What is a Merchant Cash Advance?
A merchant cash advance (MCA) offers businesses quick access to capital by providing a lump sum upfront. In return, the business agrees to repay the advance using a portion of its future sales. Unlike conventional loans that have fixed monthly payments, MCA repayments are flexible and tied to daily or weekly credit card sales, adjusting with the business’s cash flow. This makes it a flexible option for businesses with fluctuating revenue.
MCAs are not technically loans. Think of them as an advance on future sales. And how do you repay it? Well, through the business’s sales volume of card payments. That means the payments will vary depending on how well your business is running. When the sales are high, you can pay more and when the sales are down, you can pay less.
How does merchant cash advance work?
- Application process: The business applies for an MCA by providing financial records, including credit card sales history. The approval is typically quick for businesses in the UK.
- Receiving funds: Once approved, the MCA provider advances the business with a lump sum of cash, typically ranging from £5000 to £400,000. This depends on the sales volume’s creditworthiness.
- Repayment of the funds: Instead of making fixed payments, the business agrees to pay a fixed percentage of its daily or weekly credit card sales until the advance, plus fees, is fully repaid. This percentage can vary from 10% to 20%.
- Factor rate: The factor rate is a multiplier that decides the repayment amount. For example, a factor rate of 1.3 means that for every £1 borrowed, the business will repay £1.30.
According to Gov.uk, SMEs can easily get £10,000 to £400,000 worth of Merchant Cash Advance in the UK.
Example of merchant cash advance
Consider a small restaurant needing £50,000 to renovate its dining area. It opts for an MCA. The provider advances £50,000 upfront, and in exchange, the restaurant agrees to pay back 12% of its daily credit card shares, until the advance plus fees is paid.
If the restaurant’s daily credit card sales vary from £2000 to £3000, the daily repayment will range from £240 to £360.
However, the total cost of the MCA can be higher than traditional loans, as the repayment is also based on a factor rate. If the factor rate is 1.3, the restaurant will end up repaying £65,000 in total.
So what are the benefits of MCA?
Do you need a Merchant Cash Advance?
Advantages of merchant cash advance
1. No personal liability
MCA typically doesn’t require personal liability. Unlike traditional loans, where the business owner might need to provide a personal guarantee, an MCA is solely based on the business’s credit card sales.
This means if the business struggles or even fails, the owner’s personal assets, such as their home or savings, are not at risk.
2. Flexibility and ease of funding
Merchant cash advance lenders offer flexibility in terms of repayment. Firstly, the approval process is streamlined with minimal paperwork and documentation requirements. Then, the repayments are tied to a percentage of daily credit card sales whereby the amount paid back can fluctuate with the business’s cash flow.
During slower periods, the business can pay less and during peak seasons, more.
3. Quick access to cash
One major benefit of a merchant cash advance is the speed at which businesses can secure funds, often receiving the cash in just a few days. This fast turnaround is a lifeline for companies dealing with urgent financial challenges, like surprise expenses, a sudden drop in sales or a time-sensitive growth opportunity.
When businesses have the capital, they can face the roadblocks more effectively.
4. No collateral needed
Traditional loans often demand physical assets like property, inventory or equipment as security against the loans. If the borrower defaults, the lender can seize these assets to recover their money. However, with an MCA, the advance is repaid through a percentage of future credit card sales, which eliminates the need for any physical collateral.
5. No restriction on how funds are used
Once MCA is approved, the business owner is free to allocate the funds as they see fit, whether it’s to cover payroll or buy new inventory. This flexibility allows businesses to address their most pressing needs without being constrained by the specific terms traditional loans come with.
Disadvantages of merchant cash advance
1. It can be expensive
One of the primary disadvantages of a merchant cash advance is its high cost. The factor rates associated with MCAs are often higher than the interest rates on traditional loans, sometimes equating to an annual percentage rate (APR) of 40% to 90%.
This high cost is due to the risk that lenders take when providing unsecured funding, especially to businesses with poor or inconsistent revenue streams.
2. Regular payments can dent cash flow
Since repayments are automatically deducted from daily or weekly credit card sales, the business’s available cash flow can be reduced, especially when the business is slow. This constant outflow of funds can strain a business’s day-to-day operations.
With traditional loans, you have to pay yearly or monthly installments, but the frequency fluctuates in the case of MCA, which can make financial planning more challenging.
3. Lack of regulation
Merchant cash advance is a relatively unregulated market. Unlike bank loans, which are subject to strict federal and state regulations, MCAs fall into a legal grey area. This lack of regulation means the MCA providers have more freedom in setting terms and conditions, which can become unfavourable for the business.
Here’s the table of the advantages and disadvantages of Merchant Cash Advance for better understanding.
Pros & Cons of merchant cash advance - Comparison table
| Advantages | Disadvantages |
|---|---|
|
No personal liability |
Can be expensive |
|
Flexibility and ease of funding |
Regular repayments can dent cash flow |
|
No long process involved; neither any collateral needed |
Lack of regulation |
|
Quick access to cash with no restrictions on fund usage |
|
Who should consider an MCA?
Merchant funding can be a valuable financing option for specific types of businesses.
1. Businesses with high credit card transactions
Businesses that process a significant volume of credit card transactions are well-suited for MCAs because the repayments are directly linked to the sales of credit cards. This includes businesses like restaurants, retail stores and even online businesses.
2. Businesses in need of quick cash
It’s also beneficial for businesses requiring immediate cash. The application and approval process is much faster than that of traditional loans. This quick turnaround is ideal for businesses facing urgent financial needs, which can include unexpected expenses or taking advantage of an investment opportunity.
3. Businesses with poor credit
Why for them? Well, these businesses will face challenges in receiving traditional financing options like accounts receivable factoring and bank loans. MCAs don’t require a strong credit score for approval, which makes them accessible to businesses that have been turned down by banks or other financial lenders. You can even get an MCA with no credit check.
4. Seasonal businesses
Seasonal businesses like tourism that experience fluctuating revenues can benefit from the flexible repayment structure of an MCA. Because they have to repay with a percentage of credit card sales, they will pay a smaller amount in slow seasons and a greater amount in profitable seasons.
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