Getting approved for a small business loan can be a stressful and complicated process when starting or growing your business.
It’s even more frustrating to jump through all those hoops, only to find out that you don’t qualify for the capital you need.
For a small business owner who is struggling to qualify for a loan, a merchant cash advance may be the right option.
Merchant cash advances can help your business access short-term funding quickly, with deposits arriving as soon as the next business day.
In this article, we’ll explain what a merchant cash advance is, how it works, and pros and cons compared to traditional financing options.
What is a Merchant Cash Advance?
A merchant cash advance (MCA) is a short-term funding option based on your business’s credit card transaction revenue.
Unlike a conventional bank loan, an MCA allows you to receive a business cash advance that is repaid by deducting a percentage of your credit card transactions (often 10-20%) until the original amount plus applicable fees are paid in full.
In addition, it’s important to understand that a merchant cash advance is not a loan. While both can help finance your business expenses and bridge cash flow gaps, an MCA works differently than a loan, which we’ll cover below
How Does a Merchant Cash Advance Work?
Types of Merchant Cash Advances
There are two main types of MCAs to consider:
Percentage of Revenue
The most common type of merchant cash advance deducts a fixed percentage from your credit card processing revenue. This is known as the holdback amount and typically ranges from 10-20%.
This type of MCA offers maximum flexibility, as repayments will automatically readjust based on how well your business is doing.
If sales are higher this week, repayments will increase as well – allowing you to pay down the debt faster. But if sales are slower next week, repayments will also scale back – allowing you to conserve cash flow during slow times.
Overall, the percentage of revenue option is best for merchants with volatile cash flow, as it provides more flexibility with repayments.
Another approach is to set up fixed payments based on an estimate of monthly sales. In this case, the repayment term is set in advance – much like a traditional bank loan.
Fixed payments are better for merchants with more predictable cash flow who want to pay down the advance over a set period of time.
For example, a coffee shop owner needs funds quickly to fix her espresso machine and knows that her business generates consistent monthly cash flow. Choosing the fixed payment option offers her the fast funding benefits of a merchant cash advance while knowing exactly when she will pay off the debt.
Understanding the Factor Rate
There is no interest rate on an MCA. Rather, the MCA provider makes money by charging a premium known as the factor rate.
Factor rates tend to range from 1.1 to 1.5 and are influenced by the following:
- Years of operation
- Business financials
- Credit card transaction revenue
- Personal credit score
In general, riskier businesses will receive higher factor rates, similar to how traditional lenders charge higher interest rates for riskier borrowers.
Here at Gravity Capital, we provide some of the industry’s most competitive factor rates (from 1.08 to 1.24) with our standard financing option.
Calculating the Total Cost of Borrowing
By calculating the total cost of borrowing, you can compare getting an MCA against other financing options, such as a term loan or line of credit.
To do this, multiply the cash advance amount by your factor rate – this is the total amount that must be repaid. For example, if you want to borrow $10,000 and have a factor rate of 1.2, you would need to repay $12,000 in total.
Next, you need to know how quickly the loan is to be repaid, which ultimately depends on your business’s credit card transaction revenue and the holdback percentage.
Continuing with the above example, let’s assume $15,000 in monthly credit card transaction revenue and a holdback of 10%.
You can use an MCA calculator to determine the rest.
In this case, you would pay around $50 per day and take 240 days to repay the cash advance and factor fees. That’s the equivalent of a 57% effective interest rate, which is much higher than most small business loans or lines of credit. However, if we reduce the factor rate to 1.1, the effective interest rate drops to 32%; which is why it’s key to understand your factor rate and how it will impact your repayment over the long-term.
Pros and Cons of a Merchant Cash Advance
If you’re still wondering whether a merchant cash advance is right for you, here are a few pros and cons.
Easier to Qualify
Compared to conventional financing options, a merchant cash advance is easier to obtain, as MCA providers focus on credit card processing revenue moreseo than traditional financial metrics like profits or cash flow.
This makes MCAs suitable for those with financing difficulties due to bad credit.
The typical small business loan can take several business days (or even weeks) to process due to documentation requirements and internal approvals.
A merchant cash advance, however, can be approved instantly with funds deposited as early as the next business day.
MCA applications are completed online, allowing you to spend time working on your business, rather than paperwork.
Adjustable Repayment Structure
Perhaps the most advantageous feature of an MCA is its flexible repayment structure (when using the percentage of revenue option).
This structure allows you to pay less when sales slow down and pay more as revenue recovers, making it possible for your business to weather economic downturns or unexpected slow seasons.
The main drawback of a merchant cash advance is its high cost compared to other short-term financing options.
The effective interest rate, or annual percentage rate (APR), is often 50% or more, depending on the factor rate and repayment time.
That’s why it’s crucial to determine whether you need the flexibility and speed of a merchant cash advance, as you will be paying a premium to access the funds quickly.
Increased APR for Paying Early
With a traditional bank loan, paying the loan down faster may save you interest in the long run.
With a merchant cash advance, paying the funds back faster will actually increase your effective interest rate, as MCAs do not have an interest component.
This is because you repay the original cash advance plus a fixed premium based on the factor rate. The total cost remains the same, no matter how quickly you repay the funds.
Not Federally Regulated
Unlike bank loans and other credit products, MCAs are not federally regulated.
This means MCA providers are not bound by the same regulations that require consumer disclosure around lending terms and the total cost of borrowing.
At Gravity Payments, however, we are transparent with lending terms and total cost of borrowing, regardless of what is legally required.
Does Not Impact Credit Score
Since an MCA is not considered a loan, MCA providers do not report payment history to credit bureaus.
This means an MCA cannot help build your credit score.
Obtain a Merchant Cash Advance through Gravity Capital
We started Gravity Payments in 2004 to provide fair and transparent credit card processing services for independent merchants.
Now, we’re bringing that same mission to merchant financing, which is why we launched Gravity Capital to provide our merchants with quick, easy, and flexible funding solutions.
Apply today for a merchant cash advance through Gravity Capital, and take advantage of our competitive factor rates and adjustable repayment options.