Many small-to-medium-sized businesses that are unable to secure a traditional bank loan have begun turning to merchant cash advances (MCAs) as an alternative funding source. Unlike a traditional bank loan, an MCA is best for a business owner who needs access to cash quickly, often to meet a short-term need for capital. The funds are repaid by withholding a percentage of your businesses debit/credit card sales, so your rate of repayment fluctuates based on the state of your business sales.
Why Would a Business Use a Merchant Cash Advance vs. a Traditional Bank Loan?
A business owner might choose to use an MCA if they are looking for funding quickly and have had a challenging time getting funding through a traditional lending institution. Because of the easier approval process, MCAs are a great option for existing businesses or those with poor credit. Note that most MCA providers will require at least six months of operations to see a track record of your sales.
Many traditional lending institutions make it harder for businesses like this to get funding, which is leading them to seek these alternative sources that offer more flexibility. Other common reasons businesses consider MCAs include:
- Purchasing new equipment/materials or restocking inventory to grow the business
- Building a cushion for slower seasonal periods
- Purchasing new locations, or renovating/expanding current locations
- Paying off existing debt
- Improving credit
- Growing marketing efforts
It’s worth noting that some providers use the terms merchant cash advance and business cash advance interchangeably when they’re actually different types of financing products. As we stated above, the repayment structure with MCAs happens daily with a fixed amount deducted from your business bank account.
However, business cash advances require you to pay a set percentage of total sales instead. These products are similar in the sense that you will still pay more when your business’ sales are growing, and less when sales are down. But the major difference is in when and how often you repay the financed amount.
Advantages of Merchant Cash Advances
As a business owner, when you get a chance to grow your business, you usually want to take that opportunity and move forward quickly. There are many advantages of using MCAs, and this alternative funding method can help boost your return on investment as well as future sales numbers. Below are several benefits that can come from choosing to use an MCA versus a traditional bank loan.
- No fixed monthly payments: This can make repayment a lot easier. Unlike traditional bank loans where the monthly payment is typically a fixed amount with interest, an MCA is paid back based entirely on your business revenue. The payment is calculated on a fixed percentage of credit and debit card sales. If your business experiences a decrease in revenue, then your payment will also drop. Similarly, if you have a strong month with higher revenue, your payment will be higher. The higher your credit or debit card sales, the more quickly you’ll pay off the MCA.
- No collateral or down payment: MCAs are not loans because they’re unsecured; they are considered more like a business transaction. Because of this, no down payment is required, and you do not need to offer up collateral to secure the advance. This means there’s no risk of losing personal or business property. However, upholding your end of the transaction requires strong business credit and debit card receipts.
- No limits on how you spend your funds: MCA providers do not limit how you spend your funds, which makes them more attractive to businesses that need to allocate funds for varied reasons, such as paying off debt or acquiring more inventory.
- Quick approval times: Traditional bank loans can require an extensive amount of paperwork and time before being approved. With MCAs, approval doesn’t depend on your credit or FICO scores. If your business is qualified, you could be approved in just a few minutes, or funded in one business day (depending on the provider). With quicker approval times, your business can take on that growth opportunity faster.
Additional Insights on Merchant Cash Advances
Although MCAs can be a beneficial form of alternative lending for small and medium-sized businesses, there are a few aspects to take into consideration.
- There’s a potential for your APR to be in the triple digits: The APR typically ranges from about 40 percent to 350 percent depending on the provider, the size of the advance, any extra fees and how long it takes your business to repay the advance in full. Your APR can also be based on the strength of your business’ credit and debit sales. This path can be far more expensive than traditional bank loans, (with APRs of 10 percent or less) and even business credit cards (with APRs typically ranging from 15 percent to 29 percent).
- The higher the sales, the higher the APR: Because MCAs are repaid with a percentage of your credit and debit sales, the APR not only depends on the total fees paid but also how quickly you’re repaying the loan. If your business is struggling and sales are weak, your MCA payments will spread out over a longer period of time.
- There’s no benefit to paying early: Unlike traditional bank loans, you will get no interest savings from early repayment. With some MCAs, there is also the potential for an early repayment penalty. Specifically, if you’re refinancing, you could get hit with heavy fees.
- Contracts can be confusing, and there’s no federal oversight: The cost and repayment structure of MCAs can be confusing. For example, MCAs do not provide standard APRs, which makes it challenging to compare an MCA with other financial products. If you’re unable to compare, this makes it more difficult to understand whether an MCA is the right path for your business. Also, because MCAs are structured as commercial transactions (not loans), they are not subject to federal regulation. They are instead regulated by the Uniform Commercial Code in each state (as opposed to the Truth in Lending Act).
Traditional bank loans require high credit scores, a lot of paperwork and a slow approval process. Their terms and repayment structure are often fixed, leaving very little flexibility for a small business that sometimes doesn’t bring in the necessary revenue needed to cover these loan payments. The speed and ease of MCAs along with a repayment structure customized for your business can give more opportunity for growth.
However, it’s important to be aware that MCAs also have the potential to put your business into a debt cycle, especially if you don’t qualify for other types of financing. High costs and frequency of payments can cause cash-flow problems that could leave your business at risk of default. Be sure to research all of your funding options to find out what is best for your business needs.
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