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Is Merchant Cash Advance Right for Your Business?

By Spodek Law Group | February 20, 2024

Is Merchant Cash Advance Right for Your Small Business?

A merchant cash advance (MCA) can provide fast funding when a small business needs it. But MCAs also come with high costs and risks. As a business owner, you need to weigh the pros and cons to decide if an MCA makes sense for your situation.

What is a Merchant Cash Advance?

A merchant cash advance provides a lump sum of capital to a business in exchange for a percentage of future credit card sales. It works similarly to a business loan, but the payback comes from a portion of daily credit card receipts instead of fixed monthly payments.

MCA providers focus on small businesses’ credit card sales, not their credit scores or business assets. This allows many companies who cannot qualify for bank loans to still receive financing. The application process is faster as well – you can get approved for an MCA in days or weeks instead of months.

Pros of Merchant Cash Advances

Here are some potential benefits of using a merchant cash advance for your business:

1. Fast Approval and Funding

The biggest advantage of an MCA is the speed at which you can access capital. Providers can approve an application in days and fund the advance within a week or two. This rapid turnaround helps when you have an urgent need or opportunity.

For example, if you need to purchase inventory or equipment quickly, cover payroll in a pinch, or want to ramp up advertising spend, the fast funding from an MCA allows you to seize opportunities at the right moment.

2. Flexible Payments

MCA payback amounts fluctuate based on the volume of credit card sales each month. So when your revenues are higher, more money automatically goes to paying back the advance. In slower sales months, the payments decrease accordingly.

This flexibility helps businesses manage cash flow. There is less risk of falling behind on payments if you have seasonal dips or other revenue fluctuations.

3. No Collateral Required

Banks usually require collateral like real estate or equipment to secure a small business loan. With an MCA, providers advance money based on future credit card receivables – no collateral is required.

So if you have an urgent capital need but few business assets to leverage, an MCA may be one of your only options to access funds quickly.

4. Multiple Uses for the Capital

You receive the lump sum payment upfront and can use the capital for virtually any business purpose. Whether you need to invest in growth, handle operating expenses, or deal with an emergency, the money is yours to utilize as makes sense for your company.

This versatility makes MCAs helpful to bridge cash flow gaps from a variety of situations.

Cons of Merchant Cash Advances

While MCAs provide fast, flexible financing, they also come with downsides to consider:

1. High Cost

The convenience and flexibility of an MCA comes at a price – quite literally. MCAs are an expensive form of financing, with an annual percentage rate often between 30-300%.

These high rates result from several fees charged to the business:

  • Application fee – typically ranges from 1-3%
  • Daily repayment rate – usually between 5-20% of daily credit card sales
  • Origination fee – often 1-10% of the advance amount

So you’ll pay back far more than the amount advanced. Make sure to calculate the true cost before committing.

2. Daily Repayment Pressure

The daily repayment structure creates pressure to maintain strong credit card receipts. If volumes dip too low, it becomes challenging to make the daily payments and still have enough working capital to operate your business smoothly.

Some MCA contracts also contain confusing terms that change repayment rates without proper notice. So you can get stuck in a repayment cycle that feels impossible to get ahead of.

3. Potentially Vicious Cycle

A common pitfall with MCAs is business owners taking out a second or third advance before fully paying off earlier ones. It may provide short-term relief from cash crunches but creates a compounding payback burden over time.

This vicious cycle often drains working capital and makes it impossible to climb out of debt. Some providers even structure contracts to encourage this behavior, so you need to enter any MCA cautiously.

4. Damage to Business Credit Profile

While MCAs themselves don’t require strong business credit, falling behind on payments can still hurt your credit standing. Providers may report late repayments to agencies like Dun & Bradstreet.

Too many MCAs at once can also raise red flags for traditional lenders if they review your profile. So relying too heavily on this quick financing option can limit access to more conventional loans in the future.

When Does an MCA Make Sense?

Merchant cash advances carry notable risks and should not be entered lightly. But several situations can make them a viable short-term financing choice:

Urgent Situations

If you have an immediate capital need where even a few weeks matter, the rapid funding of an MCA may be necessary. For example, key inventory or equipment breaking that requires quick replacement to stay operational.

Limited Financing Options

Businesses with lower credit scores, inconsistent revenue history, or few assets for collateral often cannot qualify for bank loans or lines of credit. If you have limited alternatives, an MCA provides a way to access capital that might otherwise seem impossible.

Confidence in Repayment Capacity

You should only accept an MCA if you have strong conviction in near-term revenue growth. There must be a clear path to not just maintaining but increasing credit card volumes to manage the daily payments.

For example, using the funds for growth initiatives like adding staff, expanding facilities, or increasing advertising is less risky than covering existing operating losses.

Short-Term Bridge Financing

In some cases, a merchant cash advance makes for reasonable bridge financing while securing more conventional, lower-cost loans. If you get approved for an SBA loan, for instance, but need capital now, a short-term MCA to tide things over until the funds arrive can work.

Just be careful not to let it turn into long-term dependency.

Expert Tips on MCAs

If you decide to move forward with a merchant cash advance, keep these tips in mind:

  • Shop around – Rates and terms vary significantly between MCA providers. Compare multiple offers to find the best deal.
  • Read the fine print – MCA contracts contain confusing jargon and technical details that can obscure the true costs. Review carefully and get professional help understanding terms if needed.
  • Structure repayments conservatively – Don’t accept offers at the upper end of your repayment capacity. Build in a buffer for seasonal fluctuations and unexpected dips.
  • Monitor closely – Stay on top of daily payments and credit card volumes. Adjust expenditures if needed to maintain positive working capital.
  • Pay off quickly – Have an exit strategy to pay the advance off early if possible. Don’t let it linger at high cost over long periods.

Bottom Line

Merchant cash advances provide fast access to capital for businesses that struggle to secure funding elsewhere. But the high costs and repayment pressure also pose notable risks if used improperly.

As a business owner, you need to realistically assess your capital needs, revenue outlook, and ability to manage the daily payments. If those pieces line up, and you enter an MCA cautiously, it can serve as an emergency funding bridge or fuel for growth.

Just don’t view MCAs as long-term solutions – the compounding fees and pressures will catch up to you. Have a plan to pay off any advances quickly and transition to more affordable forms of financing.

With eyes wide open about the pros and cons, merchant cash advances can be reasonable options for some small businesses. Assessing your specific situation will determine if securing one makes strategic sense.

I hope this overview gives you a balanced perspective on MCAs to inform your financing decisions. Let me know if you have any other questions!

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