Is a Merchant Cash Advance (MCA) the Solution for Your Business?

Are you a small business owner struggling with cash-flow issues? If so, you may be considering a merchant cash advance (MCA) as a potential solution. MCAs can be a lifeline for founders of new startups or businesses with low credit scores who are unable to secure traditional small business loans. However, it’s important to be aware of the significant downsides that come with this alternative financing option.

What is an MCA?

An MCA is a type of business financing that differs from traditional small-business loans. Instead of repaying the loan in fixed installments, an MCA is repaid through a percentage of your business’ future sales. Lenders charge a factor rate, which is a fee added to the funding amount, to arrive at a fixed repayment amount.

Repayment periods for MCAs are typically short, ranging from three to 18 months. The combination of short repayment periods and high factor rates results in a much higher annual percentage rate (APR) compared to small-business loans or credit cards.

How does an MCA work?

With an MCA, your business receives a lump-sum payment from the lender, who then acquires the rights to a portion of your future sales. There are two main methods to repay an MCA:

1. Percentage of credit card sales: If your business generates sufficient credit card sales, the lender will deduct a percentage, known as the “holdback rate,” from your daily sales until the funding amount and additional fees are repaid.

2. Fixed withdrawals from your bank account: If your business doesn’t have significant credit card transactions, the lender may opt to make fixed withdrawals from your bank account based on an estimated monthly revenue. These withdrawals can occur on a daily or weekly basis.

Pros and cons of an MCA

Pros:

• Easier qualification: MCAs are easier to qualify for compared to traditional business loans.
• Faster funding: The application process is quick, and funding can be deposited into your bank account within 24 hours.
• No collateral required: Unlike traditional business loans, MCAs don’t require you to put up collateral.
• Lower payments during slow periods: Since repayment is based on a percentage of sales, payments are lower during slower periods.

Cons:

• Constant repayment cycle: Daily repayments can impact your future cash flow, potentially trapping your business in a cycle of debt.
• No credit reporting: On-time payments won’t improve your business credit score, while defaults won’t negatively impact it.
• High APR: Due to the short repayment periods and high factor rates, the APR for MCAs can be significantly higher than traditional business loans.
• No early repayment benefit: Unlike traditional loans, there is no benefit to repaying an MCA early, as the total repayment amount is fixed.
• Lack of regulatory oversight: MCAs are not subject to federal regulation, as they are considered purchases of future sales rather than loans.

Who is an MCA good for?

MCAs are beneficial for small business owners with limited business history or poor credit scores. They can also provide quick cash for seasonal businesses during slower months, as the financing can be repaid using future sales from busier periods.

When is an MCA a good choice?

If you fall into one of the categories mentioned above and need funding quickly, an MCA may be the best option for your business. The application process is faster, and funding is typically provided much quicker than with traditional small-business loans.

Alternatives to MCAs

For businesses with a lengthy history and good credit, there are better alternatives to MCAs available:

1. Business loans: Small-business loans offer more favorable rates than MCAs and can be applied for online.
2. Business credit cards: Although they may have higher fees, business credit cards are a cheaper option than MCAs if you qualify.
3. Invoice factoring: If your business has significant accounts receivable, you can consider selling them at a discount to receive a lump-sum payment quickly.

MCA should be a last resort

Due to the high fees associated with MCAs, they should only be used as a last resort for funding. If you don’t qualify for traditional business loans or credit cards, an MCA can be an option during cash-flow crises. However, be aware that the constant repayment cycle may lead to long-term debt.

Frequently asked questions (FAQs)

• Are merchant cash advances (MCAs) legal?
  Yes, MCAs are legal, but they are not federally regulated like loans.

• How is an MCA repaid?
  Repayments are made by deducting a percentage of future sales. The lender may take repayment funds on a daily basis or make fixed withdrawals from your bank account.

• Do MCAs report to credit bureaus?
  No, MCAs do not report to credit bureaus, so they won’t impact your business credit positively or negatively.

For more information about personal finances, visit the Personal Finances Blog and stay tuned for more informative articles!