What To Look For In A Merchant Cash Advance Contract

What To Look For In A Merchant Cash Advance Contract

Hey there! If you’re a small business owner looking into merchant cash advances, you’ve come to the right place. I totally get it – sometimes you just need quick access to capital to keep things running smoothly. But before you sign on the dotted line for a merchant cash advance (also called an MCA), it’s really important to understand what you’re getting into. I’ve gotten a few MCAs for my business over the years, so I want to share some tips from my experience to help you make the best decision.

What is a Merchant Cash Advance?

First things first – what even is a merchant cash advance? Basically, an MCA company gives you an upfront lump sum of cash in exchange for a percentage of your future credit card sales. So it’s not a loan – you’re selling a portion of your future sales. The MCA company then takes a fixed percentage of your daily credit card revenue until the full advance amount plus fees is paid back[1].

Because it’s not technically a loan, MCAs aren’t regulated like loans are. There’s no interest rate – instead there’s a “factor rate” that determines how much you’ll pay in fees. For example, a 1.4 factor rate on a $10,000 advance means you’ll repay $14,000 total[2]. Yep, crazy expensive!

Pros of MCAs

Okay, so why do people get merchant cash advances if they’re so expensive? There are some advantages:

• Fast funding – You can get approved in as little as 24 hours and get the money quickly[3]
• Flexible requirements – MCAs work with weaker credit and don’t require collateral[4]
• Payments align with revenue – You repay based on a % of daily sales, so payments go down if your sales do[5]

Cons of MCAs

But there are also some big drawbacks to consider:

• Insanely expensive – Factor rates are equivalent to 60-200% APR[2]
• Frequent payments – Money is taken daily from your sales, hurting cash flow[4]
• Tough to compare – Agreements don’t show APRs like loans do[5]
• Can lead to debt cycles – Easy to get stuck needing a new MCA to repay the old one[3]

What to Look for in MCA Contracts

Okay, so if you do decide to go the MCA route, it’s really important to understand the contract terms. Here are some key things to review:

Factor Rate & Fees

Factor rates range from 1.1-1.5x the advance amount. The higher the rate, the more expensive the financing. Make sure you calculate the equivalent APR so you can compare costs to loans[5].

Daily/Weekly Payment Amount

Many MCAs take a fixed daily or weekly payment from your bank account. Understand the payment amount and how long it will take to fully repay[3].

Repayment Start Date

Some MCAs take the first payment upfront. Know when daily payments will start coming out of your account[5].

Personal Guarantees

Many MCAs make the business owner personally responsible for repaying the advance. Understand your liability[4].

First Priority Lien

MCA companies get first dibs on your sales revenue until repaid. This limits your options for other financing[3].

Restrictive Covenants

MCA contracts often limit your ability to open new locations, take other financing, or make refunds. Watch for clauses that restrict your business flexibility[4].

Modification Rights

Some MCAs include provisions allowing the provider to change contract terms if you violate a covenant. Make sure you understand the implications[4].

Access to Statements

Providers can access your merchant/bank statements anytime to verify sales volumes and ensure you’re following the contract. Know what they can see[5].

Events of Default

Understand exactly what constitutes a default, like missing payments for X days. Default can allow the MCA company to take aggressive action like debiting your account or enforcing the personal guarantee[4].

The Bottom Line

I know how tempting fast cash can be when you’re in a tight spot! But merchant cash advances are one of the most expensive financing options out there. Be sure to read the fine print, consider all alternatives first, and consult a lawyer if you have concerns. With the right precautions, MCAs can sometimes be a viable short-term solution just to keep things afloat. But tread carefully – those factor rates and rigid terms can really catch you off guard. Let me know if you have any other questions!

Citations

[1] https://www.nerdwallet.com/article/small-business/merchant-cash-advance
[2] https://www.federallawyers.com/debt-relief/what-to-look-for-in-a-merchant-cash-advance-contract/
[3] https://fundbox.com/resources/guides/merchant-cash-advance/
[4] https://www.mondaq.com/unitedstates/contracts-and-commercial-law/1236458/merchant-cash-advances—what-you-should-know
[5] https://attorney-newyork.com/2022/10/18/what-to-look-for-in-a-merchant-cash-advance-contract/