Merchant cash advance (MCA) is a form of business financing designed to help companies get cash fast. With relatively easy-to-meet requirements, businesses that would not qualify for conventional loans could get a quick cash injection. However, such convenience comes at a cost.
This article guides you through the fundamentals of merchant cash advance, including how an MCA works, its pros and cons, and the costs of MCA. In the event that merchant cash advance does not suit your business, we also provide alternatives and recommendations to help you grow your company.
- What is merchant cash advance?
- Why and when should you get a merchant cash advance?
- How does merchant cash advance work? (With example)
- Costs of merchant cash advance
- Pros and cons of merchant cash advance
- Is merchant cash advance right for your business?
- Alternatives to merchant cash advance
- Merchant cash advance vs. revenue-based financing
- Some last words
What is merchant cash advance?
As its name suggests, merchant cash advance is a form of cash advance given to business sellers. In an MCA, the cash advance provider gives you an upfront sum of cash in exchange for a portion of your future sales.
Merchant cash advance has a rather special repayment structure. Instead of making one fixed payment every month, you will repay with a percentage of your daily credit card sales until the full amount is settled.
In a merchant cash advance, the MCA provider usually works with your credit card service provider to obtain information about your business sales volume and collect money from your credit card terminal.
Some people therefore refer to merchant cash advances as credit card processing loans.
Strictly speaking, however, a merchant cash advance is not a loan — there is little or no emphasis on your credit history, and no collateral is needed to secure the cash advance.
Why and when should you get a merchant cash advance?
You may consider getting a merchant cash advance if any of the following applies to your business:
- You need quick access to cash to cover unexpected expenses;
- Your company does not have enough assets to serve as collateral for a loan;
- You run a seasonal business whose sales fluctuate greatly throughout the year, meaning that repayment in fixed periodic installments could put pressure on your company’s cash flow;
- You want to save the hassle of manual loan repayment, or the late payment fees arising from accidentally missing a deadline;
- There are concerns over the credit history of your business or yourself.
How does merchant cash advance work? (With example)
To understand how a merchant cash advance works monetarily, there are two concepts to learn about: factor rate and holdback percentage.
1. Factor rate
In a merchant cash advance, the factor rate determines the sum that you need to pay back. More specifically, the total repayment amount is calculated by the cash advance multiplied by the factor rate.
Below are two examples to illustrate this.
- Cash advance = $20,000
- Factor rate = 1.2
A factor rate of 1.2 means you have to repay $1.2 for every dollar you receive. Therefore, you will have to repay $20,000 x 1.2 = $24,000 in total.
- Cash advance = $20,000
- Factor rate = 1.5
With a factor rate of 1.5, you have to pay back $1.5 for every dollar received. Total repayment is equal to $20,000 x 1.5 = $30,000.
2. Holdback percentage
Holdback percentage, also known as retrieval rate, represents the portion of daily sales that the MCA provider takes from you. The holdback percentage in a merchant cash advance usually ranges between 10% and 20%.
Let’s say the holdback percentage is 12%. If you have $2,000 credit card sales today, the MCA provider will take $240 from you as repayment of the cash advance. If $3,000 worth of credit card transactions is made on the next day, then $360 will be automatically deducted from your revenue.
Merchant cash advance example
After exploring the concepts of factor rate and holdback percentage, let’s dive into an example of how a merchant cash advance can be repaid.
Assume an MCA has been made on the following terms:
- Cash advance: $20,000 (given on day 0)
- Factor rate: 1.5
- Holdback percentage: 12% of daily credit card sales
In this example, the repayment sum is $20,000 x 1.5 = $30,000. This amount will be repaid through 12% of your daily credit card sales until fully settled.
Putting words into numbers, below is a table to illustrate how the cash advance will be paid back:
What happens if you default on a merchant cash advance?
As merchant cash advances are unsecured, a personal guarantee is often required by the MCA provider, which means you are personally responsible for your company's cash advance.
Defaulting is not a good idea as it could hurt your personal financial standing and credit history.
Costs of merchant cash advance
Every form of business financing comes with a cost. While there is no simple formula to calculate the cost of capital in an MCA, it can be explained by way of illustration.
1. Factor rate determines total repayment
The cost of capital of an MCA is closely linked to the factor rate. The higher the factor rate, the more you need to pay back, hence the higher cost of capital.
Below is a table to illustrate this:
2. With the same factor rate, a higher cash advance amount has a higher cost
In an MCA, the amount of cash advance is another component that potentially affects your cost of capital.
The illustration below is based on a factor rate of 1.5. Keeping the factor rate constant, the cost of capital rises as the cash advance increases:
How much does a merchant cash advance cost?
Merchant cash advance costs are case-specific. Depending on the factor rate set by the MCA provider and the amount of cash you need, you could be paying somewhere between a few thousand to a hundred thousand dollars for an MCA.
