Understanding different types of financing can be important when starting and growing a business. A merchant cash advance (MCA) is one option that offers quick access to funds. It can also be easier to qualify for an MCA than traditional small business loans or lines of credit.

However, MCAs tend to be relatively expensive, the fee structure can be confusing and the payments could strain your cash flow. Learn how MCAs work, their pros and cons and how to decide if an MCA is a good option for your business.

What is a merchant cash advance?

A merchant cash advance isn’t a loan. Instead, the MCA provider purchases a portion of your future credit and debit card sales. You might find MCAs directly from companies online, or via a broker that connects small business owners and the MCA provider.

With an MCA, you receive a lump sum advance right away. You then repay the advance, plus fees, from your card sales or with automatic daily payments from your business bank account.

Since they’re not loans, some of the state and federal regulations that apply to small business lending don’t apply to MCAs. As a result, MCA providers might be able to charge you higher fees than lenders could legally charge you to borrow money. 

How does a merchant cash advance work?

The specifics vary depending on the MCA provider, but MCAs generally share several features: 

  • The MCA provider approves you for a maximum advance amount. Once you apply, the MCA provider will review your eligibility and approve you for a maximum amount. You can choose to receive less if you don’t need the entire amount.
  • Your total repayment amount depends on a factor rate. Instead of charging interest, MCAs use a factor rate that determines how much you need to repay for each dollar you receive. For example, with a factor rate of 1.5, you’ll repay $1.50 for every dollar you’re advanced—or an extra $500 for every thousand dollars. Factor rates tend to vary from around 1.1 to 1.5.
  • Your periodic payments could depend on a holdback rate. Your holdback rate determines the percentage of your sales that you need to pay to the MCA. You may have to make daily or weekly payments based on your actual or estimated card sales. Holdback rates tend to range from around 10% to 20%. 
  • You may have to pay additional fees. MCA providers may also charge additional fees. An origination fee or broker fee could be taken out of your advance, and there may be ongoing account or processing fees while you’re repaying the MCA.
  • You often make daily or weekly payments. After receiving the advance, you may have to start making daily or weekly payments.

The MCA repayment process generally works in one of three ways: 

  • Your card processor sends a portion of your sales to the MCA provider.
  • The card processor sends the money to a bank account that the MCA controls and the MCA takes its cut before sending you the remainder. 
  • The MCA provider sets up automatic withdrawals from your bank account. 

Ask if the repayment amount will fluctuate based on your actual sales. Sometimes, the provider uses your estimated sales at the start to set fixed payment amounts. In either case, you can generally expect to repay the MCA within a three- to 18-month period. 

Benefits of merchant cash advances

MCAs can offer access to funding and repayment schedules that you won’t find with other types of financing.

  • Quick and easy financing. It can be easy to apply and get approved for an MCA. Even if you don’t have good credit, you might get a large advance based on your previous sales volume.
  • Potentially variable repayments. If the MCA bases the repayment amount on your sales, the ongoing adjustments could make repaying the MCA easier than a loan when business is slow.
  • Cheaper renewals for additional funding. You might have the option of getting another cash advance from the same provider, or “renewing” your MCA, with more favorable terms. 

Drawbacks of merchant cash advances

See if the drawbacks outweigh the benefits before getting an MCA.

  • Can be relatively expensive. The equivalent annual percentage rate (APR) of an MCA is often much higher than what you’d pay for a business loan or line of credit. 
  • May require a personal guarantee. Although MCAs often don’t require collateral, you might be asked to sign a personal guarantee. That means you’ll personally be responsible for repaying the advance if your business doesn’t make the payments. 
  • Eats into cash flow. Although variable repayments can sometimes be a benefit, they can also lead to larger repayments when your business is doing well. Higher payments could hurt your cash flow and limit your options for growing your business. 
  • Limited benefits for early payoffs. The factor rate and repayment amount are set at the start. As a result, you might not save much money if you pay off your MCA early. However, paying off the MCA could still be helpful if the provider charges ongoing fees. 

When should you consider a merchant cash advance?

MCAs tend to be best for businesses that need extra money quickly and can’t qualify for more affordable financing. 

For example, you might want to consider an MCA if you:

  • Have a new business or poor credit and don’t qualify for other types of financing. 
  • Experience a sudden shortage—or a limited-time opportunity—and you need money within a few business days.
  • Don’t have many assets that you can use as collateral for a loan or line of credit with more favorable terms. 

A traditional small business loan or line of credit might be better if you have an established business or good credit score. You could also look into other forms of alternative financing. For example, microloans and crowdfunding might have more relaxed eligibility requirements if you don’t need the money right away. 

Tips for comparing MCA providers

Even if you need money quickly, compare several MCA providers before applying to make sure you get the best terms possible. Key terms to compare include:

  • Eligibility requirements. Providers often list minimum requirements, such as monthly revenue, time in business and personal credit scores.
  • Online reviews. Find out if other business owners had good experiences working with the provider. Look for reviews on third-party websites—not the ones the company highlights on its website.
  • Fees and factor rates. Get quotes from several providers to see which one offers the lowest factor rate. Additionally, find out if and when they charge any additional fees to determine which will be the least expensive overall. 
  • Repayment process. See if your payments must be made daily, weekly or less frequently. Find out where the payments will come from and whether they’ll be based on your actual or estimated sales. 

You can often complete applications and secure funding with a completely online process. You may need to upload documents to verify your identity and your business’s information. These could include a government-issued picture ID, recent bank account, and credit card processing statements and business tax returns. Get prepared by gathering these ahead of time.

Get the best financing for your situation

MCAs often aren’t the first choice for small business owners. But it’s important to know how they work because an MCA might be your best option in certain circumstances. When that’s the case, try to compare offers before accepting an advance, and have a plan for how you’ll use the money. 

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