A merchant cash advance is different from a normal small business loan. Sometimes known as MCA, they can provide quick cash to businesses. Many lenders do not consider them a loan as they offer companies collateral in exchange for a portion of the company’s future sales. Before deciding whether a merchant prepayment is right for you, let’s take a look at how it works.
What is a Merchant Cash Advance?
A merchant cash advance is technically not a loan. Instead, a lender provides an advance payment to a company, usually in the form of a lump sum that is deposited into the borrower’s bank account within 24 to 48 hours.
According to GreenStarCashMCAs are similar to payday loans for individuals in that the borrowed money is expected to be paid back when the borrower receives income. For payday loans, this is the borrower’s paycheck. For businesses, this means future sales.
The risk of the loan and how much the lender will offer are determined differently than the way banks or institutions approve small business loans. Typically, the lender will consider past and current sales of your business before extending a dealer cash advance. This helps them weigh the likelihood of the advance payment being repaid on time. Due to the risk inherent in the volatility of sales, MCA rates may be higher than other credit options.
How does a Merchant Cash Advance work?
Although merchant cash advances have historically only been offered to businesses that relied on debit and credit card sales, the offering has expanded. This is because MCAs can be structured in two ways.
The first is the most common. A lender evaluates your company’s history, sales, and projected earnings. These numbers can be used to determine how likely it is that your company will repay the advance and how long it will take. The lender will then provide you with an advance payment or a lump sum in cash, depending on how much your company will earn in the future.
They also set a repayment rate that will be deducted from your credit or debit card sales. This is known as holdback. The holdback is the daily or monthly percentage of your company’s credit and debit card sales that is used to pay back your MCA. It’s usually a fixed rate and can be anywhere from 10 to 20 percent.
It also gives fees known as Factor rate. It is based on your company’s risk and probability of repayment. The factor rate is generally between 1.2 and 1.5 percent.
The more transactions your company makes, the faster you can pay off your advance payment. When you are having a slow period the money taken in repayment will be lower. Because the amount you pay for the advance is proportional to your sales, it can be easier to consistently pay off your debt.
An example is if your company needs $ 20,000 to buy inventory. The lender extends you an MCA for $ 20,000, but also assigns you a 1.4 factor rate. This means that you have to repay a total of $ 28,000. You will deduct 10% of your monthly credit and debit sales until you have paid back the loan in full.
The second option is fixed weekly or daily deposits from a bank account. This is known as the ACH dealer prepayment. The lender estimates your monthly earnings and then periodically allocates an amount to be withdrawn from your account. This type can be ideal for businesses that don’t rely heavily on credit or debit transactions. However, the repayment amount is not linked to your turnover. The amount withdrawn does not fluctuate regardless of whether the previous month’s earnings were poor.
Why do companies choose an MCA?
they are fast
A merchant cash advance can be a good option for some small businesses. They are quick and easy. In most cases, the lender will review your receipts to determine eligibility. The application process is not complicated or bureaucratic. You can have the money in your account as early as 24 hours after approval.
The repayment amount is variable
A fluctuating repayment amount based on sales is preferred by most small businesses. If you’ve had a lackluster month, you no longer have to worry about having money. If your sales went down, so did your payment.
No physical collateral required
Unlike other types of loans, your business does not need to build valuable physical assets to receive an advance. That said, if you can’t repay your loan, you don’t risk your assets being taken. However, in some cases a personal guarantee is required. If your company cannot repay, you are personally responsible for the remaining debt.
Is an MCA Right For Me?
Whether or not a merchant prepayment is right for you depends on several factors. You know your company best. Funds are usually easy to secure and are quick to deposit. Although the repayment amount is tied to your sales, the fees and APRs associated with MCAs can be high. Review the agreement carefully and consider alternatives before making a decision.