Pros and cons of merchant cash advance
Advantages of merchant cash advance
1. Credit history is not a major consideration
MCA providers mainly look at your company’s credit card sales records to assess your ability to repay the cash advance, hence your eligibility for an MCA.
For companies without strong credit histories, merchant cash advance could be a source of alternative financing.
2. Relatively less paperwork
Applying for loans could be a laborious process. Bank lenders, for example, usually need a copy of your company’s financial statements, tax returns, business plans, and the list goes on.
MCA providers usually request less documentation from businesses applying for cash advances. Some providers make advances after assessing a few months of your company’s bank statements and credit card processing records. The application procedure is quicker and easier.
3. Quick access to capital
Conventional forms of business financing, such as bank loans, could take months to process. With MCA, the wait period could be shortened to days or weeks.
4. No collateral required
Bank lenders usually require that borrowers provide valuable business assets as collateral, but MCA providers do not.
Without the collateral requirement, companies that do not qualify for commercial loans could rely on MCA to get extra cash.
5. Few or no restrictions on usage of money
Some lenders impose loan covenants. For example, loan agreements may allow the use of funding only for certain purposes, require the borrower company to maintain financial ratios at certain levels, so on and so forth.
In the case of merchant cash advances, these restrictions are less common.
6. No fixed repayment schedule
In an MCA, repayment of the cash advance is based on a fixed percentage of your credit card sales. More is remitted to the MCA provider when business performance is good, less is repaid when sales dip.
You will not be locked into a fixed repayment schedule, which means you are not required to pay back certain amounts of money by certain dates.
Disadvantages of merchant cash advance
1. Frequent repayments create cash flow risks
In an MCA, a percentage of your credit card sales is automatically remitted to the MCA provider on a daily basis. In other words, your daily income is affected until repayment is complete.
You should therefore make sure that an MCA does not cause extra cash flow problems.
If MCA repayments hinder cash flow in a way that you need to get new business cash advances to cover old ones, there are good chances that your company will end up in a vicious debt cycle.
2. Merchant cash advances are costly
The total repayment amount is a multiplier of the cash advance. The cost of getting an MCA could be high, especially when you need a large amount of cash.
3. Cash advance amount limited by cash flow
Before making cash advances, MCA providers gauge your ability to repay based on your company’s financial situation.
It would be unrealistic to expect, say, $50,000 of business cash advance when you only make $10,000 credit card sales in a month.
4. MCA providers could be specific about terminals
Some MCA providers only make cash advances to companies who use designated credit card terminals. Your choice of MCA providers could be limited by the terminal you use.
Is merchant cash advance right for your business?
In addition to the various drawbacks, merchant cash advances have some limitations.
In order to get a merchant cash advance, your business must have a sufficiently large credit card sales volume and the requisite payment infrastructure. You must also ensure that an MCA aptly addresses your business needs.
To help you decide whether a merchant cash advance is suitable for your company, below are some questions to consider:
1. Does your company accept credit card payments?
MCA providers get a percentage of your sales revenue when customers pay via your credit card terminal. If your business does not allow credit card payments, MCA will not be available to you.
2. Do your customers pay with credit cards often?
The volume of your credit card sales gives you the entry ticket to a merchant cash advance.
It would be best if your customers make most of the transactions through credit cards, so that you will have strong sales records to apply for an MCA and stable income to repay the cash advance.
3. Is your company looking for a short-term or long-term financing solution?
Merchant cash advances generally have short repayment periods (ranging from 4 to 18 months).
If you are looking for a stopgap solution to overcome temporary cash flow issues, MCA could be an option. However, merchant cash advances cannot support the long-term needs of your company, such as business growth and expansion.
Alternatives to merchant cash advance
Merchant cash advance is a quick and rather flexible source of funding. Yet, it is an expensive, short-term solution which may not be suitable for businesses in every field and situation.
This section introduces some alternatives to merchant cash advance, helping you get a thorough picture of the business financing solutions available and decide what is best for your company.
1. Online small business loans
Like MCA providers, online lenders have more lenient requirements on credit history than traditional bank lenders.
Nonetheless, online small business loans usually come with high interest rates and should be avoided if possible.
2. Inventory financing
Inventory financing refers to short-term, asset-based loans or lines of credit made available for businesses to purchase inventory. Instead of using property, cars or equipment as collateral, the purchased inventory is used to secure the loan.
As the name indicates, inventory loans are advanced with the purpose of helping borrowers buy inventory. If your company needs cash for other spendings, you would be better off exploring other business financing solutions.
Learn more: Inventory Financing: Everything You Need To Know
3. Invoice financing
Invoice financing is also a form of asset-based financing. You can sell outstanding invoices at a discount to get immediate cash, or use invoices as collateral for a loan.
While invoice financing has low qualifying thresholds, high interest rates and fees make it an expensive financing method.
