For many small business owners there comes a time where they need a little extra. A little extra help, a little extra time, a little extra cash. Often, the first place they’ll turn to is the bank - and for good reason. 

Bank loans are some of the cheapest ways for small businesses to get their hands on capital. But these loans can come with strict approval processes and if approved the cash can still take up to a few weeks to land in their account. 

If you’re a small business owner in need of fast and flexible funding, a merchant cash advance could be the right option for your business.

 

What is a Merchant Cash Advance?

A merchant cash advance, also known as a business cash advance, is a popular alternative to traditional bank loans. 

 

A lender gives your business a sum of money, and you repay it as an agreed percentage of future sales revenue. Merchant  cash advances are a great way for small businesses to get quick access to capital, particularly if their sales see predictable seasonal changes.  

 

It’s important to note that a merchant cash advance is not a loan. Merchant cash advances are commercial transactions where a lender purchases a percentage of your future sales.

 

This is a popular financing option for businesses like restaurants, which drive the majority of their revenue through debit and credit card sales. Providers of merchant cash advances prefer these businesses because debit and credit card transactions are easy for lenders to track.

 

How Merchant Cash Advances Work 

There are three main steps to merchant cash advances. The application, the distribution of funds and the repayment. 

Luckily for applicants, merchant cash advances tend to be approved and distributed much quicker than traditional loans. They are a short-term financing solution that can be repaid in a few months to around a year.

Who Is Eligible?

Businesses with a consistently high monthly revenue are great matches for merchant cash advances, especially if the business owners struggle to qualify for a small business loan due to their credit history or lack of securable assets. 

When it comes to credit scores, merchant cash advance providers are not nearly as strict as banks. In fact, they are looking at a very different set of criteria when deciding whether to issue funds.

Providers assess the risk of lending capital by evaluating industry, business performance, and - to a lesser extent - credit ratings. Then they assign a  percentage rate for how much the business will pay in fees. Factor rates can range from 20% to 50%. 

How Do You Apply For One?

Applying for a merchant cash advance is easy. You can apply for your advance online and often you will receive a response within 24 hours.

 

The application does not require much paperwork, but you will need to provide:

  • Credit card receipts and/or credit card processing statements
  • Business bank account statements
  • Bank routing numbers and relevant business information 

 

Although providers may check your credit during the application process, it is not usually the deciding factor. Providers prioritize consistent cash flow over credit scores. 

It is this unique qualification process of merchant cash advances that makes them a reliable option for business owners with bad credit or a limited business credit profile.

 

If approved, you may be offered something like the following:

Merchant cash advance total: $100,000

Factor rate: 1.3

Fees: $30,000

Total amount repaid: $130,000

Repayment Structures

Merchant cash advance providers generally offer two options for structuring repayments. You can either repay your advance as a percentage of future credit and/or debit card sales or repay with daily or weekly withdrawals from your business bank account. 

To see if either of these repayment options are right for you, let’s take a more detailed look at both.

 

1. Repayment Via Credit and Debit Card Sales

If you choose repayment via credit and debit card sales, providers will take a weekly percentage of those sales. The percentage they take is called a holdback and ranges from 10% to 20%.

It’s worth noting that this is the most common and flexible repayment option for merchant cash advances. With this method, repayments fluctuate based on monthly sales numbers. Repayment can take anywhere from 3 months to over a year.

If your sales are higher than expected you can repay the advance faster. That also means that if sales fall, so do the size of your repayments which will lead to a longer payoff time. That isn’t necessarily a bad thing as it ensures you will only ever pay back what you can afford.

Picture this, you take on a Merchant Cash Advance with the following:

Merchant cash advance amount: $100,000

Daily % of credit card sales taken by provider: 10%

Factor rate: 1.3

Total repayment: $130,000

This is what repayment could look like:

Monthly credit card sales: $250,000

Monthly repayment: $25,000

Daily repayment: $833

Time to repay: Approx. 5 months

 

In the above example, you would repay $25,000 a month and make daily repayments averaging $833. At this rate, you would pay off your MCA in a little over 5 months, but if your sales drop to $150,000 it would take closer to 8 ½ months.

