Pros and Cons of Merchant Cash Advances for Small Businesses

A merchant cash advance (MCA) is a form of business financing that provides fast access to capital for small businesses and startups. MCAs allow companies to receive a lump sum of cash upfront in exchange for a percentage of future credit card and/or debit card sales over a fixed period.

Unlike traditional small business loans, MCAs don't require strong business credit, existing revenue, or assets for collateral. The approval decision is primarily based on a business's credit card sales volume. This makes MCAs an excellent financing option for newer companies or those with past credit challenges.

MCA providers advance a specific amount of capital ranging from $5,000 to $500,000. The business then repays the advance through daily or weekly remittances of a fixed percentage of credit card sales. This repayment structure allows flexibility for the company to repay more quickly when sales are higher and slower when sales are lower.

The simple application process and fast funding timeline make MCAs attractive for small business owners who need quick capital to take advantage of growth opportunities or manage cash flow crunches. However, the high costs and risks associated with MCAs make them unsuitable for some businesses. Careful consideration of the pros and cons is essential before obtaining an MCA.

What is a Merchant Cash Advance?

A merchant cash advance (MCA) is a form of business financing that provides fast access to capital in exchange for a percentage of future credit card sales.

Unlike a business loan, an MCA does not require fixed monthly payments. Instead, the merchant repays the advance through daily deductions from credit card receipts over a set period, usually 3-18 months.

The MCA industry emerged in the early 2000s as an alternative financing option for small businesses that couldn't qualify for traditional bank loans or needed funds faster than a loan could provide.

MCAs allow businesses to leverage their credit card sales history to obtain capital to reinvest in their company's growth. The repayment structure also provides more flexibility to seasonal firms with fluctuating cash flow.

While MCAs carry higher costs than conventional loans, they have become an increasingly popular financing choice for small and medium-sized businesses looking to access capital quickly and easily. The MCA industry has grown rapidly over the past decade, with an estimated $15 billion to $20 billion in capital provided to U.S. businesses annually.

Pros of Merchant Cash Advances

Merchant cash advances offer several potential benefits for small businesses compared to traditional small business loans. Here are some of the main pros to consider:

• Quick and Easy to Obtain: The application process for merchant cash advances is generally much faster and less stringent than getting approved for a small business loan from a bank. Providers mainly base approval on a business's credit card sales history rather than credit score. This allows many companies that may not qualify for a loan to get financing. Approvals can happen in days or weeks rather than months.
• Flexible Repayment: With a merchant cash advance, repayments are taken as a percentage of future credit card sales, generally 5-20%, depending on the provider. This repayment structure ties the loan directly to revenue, rising and falling with the business's cash flow. There are often no fixed monthly payment amounts or repayment term lengths, which helps businesses manage cash flow crunches.
• Based on Credit Card Sales over Credit Score: Traditional lenders rely heavily on personal credit scores to approve financing. Merchant cash advance approvals depend primarily on your business's credit card sales history rather than personal credit. So, if your business has steady revenue streams but your personal credit is lacking, a merchant cash advance may still be an option. The focus is on your business's health.

Merchant cash advances offer several advantages over traditional small business loans, making them an attractive option for businesses needing fast capital or greater repayment flexibility. With quick turnaround times, flexible repayment terms, and alternative qualification criteria, they provide easily accessible financing that may not be available through traditional lending channels.

For businesses facing urgent financial needs or seeking more adaptable repayment options, merchant cash advances can be a lifeline. Unlike conventional loans, they often do not require extensive paperwork or a lengthy approval process, allowing businesses to access funds swiftly when needed.

Moreover, merchant cash advances offer repayment flexibility, as payments are typically based on a percentage of daily credit card sales or other receivables. This means that businesses may pay back less during slower periods, alleviating some of the financial strain that can accompany fixed monthly loan payments. Visit https://www.gofundshop.com/blog/commercial-business-loans/commercial-construction-loans-types-of-loans-for-construction-company/ to learn more about the various types of financing available to construction companies, including merchant cash advances.

Cons of Merchant Cash Advances

Merchant cash advances come with some downsides that small business owners should consider carefully before moving forward:

• High-interest rates—MCAs can have an annual percentage rate between 30% and 300%. This is significantly higher than most business loans. When factoring in fees and interest, the total amount repaid can be double the original advance amount.
• Daily repayment can be burdensome - With an MCA, repayments are taken automatically as a percentage of daily credit card sales or receivables. This daily debiting can make it challenging to manage cash flow, especially on slow business days.
• Providers have limited regulations—MCA providers are not subject to the same regulations as banks and lenders. Working with providers that lack transparency or have predatory structures can be risky.

Business owners should weigh the benefits against these potential drawbacks. Understanding the terms, evaluating alternatives, and partnering with reputable providers can help avoid significant pitfalls of merchant cash advances.

Alternatives to Consider

There are several alternatives that small businesses can explore instead of or in addition to merchant cash advances:

Business Loans

Traditional business loans from banks allow access to more considerable lump sums of capital than merchant cash advances. Interest rates are usually lower as well. However, they often require strong credit scores, collateral, and a longer time to get approved.

Invoice Factoring

With invoice factoring, a business can sell its unpaid invoices to a factoring company at a discount to quickly access working capital. This avoids waiting 30-90 days for clients to pay invoices. It works for B2B businesses with steady sales volumes. But factoring fees can add up over time.

401(k) Business Financing

Entrepreneurs can use their 401(k) or IRA retirement funds to invest in their businesses without tax penalties. This avoids giving up equity or interest costs. However, it puts retirement funds at risk if the company fails. And withdrawals may still owe taxes plus a 10% early withdrawal penalty if under age 59 1⁄2.

Crowdfunding

Crowdfunding platforms like Kickstarter or Indiegogo allow startups and businesses to raise small investments from many backers. This helps validate and launch new products and services. However, it can take a lot of work to attract enough backers. And there’s no guarantee the business will deliver on promises made during the campaign.

With the right fit, merchant cash advances can still be beautiful for rapidly growing small businesses. But having backup options available is always wise. Assessing each financing method against current and future business needs makes it easier to pick the right solution.