Small business owners guide to a merchant cash advance

Small businesses may need help to increase revenue, attract and maintain customers, or invest in inventory – and a merchant cash advance could help.

Unforeseen costs, seasonal fluctuations, and unprecedented circumstances can all impact small business growth.

Merchant cash advances can offer companies short-term support to keep their enterprises running smoothly.

What is a merchant cash advance?

A merchant cash advance, or MCA, is short-term funding for businesses that accept debit and credit card payments.

An MCA is an alternative mode of financing to traditional small-business loans.

With an MCA, lenders provide businesses with an upfront sum of money, which a business then repays using a percentage of its card transaction sales, plus fees.

Unlike small business loans, companies can acquire an MCA without needing to offer up assets for security, such as property or inventory, to access funding.

Read our guide on managing business debt.

How does a merchant cash advance work?

Traditionally, the MCA repayment procedure is structured as follows:

1. A provider establishes a business’s factor rate – which is a tool in a decimal form that expresses interest rates for business financing - and then lends the company an upfront sum.
2. The sum is deducted daily, weekly, or monthly via a percentage of the company’s sales, plus interest, until the amount is repaid in full.
3. The amount repaid is determined by debit and credit card sales; however, a typical deduction can be around 10% of each card sale.

Repayment time scales for MCAs typically range from three to 18 months.

Unlike other small business loans, there are no conventional repayment terms as they are subject to the company’s sales; the higher the number of debit or credit card purchases, the quicker the advance can be repaid.

How can a merchant cash advance help your business?

Merchant cash advances can benefit small businesses requiring urgent capital to cover emergencies, short-term expenses, or cash flow shortages.

Businesses can use MCAs to cover numerous expenses, such as:

• equipment purchases
• repairs and renovations
• marketing and advertising strategies
• inventory purposes
• working capital
• expansion costs.

Read our guide on dealing with working capital problems.

What are the advantages and disadvantages of a business credit line?

Advantages:

• flexible payments: A business line of credit offers more flexibility than a secured loan and can be used for multiple purposes, such as purchasing inventory or covering payroll
• instant funding: Accessing an MCA can be easier than applying for a small business loan and requires less documentation, making the application process faster; funds can be distributed into business accounts in as little as a few hours
• adaptable repayment plan: A credit line provides workable repayment terms to accommodate the growth of the business; for example, seasonal shifts reduce the monthly revenue, and the company only needs to pay the minimum amount due
• personal and business distinction: A credit line enables small business owners to streamline and monitor business expenses only, thereby keeping personal accounts separate
• build company credit: Using a business line of credit allows companies to establish a positive payment history that appears on business reports.

Disadvantages:

• possible debt: The frequent deductions of MCAs from incoming sales have the potential to impact a business’s cash flow, and if payments aren’t met, small businesses can be at risk of being unable to service their debt
• nothing to gain from repaying early: As companies pay a fixed amount of fees and are restricted from making early repayments, they can’t benefit from interest saving through early repayment
• contracts may need clarification: MCA contracts can be unclear, particularly the nature of factor rates and repayment schedules based on sales percentages
• cash payments are redundant: MCAs work on card transactions only, and encouraging customers to pay via cash through special offers or promotions can be seen as a breach of conditions by the lender
• expensive: The high fees and interest rates with MCAs can be more costly than other funding options.

What type of business is a merchant cash suitable for?

Merchant cash advances could be suitable for all small businesses that receive payments via a substantial volume of card transactions, whether online or face-to-face.

Many businesses could benefit from MCAs, for example:

Retail businesses: Shops that accept card payments can use a merchant cash advance to purchase extra inventory; for example, a small clothing business may need additional Christmas stock around December; therefore, an MCA can help pay for the extra goods.

Hospitality: Restaurants, cafes, and hotels could use an MCA to purchase ingredients, kitchen appliances, tables and chairs, utensils, wall decorations, or renovations.

Trade businesses: Service businesses such as carpenters, plumbers, or electricians could use an MCA to fund emergency repairs, which may entail purchasing the necessary tools or materials to complete priority jobs.

How to apply for a merchant cash advance

To apply for a merchant cash advance, companies must complete an application and provide the necessary documentation, including recent bank statements.

Once an application is approved, an offer outlining the funding terms will be sent directly to the business.

Alternatives to MCAs

Merchant cash advances should only be used by businesses that can repay the MCA quickly and successfully.

MCAs are more suited for short-term cash flow solutions.

For business owners looking for more cost-effective or long-term solutions, alternative options, such as business, credit, or pay later schemes could be worth considering.

A business loan

Taking out a small business loan is an option as the repayment rate is fixed and with lower interest rates.

Small business loans usually offer a more extended pay-back period than MCAs.

Credit card loans

Applying for a credit card could provide credit with lower costs.

Buy now, pay later schemes

If businesses are looking for short-term loans, buy now, pay later schemes may be an option; some buy now, pay later plans don’t charge interest if it’s over a short-term period and paid back on time.

Read our full guide on other forms of finance.