable to repay your advance or default on your advance, your MCA provider may use a UCC-1 lien to demand that your customers and credit card vendors pay them instead of you. This could be devastating for your reputation.

How Does a Merchant Cash Advance Work?

One of the big benefits of an MCA is its convenience. Here’s the process behind how a merchant cash advance works:

1. You approach an MCA provider: You first request a certain amount from an MCA provider. Typically, an MCA provider will advance anywhere between $5,000 and $500,000. There are many MCA providers out there—some well-known MCA providers include Kapitus, Credibly, Fora Financial, and PayPal. 
2. The MCA provider reviews past credit/debit sales: The MCA provider will review your past sales receipts to determine your eligibility, factor rate, and holdback rate.
3. If approved, you begin repaying the advance immediately: Once you receive the funds you requested, the MCA provider will begin the daily draw based on your holdback rate and daily sales until you’ve paid off the principal cash advance plus the factor rate. The cash advance term is usually short—between three months and two years. (Some MCA providers will use a weekly draw, but the outcome is the same: You begin paying the advance back almost immediately.)

How & Why to Use an MCA

MCAs could be a useful strategy for small businesses in several circumstances:

• You need short-term funding to address an unexpected expense.
• You experience an unexpected event that affects operations and need a cash infusion to solve it.
• You cannot access a small business loan and need cash immediately.

An MCA is not a long-term financial strategy. You should avoid using an MCA to fund things like business growth because the payment terms and costs are usually too short and too expensive to support longer-term business growth.

Factor Rates: Why MCAs Can Be So Expensive

Unlike conventional loans, which use APRs, MCAs use factor rates. 

Factor rates are a multiple that MCA providers use to reach the total cost of the cash advance. They’re often used for short-term cash infusions, and the reason they’re expensive is because they allow for quick access to capital with fewer qualifications.

Typically, the factor rate ranges between 1.1 and 1.5. In other words, for every dollar you’re advanced, you’re paying between $1.10 and $1.50, or 110% to 150% of the amount you’re being advanced.

Additionally, paying off an MCA early will not save you money, since the factor rate already bakes in the total cost of the advance. On the other hand, you may be able to save money with an early repayment of a traditional loan that uses an APR.

An Example MCA in Action

Say you run a company that sells cupcakes, and your oven breaks down. You don’t have the cash on hand to fix it, so you decide to use an MCA to fund repairs.

You request a cash advance of $100,000. Based on your company’s credit/debit sales, the MCA provider determines that they can advance you that cash with a factor rate of 1.5 and a holdback rate of 20% over 90 days.

Principal: $100,000

Total Cost of MCA: $100,000 (principal) x 1.5 (factor rate) = $150,000

Average Daily Cost of MCA: $1,666.67

Now, this doesn’t mean that you’ll necessarily be paying $1,666.67 every day to pay off the MCA. However, this math could help you determine whether an MCA would be right for you, since it gives you a general idea of how your business will need to perform daily to pay the MCA off on time.

Now, let’s factor in the holdback rate.

Remember: The holdback rate is the daily percentage of sales that the MCA provider will draw from your account as repayment for the cash advance.

Days After Receiving MCA	Credit/Debit Sales	Holdback Rate	Amount MCA Provider Draws	Outstanding Balance
0	-	-	-	$150,000
1	$10,000	20%	$2,000	$148,000
2	$15,000	20%	$3,000	$145,000
3	$2,000	20%	$400	$144,600
4	$25,000	20%	$5,000	$139,600
5	$3,000	20%	$600	$139,000

Important: With an MCA, the higher your daily sales, the more the MCA provider will draw from your account.

Repaying your MCA on time is a direct function of daily cash flow. So, if you have more good days than bad days, you’ll be more likely to pay the advance off on time, with the understanding that the MCA provider will take more money out of your account on days with higher sales.

Merchant Cash Advance Calculator

Use our MCA calculator to help determine your total repayment amount and timeframe, as well as the total cost of interest.

Merchant Cash Advance Repayment Terms

There are usually two different ways to repay an MCA.

The most common repayment method is using a daily draw based on daily credit/debit sales. The example above shows how the daily draw method works.

A less common MCA repayment method relies on fixed payments. These fixed payments are usually based on estimated monthly sales. Like a more conventional loan, you make the same payment regardless of daily sales. However, unlike a conventional loan, you must make these payments daily (or weekly). This can be a boon when sales are good and a bust when sales are bad.

Merchant Cash Advance Rates and Fees

In the previous example, we looked at factor rates, which exist among all MCAs. Factor rates will typically range between 1.1 and 1.5. Your exact factor rate will vary based on the MCA provider you choose, how much money you’re asking for, your business’ daily sales performance, and other factors.

However, in addition to factor rates, you may also run into additional fees, such as:

• Origination Fees: A common fee for processing a cash advance request. It’s usually a percentage of the money you’re requesting.
• Funding Fee: Another fee for reviewing your request. Depending on the MCA provider, it could be a percentage of the money you’re requesting or a simple flat fee.
• Admin Fee: Usually a flat fee that goes toward maintaining and administering your cash advance.

If you’re considering an MCA, be sure that you request documentation of all fees that an MCA provider may charge you, along with the costs of those fees relative to the amount of money you’re requesting.

Refinancing a Merchant Cash Advance

If you’re reaching the end of your MCA’s term but aren’t on pace to pay it off, you might be able to refinance it.