4. Revenue-based financing
Revenue-based financing (RBF) is an alternative financing solution in which companies raise capital based on future revenue. It is non-dilutive, and requires no collateral from recipient companies.
In revenue-based financing, RBF platforms (such as Choco Up) give you a lump sum, which you will repay through a portion of your company’s monthly revenue.
Repayment continues until a predetermined amount is repaid in full. Typically, this predetermined amount is the capital plus a flat fee.
If you think that revenue-based financing shares some resemblances with merchant cash advance, you are right.
Both MCA and RBF adopt a revenue-sharing approach in repayment, using a portion of your company’s revenue to pay back the funding.
But the question is, how are MCA and RBF different from each other? Which is better for your company? The next section will give you answers.
Merchant cash advance vs. revenue-based financing
Historically, merchant cash advance gained popularity as a lifeline for cash-strapped businesses in the wake of the financial recession in the 2000s.
On the other hand, revenue-based financing took off as a source of capital for fast-growing companies during the startup boom.
Against the vastly different backdrops, MCA and RBF are tailored for different users and differ in some of their features.
This section therefore explores the differences between merchant cash advance and revenue-based financing.
1. Different use cases
To begin, merchant cash advance and revenue-based financing benefit different users. While business cash advances are commonly used to smooth out cash flow issues, RBF funding is usually used by companies to fuel growth.
To illustrate how companies accelerate growth using RBF funding, BuzzAR is a case in point.
Starting off as a technology firm with a focus on business-to-business (B2B) augmented reality solutions, BuzzAR did not receive much interest from investors when it tried to raise funding for expansion into the business-to-consumer (B2C) space.
We at Choco Up, however, did not see it that way.
BuzzAR was a company with enormous growth potential. Bell, its co-founder, had a dream to bring BuzzAR’s entertainment apps to the consumer level and make children smile. To us, it was an opportunity to help a business and its owner grow and achieve their goals.
Choco Up therefore offered RBF funding to BuzzAR. With growth capital from Choco Up, BuzzAR successfully developed 5 new products (all of which are B2C), and 10X their user growth.
Learn more: How did BuzzAR get 10X new users?
2. RBF platforms use data and technology to create seamless funding experiences
As time passes, technology advances.
Born in the old days, merchant cash advance providers primarily rely on credit card statements and other documentation to assess companies’ financial situations. Revenue-based financing platforms, on the other hand, make use of data integration to do the same.
For example, Choco Up’s tech platform allows funding applicants to connect their sales accounts (e.g. Stripe, Shopify, Xero, etc.). With just a few clicks, our data integration platform will generate performance reports and give preliminary funding offers.
Taking tedious paperwork out of the picture, Choco Up creates a faster and simpler experience for RBF funding applicants. If all goes well, funding could be available in as little as 48 hours.
Click here to apply for RBF funding!
3. Different repayment frequency and amount
Although MCA and RBF both adopt a revenue-sharing model, they differ in terms of when and how much should be repaid.
In terms of repayment frequency, MCA providers take money from your card terminal every day, whereas RBF platforms share your revenue on a monthly basis. In this respect, revenue-based financing provides more flexibility to manage your company’s cash flow throughout the month.
Comparing MCA and RBF, repayment amounts are also calculated differently. Merchant cash advances are repaid as a multiplier of the cash advance, but RBF platforms charge a flat fee only.
To sum up the similarities and differences between merchant cash advance and revenue-based financing, below is a comparison table for easy reference:
Merchant cash advance
Short-term solution to smooth out cash flow gaps
Accelerate business growth
Some paperwork involved
Use of data and technology,
Cost of capital
Depends on factor rate and
Flat fee only
Percentage of credit card sales
Percentage of monthly revenue
Businesses with credit card sales
Businesses with revenue
Restrictions on use of funding
Some last words
Despite being a relatively new form of financing, revenue-based financing has gained wide popularity amongst fast-growing businesses.
Startup founders value its non-dilutive feature, e-commerce companies benefit from hassle-free funding experiences enabled by data integration, whereas small and medium-sized enterprises gain access to growth capital which is often unavailable via conventional lending options.
At Choco Up, we believe that business financing is not just about money. It is also about helping companies realize their upside growth potential, as well as creating value for businesses and the people they serve.
With this vision, we have helped hundreds of businesses grow with RBF funding, and we look forward to bringing positive impacts to many more.
Interested in learning more about raising capital for your company? Check out the following guides we prepared for you:
- E-commerce Financing: Options to Finance Your Online Business
- E-commerce Lending: Loan Options and Alternatives
- E-commerce Funding: A Guide to Your Options
About Choco Up
Founded in 2018, Choco Up is the leading revenue-based financing platform in Asia Pacific, offering non-dilutive growth capital to fast-growing companies.
Currently covering more than 10 markets and 10 sectors, Choco Up has helped hundreds of businesses capture growth while protecting equity upside.
Click here to apply for RBF funding!