In the current business landscape, securing funding is crucial for growth and overcoming unforeseen challenges, especially for SMBs.
This is where merchant cash advances (MCAs) emerge as a viable alternative financing solution. A significant 10% of small businesses that sought financing in 2021 opted for MCAs, marking a notable increase from 7% in 2015.
In this blog, we will see how MCAs can help businesses with varied credit backgrounds to access the necessary capital. We’ll explore the intricacies of MCAs, their eligibility criteria, and how they compare to traditional business loans.
Understanding Merchant Cash Advances (MCAs)
A merchant cash advance isn’t a traditional loan in the strictest sense. Instead, it’s a financing option with roots in alternative finance.
An MCA provider purchases a portion of your future credit and debit card sales at a discounted rate. This means you’re getting cash upfront while you promise to give a percentage of your sales until the advance, plus fees, is repaid.
The payback period usually varies from 3 to 12 months, and the holdback rate—the percentage of daily credit card sales applied to the advance—can range from 5% to 20%, depending on the provider and risk assessment.
Here’s a breakdown of the key characteristics of MCAs:
- Eligibility: MCAs typically have less stringent credit score requirements than traditional loans. This makes them a good option for businesses with bad credit. They are also good for businesses with limited credit history. However, lenders will primarily assess your business’s monthly credit card processing volume to determine eligibility and repayment capacity.
- Repayment Structure: Repayment is tied to your business’s revenue stream. They deduct a fixed amount from your daily or weekly credit card sales until we have paid the advance and fees in full. This flexibility allows for fluctuations in your sales volume.
- Speed of Funding: The application process for MCAs is generally faster than that for traditional loans, with approvals often granted within days which makes MCAs ideal for businesses. They need fast access to capital for emergencies or time-sensitive opportunities.
Qualifying for a Merchant Cash Advance: A Look at the Requirements
It’s true that your credit score is the least important funding criteria for MCA lenders. But, these MCA providers might look for the following:
- Minimum Monthly Revenue: Your business must have a consistent monthly credit card sales level to ensure your ability to repay the advance. While specific numbers can vary, some lenders may have a threshold of less than $500,000.
- Time in Business: Most MCA lenders prefer businesses that have been operational for at least six months and show a track record of generating revenue.
- Processing Statements: Recent credit card processing statements are crucial for the lender to assess your business’s sales volume and suitability for an MCA.
- Business Plan (Optional): A well-defined business plan outlining your needs and how the capital will be used can strengthen your application.
Remember, MCA terms and fees can vary a lot between individual providers. Before deciding, consider the factor rate and extra fees. For instance, the percentage of merchants seeking MCAs has slightly decreased from 9% in 2019 to 7% in 2022.
Traditional Business Loans vs. Merchant Cash Advances: Weighing Your Options
Traditional loans and MCAs provide business funding. But, they serve different needs and have clear pros and cons.
Here’s a comparative analysis to help you choose the most suitable option:
| Feature | Traditional Loan | Merchant Cash Advance (MCA) |
| Advantages<br>* Cost | Typically lower overall cost with interest rates and fees | Higher cost due to factor rates and fees |
| Example | A loan with a 5% interest rate might be cheaper than an MCA with a 20% factor rate. | |
| Payments | Fixed monthly payments provide predictability in your budget | Flexible repayments based on a percentage of your sales; can be unpredictable during slow periods |
| Example | You know you need to pay $1,000 every month for the loan term. | If sales are slow one month, you might repay less than usual on the MCA. |
| Funding Amount | Larger funding amounts available | Smaller funding amounts typically offered |
| Eligibility | Stricter eligibility requirements | Fewer credit history restrictions |
| Example | You may need a good credit score and business plan to qualify for a traditional loan. | An MCA might be an option for businesses with a lower credit score. |
| Processing Speed | Lengthy application process with documentation requirements | Faster funding |
Choosing the Right Option:
With lower interest rates, traditional loans are ideal for well-established businesses that require substantial capital. However, if your credit score is low or you need quick access to funds for short-term needs, an MCA can be a good option.
You need to understand the eligibility criteria, repayment structure and compare them to those of traditional loans. Then, you can decide to get the funding that suits your business growth. The best solution for your business will depend on your specific needs.
FAQs
Q1: What are the typical fees associated with a merchant cash advance?
A: The main fee for an MCA is the factor rate. It is a percentage of the advance that shows the cost of borrowing.
Additional fees may include application, processing, and termination fees (if you repay early). It’s crucial to understand all fees involved before finalizing an MCA agreement.
Q2: Can a merchant cash advance improve my business credit score?
A: On-time repayments of your MCA can impact your business credit report. But, managing your cash flow well is key. It helps avoid delinquencies which can affect your score.
Q3: Is it safe to use a merchant cash advance provider?
A: Try to look for reputable MCA providers with transparent terms and fees. Ensure that they have a license in your state and avoid lenders with hidden costs or aggressive collections.