However, refinancing an MCA is much different than refinancing a conventional loan.

With a conventional loan, you’re paying off an old loan with a new loan.

With an MCA, you’re still on the hook for the original borrowing cost. This could mean that the new cash advance requires you to pay interest on both the old cash advance and the new cash advance. These costs can explode quickly and put you in a debt cycle.

In short, not all MCA providers allow refinancing, and the ones that do may require you to pay interest on both the old and new advance. This is another reason why you should not use an MCA as a long-term borrowing strategy.

Alternatives to MCAs

Merchant cash advances can be convenient, but since they come at a high cost it might mean that other alternative financing options are better for your business. Here are a number of options

• Business Term Loans
• Business Line of Credit
• SBA Loans
• Equipment Financing
• Invoice Factoring
• Business Credit Cards
• Trade Credit

RELATED: Types of Business Loans

Merchant Cash Advance FAQs

What’s the difference between an MCA and a small business loan?

An MCA is a short-term cash-infusion strategy. Credit scores and collateral aren’t factors for eligibility. Repayment is made daily or weekly based on credit/debit sales, factor rates, and holdbacks. They use factor rates instead of APRs. MCAs allow quicker access to capital at a higher cost.

A small business loan can be a short- or long-term financial strategy. They require good credit and most require collateral. Repayment is almost always made monthly by a certain fixed date, with interest. They use APRs instead of factor rates. Loans have more stringent regulations and may have longer approval processes but are generally lower in cost.

How can I get an Merchant Cash Advance?

Begin by contacting Credibly or Kapitus and fill out their application online. 

These applications are generally simple and quick to complete and require only basic business information, such as:

• Your name and the business’ name
• Monthly credit card volume
• Annual gross business revenue
• Amount of cash you’re requesting

However, before you agree to an MCA, be sure to read all terms, understand all fees and costs, and prepare for potential cash flow issues that could prevent you from repaying the advance.

What happens if you default on an MCA?

The consequences of defaulting will depend on your MCA agreement. However, here are a few potential consequences of defaulting on an MCA.

• Late fees: MCA providers may charge late fees for missing payments.
• Collections: MCA providers may be able to access your business account to access overdue funds, including the use of Automated Clearing Houses (ACHs) to automatically withdraw any funds available to repay your debt.
• UCC-1 Liens: If MCA providers still can’t obtain what you owe, they may file a UCC-1 lien, which could demand that your customers and credit card vendors pay them directly instead of you.
• Lawsuits: MCA providers can sue you for unpaid debts plus additional legal fees. In some cases, MCA providers that are victorious in court can seize business funds, accounts, equipment, and more to collect what’s owed.
  • Legal judgments can also damage your business credit. While defaulting on an MCA won’t affect your credit per se, a legal judgment against you could potentially show up on your credit report.
• Personal Guarantees: If your MCA provider required a personal guarantee, you may be personally responsible for outstanding debt, which could allow MCA providers to seize your personal assets.

Important: Missing even one payment can result in a default. So, if your credit terminal or business account suffers a glitch and the MCA provider can’t access funds for the daily draw, it could put you in default.

Are there restrictions for how funds are used?

Generally, Merchant Cash Advances (MCAs) are known for their flexibility and typically come with few restrictions on how the funds can be used. However, the specific terms vary by provider.

• Agreement Terms: While most MCA providers do not place explicit restrictions on how the funds can be used, it’s important to carefully review the terms of your specific agreement to ensure there are no particular use-case limitations.
• Provider Policies: Some MCA providers might impose subtle guidelines or preferred uses tailored to your business’s needs for better alignment with their risk management strategies.
• Business Impact: Given the true cost associated with MCAs (due to higher factor rates), businesses should use the funds in a manner that is likely to generate a relatively quick and substantial return to manage the repayment burden effectively.

How to Tell if MCA Is Right for Your Business

Deciding if a MCA is right for your business involves evaluating several crucial factors. Here’s a logical step-by-step guide to help you make an informed decision:

1. Do you need quick access to funds?
2. Can your daily or weekly cash flow support the regular deductions required to repay the MCA?
3. Have you calculated the total repayment amount including fees and factor rates?
4. Have you explored other financing options like small business loans, lines of credit, or invoice financing?
5. Do you meet the qualification criteria for other types of financing, or is your credit score an issue?
6. Is your business stable and generating consistent sales revenue?
7. Is flexibility in repayment terms important to you?
8. Do you need the funds urgently, within a few days?
9. Are you clear on how you will use the funds, and will it generate enough return to make the high cost worthwhile?
10. Are you dealing with a reputable MCA provider with clear and transparent terms?

If you answered “Yes” to most of these, then a merchant cash advance might be suitable for your business. Keep in mind that MCA usually only makes sense if you borrow what you can pay back in the next few weeks or months’ worth of credit card revenues.

Closing Out Merchant Cash Advance Loans

Merchant Cash Advances offer a unique and flexible financing solution for businesses in need of quick capital. With an easy approval process and speedy funding, they present a viable alternative for those who may not qualify for traditional loans, or who require rapid financial intervention.

However, the convenience of MCAs comes at a cost—higher factor rates leading to substantial repayment obligations. Businesses must be honest in evaluating their cash flow and potential returns when opting for an MCA to ensure that the benefits outweigh the financial burden. By carefully considering these factors and understanding the terms, MCAs can be a powerful tool for business growth and stability.