If your small business is facing a cash-flow issue, you might be considering a merchant cash advance (MCA) as a potential solution. An MCA can be particularly helpful for founders of new startups with little to no business history or for businesses with low credit scores. If securing a traditional small business loan has been challenging, an MCA might be a viable alternative. However, it’s essential to understand both the benefits and the potential drawbacks of this type of financing.

What is an MCA?
An MCA is a type of business financing different from a traditional small-business loan. It is repaid through a portion of your future sales. MCA lenders charge a factor rate, a fee added to your funding amount to determine the fixed repayment amount.

Repayment periods are typically short, ranging from three to 18 months. The cost of borrowing with an MCA is often higher compared to small-business loans or lines of credit. Since the total repayment amount is fixed, there’s no benefit to early repayment, unlike traditional loans where interest is charged on the outstanding principal.

How does an MCA work?
An MCA provides your business with a lump-sum payment in exchange for a portion of your future sales. There are two main repayment methods:

• Percentage of daily credit card sales: If you have sufficient credit card sales, your lender will take a percentage of your daily sales (the “holdback rate”) until the funding amount and fees are repaid.
• Fixed withdrawals from your bank account: If credit card transactions are not significant, your lender may opt for fixed daily or weekly withdrawals based on an estimate of your monthly revenue.
  Pros and Cons of an MCA

Pros:

• Ease of Qualification: MCAs are significantly easier to qualify for than traditional business loans.
  Speed of Funding: Funding is typically quicker than with traditional business loans, often within 24 hours.
• No Collateral Required: Unlike traditional business loans, MCAs do not require collateral.
• Flexible Repayment Schedule: Repayments are based on your business’s sales, meaning payments are lower during slower periods.
• No Impact on Credit: MCAs do not report to credit bureaus, so they won’t negatively impact your credit if you default.

Cons:

• High Cost of Borrowing: Due to short repayment periods and high factor rates, the cost of borrowing can be higher than traditional business loans.
• No Early Repayment Benefit: The fixed repayment amount means there is no benefit to repaying early.
• Potential for Cash Flow Issues: Constant daily repayments can lower cash flow and potentially trap your business in a cycle of debt if not used strategically.
• Low Regulatory Oversight: MCAs are not federally regulated and do not fall under state usury laws or the Truth in Lending Act.

Who is an MCA good for?
MCAs are ideal for small business owners who lack a lengthy business history or have poor credit scores. They are also suitable for seasonal businesses needing quick cash during slower months, which can be repaid with future sales from busier periods.

Alternatives to MCAs
If you have a longer business history and good credit, there are better alternatives:

• SBA Loans: Offer more favorable rates and can be applied for online if you don’t need immediate cash.
• Business Line of Credit: Provides flexible access to funds when needed, often with lower rates than MCAs. It allows you to borrow as needed and pay interest only on the amount used.
• Invoice Factoring: Allows you to sell accounts receivable at a discount for a quick lump-sum payment.

When is an MCA a good choice?
An MCA is a good choice if you need funding quickly and fall into the categories mentioned above. The application process is straightforward, and funding is typically faster than traditional loans.

Conclusion
MCAs can be a helpful tool in times of a cash-flow crisis, especially if traditional funding options are not available. However, it’s important to be aware of the potential for a debt cycle. Use MCAs judiciously and consider them as part of a broader financial strategy for your business.

Frequently Asked Questions (FAQs)

Are merchant cash advances (MCAs) legal?
Yes, MCAs are legal. They are not considered loans and therefore do not fall under state usury laws.

How is an MCA repaid?
MCAs are repaid by taking a percentage of your future sales daily or through fixed withdrawals from your bank account.

Do MCAs report to credit bureaus?
No, MCAs do not report to credit bureaus, so they will not impact your business credit score.