 

If you plan to use this repayment method, make sure you have realistic forecasts for your monthly credit card sales so that repayments don’t drag on longer than expected.

 

2. Repayment Via Fixed Withdrawals 

Another repayment method that providers use to give businesses access to working capital is fixed withdrawals such as ACH withdrawals. With this option, providers withdraw a daily amount directly from a business’s bank account. The withdrawal amount is fixed and is based on an estimate of your monthly sales. The difference between this and repayment via credit and debit card sales is that the amount is predetermined and will not fluctuate alongside your revenue.

Let’s look at how repayment could work with this option.

You take on the following Merchant Cash Advance:

Merchant cash advance amount: $100,000

Daily % of credit card sales taken by provider: 10%

Factor rate: 1.3

Total repayment: $130,000

Monthly expected revenue: $150,000

Weekly repayment: $3,500

Daily repayment: $500

Time to repay: Between 9-10 months

 

These transactions are not flexible, but they generate funding for businesses with revenue that’s not driven by credit or debit card sales.

 

Merchant Cash Advance Rates: How Much Does It Cost?

Determining your annual percentage rate, or APR, is the best way to calculate the total borrowing costs for your merchant cash advance. Merchant cash advances rarely take longer than a year to repay meaning this calculation may be misleading at first impression. You should also keep in mind that APR fluctuates based on how long it takes you to repay your advance. 

 

When you know how to calculate your own APR, you can use it to evaluate the cost of your advance and even compare lenders. Here’s a step-by-step look at how to calculate your merchant cash advance rates:

How to calculate your merchant cash advance rates:

 

  • Step 1: Amount of advance (X) factor rate = total cost 
  • Step 2: Total cost - amount of advance = borrowing cost 
  • Step 3: Borrowing cost (/) amount of advance = percentage cost 
  • Step 4: Percentage cost (x) 365 = x 
  • Step 5: x (/) pay period (in days) = Annualized Interest Rate

 

Let’s walk through these same steps using the example from earlier with an estimated repayment period of 9 months.

How to calculate your merchant cash advance rates with a 9 month repayment period

  • Step 1: $100,000 x 1.3 = $130,000
  • Step 2: $130,000 - $100,000 = $30,000
  • Step 3: $30,000 / 100,000 = 0.3
  • Step 4: 0.3 x 365 = 109.5
  • Step 5: 109.5 / 270 = 0.4055 or 41% 

 

This is considered an Annualized Interest Rate. It’s often not a true indication of APR because there can be additional fees you may need to consider, such as administrative costs.

These fees can make them an expensive option, depending on your lender, so it’s important to shop around. Use your APR to compare your advance to traditional financing options and decide if it’s the best choice for your business.

 

The Pros and Cons of a Merchant Cash Advance

While a merchant cash advance may be an expensive option, many small businesses find them helpful for taking on new projects or settling short-term financial issues, like seasonal declines. If you’re able to make timely repayments, a merchant cash advance is a fast and practical option for growing your business.

 

Let’s take a closer look at the pros and cons:

Pros

Quick Turnaround

The application process is quick and simple and you can get access to your advance in as little as 24 hours. You don’t need a lot of paperwork to get started either, so you’re spending less time on admin.

 

You Don’t Need Collateral

Merchant cash advances are unsecured, so you don’t have to put your business’s or personal assets at risk in order to qualify. This is another reason why they are a popular option for business owners who haven’t had a chance to build good personal credit or even a business credit profile.

 

Repayments Fluctuate with Sales

When your sales decline or stop altogether, so do your repayments (assuming you’ve chosen repayment via credit and debit card sales)! This means that the size of your repayments reflects the success of your monthly sales, and there’s no added stress when sales are low. You may even pay your advance off faster than expected with a few months of high sales. 

Having said that, merchant cash advance providers all have different terms, so be sure to read the legals closely! Look out for any hard deadlines that force full repayment if you don’t pay back in time, or covenants on minimum capital that cause the agreement to default.

Cons

High APR

When it comes to merchant cash advances, critics would say that high APRs are the biggest issue. And they’re 100% correct.

APRs can range anywhere from 20% to as high as 250%. Compare that to a small business loan, which tends to have an APR of 10% or lower

 

However, most businesses won’t take out a merchant cash advance if they expect it to take more than a few months to repay. In those cases, they are more likely to look at other financing options, such as VC funding or a bank loan.

 

Having said that, if it does makes sense for your business to take out an advance for longer than a few months, you may be able to negotiate any of the following:

  • Advance size 
  • Fees
  • Repayment timeline 

Impacts Your Credit Score

Like most financing options, a merchant cash advance can have a negative impact on your credit score if you’re unable to make repayments. That’s why it is important you’re realistic with your expected revenue and repayment timeline.

 

Contracts Can Be Confusing

The language in contracts for merchant cash advances can be confusing for new business owners, given the various terms used to explain the structure of the repayment process. Here are a few terms you should become familiar with if you’re considering taking out a merchant cash advance:

 

  • Holdback/specified percentage- daily percentage of credit card sales deposited towards repayment
  • Purchase Price/principal amount - the amount of the advance you receive 
  • Receipts purchased amount - how much you repay in total 
  • Factor rate - a multiplier of the purchase price used to calculate receipts purchased amount 
  • Payback period - The time it takes to repay the full receipts purchased amount 
  • Payment frequency - how often a lender withdraws repayments (daily, weekly)

 

We’ve purposefully tried not to use too many of these terms throughout this guide, but it’s important that you know them. Bookmark this page so that you can come back and reference it when looking through your merchant cash advance contract. 

 

Best Uses for Merchant Cash Advances 

Merchant cash advances are a great way to get access to capital for seasonal or short-term projects that are very likely to generate revenue quickly. Here are a few examples of how to use merchant cash advances:

  • Invest in advertising that will make a quick return
  • Purchase bulk or seasonal inventory at a discount
  • Increase working capital to pay short-term debts or unplanned expenses  
  • Fix temporary cash flow problems

 

How to Qualify for a Merchant Cash Advance

You don’t need to have been in business for five years or have the credit profile of a saint to get started with a merchant cash advance. Your payment history has more weight than your credit history.

More often than not, great sales numbers make up for poor or lacking credit. Get to know the ins and outs of what you’re signing up for, and anticipate repayments to begin as soon as you receive your advance.

 

Alternatives to Merchant Cash Advances

We’ve dug into when to take on a merchant cash advance work, but if you’re looking for a different type of finance, where should you turn?

 

Let's look at the main options.

Revenue Based Finance

Revenue based financing is based on, you guessed it, how much revenue a business is regularly bringing in. Lenders provide a loan in exchange for a percentage of future revenue. 

This makes revenue based finance similar to merchant cash advances because repayments will fluctuate depending on cash flow. The difference is that revenue based finance options take repayments monthly not daily or weekly.

Small Business Loans

Why would you choose a small business loan instead of a merchant cash advance? 

It's simple. Business loans usually come with a lower interest rate and have better terms over longer repayment periods. In our digital age, many online loan providers offer a range of flexible financing options, so a traditional bank loan isn’t the only option.

Is a Merchant Cash Advance Right for Your Business?

With a merchant cash advance, small businesses get fast access to capital and choose the repayment option that works best for them. When used correctly it can help a business grow or buy much needed stock or equipment.

When worked out over a short-term basis (a few months), this financing option makes a lot of sense, but over the course of a year, the costs add up.

If your business has predictable monthly revenues but doesn't qualify for a small business loan, or doesn’t want the flexibility of getting capital without securing your own assets against it, a merchant cash advance is a reliable choice.

 

At Uncapped, we offer investment capital through a revenue share agreement similar to a merchant cash advance. Offers range from £10k to £5m. See if you qualify!