What Is a Merchant Cash Advance?: Fast Cash, for a (Big) Price

Merchant cash advances provide a tempting alternative to traditional business loans—at a high cost.

Last Updated: 2 months ago
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The recently funded Paycheck Protection Program offers small businesses a way to meet payroll needs with financial aid from the government. This aid is only being provided through the SBA and its authorized lenders. And businesses can receive a loan of up to $10 million to help cover payroll.

To access this loan, you’ll have to complete an application with an authorized lender that consists of a two-page form in addition to required documentation. If you qualify, you’ll be loaned 250% of your average monthly payroll in 2019. You may also qualify to have the loan forgiven if no employees are compensated above $100,000 and at least 75% of the money goes to paying workers. If you can’t obtain forgiveness, the loan must be repaid in two years at a 0.5% interest rate after six initial months of interest deferment.

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Concerned about how to recover from the effect COVID-19 has had on your business and its finances? Well, you might qualify for special disaster loans from the U.S. Small Business Administration (SBA). Businesses can get loans up to $2 million, and these loans have an interest cap of 3.75%. The SBA website has more information.

When cash gets tight, many business owners turn to business term loans. But sometimes, you don’t have the time or the credit score to get one―but you have to get more working capital somehow.

Enter the merchant cash advance, an alternative to traditional business financing options. You get cash up front in exchange for a percentage of your credit card sales. And you don’t need a perfect credit score to get one. Sounds convenient, right?

Maybe―until you hear the details.

Merchant cash advances provide a fast way to get cash, but the confusing fee structure and inflexible repayment schedule can easily turn them into debt traps.

We’ll dig deeper into all that in our guide below. We’ll also explain why you might choose to get one anyway and show you some alternative financing options to look at instead.

Merchant cash advance 101

As we said above, a merchant cash advance (MCA) gives your business a lump sum of money. In exchange, you agree to repay the advance by giving up a percentage of your future credit card sales.

Because merchant cash advances rely on credit card sales, they work best for businesses that have a large, regular volume of credit card and debit card transactions (such as restaurants and retail stores). If you do mostly cash business, an MCA isn’t right for you.

Is it a merchant cash advance loan?

A merchant cash advance isn’t actually a loan, since it doesn’t have interest or a defined term. Likewise, cash advance companies aren’t actually lenders. But you’ll still see people refer to cash advance loans and MCA lenders, mostly for convenience.

If you do decide to get an MCA, your cash advance provider will take a fixed (unchanging) rate percentage of your credit card sales, called a retrieval rate. They’ll continue to take this daily percentage until you’ve repaid your business cash advance, plus fees.

Your fees are dictated by your factor rate, which is just a number that tells you how much your cash advance will cost you.

Confused yet? Some people would argue that’s the point. In fact, merchant cash advances have often been called predatory, precisely because they use confusing numbers to mask the high costs. (We’ll cover this more in a minute.) And to be clear, merchant cash advances are one of the more expensive kinds of business financing out there.

Pros
  • Fast application and funding
  • Percentage-based repayment
  • High approval rates
Cons
  • High APR
  • Potential for debt cycle
  • Few industry regulations
Best Merchant Cash Advance Companies
Lendio
Kabbage
OnDeck
Fundbox
QuarterSpot

Even so, merchant cash advances remain a popular funding option for many businesses. In part, that’s because they’re fast. Many merchant cash advance companies offer same-day or next-day funding. When you need money ASAP, that’s a tempting offer―even if the fee structure is confusing.

Plus, many cash advance providers have very low credit requirements. A traditional lender (a bank or a credit union) will often ask for a personal credit score in the high 600s. A merchant cash advance company, on the other hand, will likely accept a credit score in the 500s.

So you can see, there are real reasons why you’d want a merchant cash advance―and real reasons why you should avoid them.

To be frank, we usually advise you only get a merchant cash advance as a last resort. There are other kinds of business financing that have similar pros (fast funding and low credit requirements) and fewer cons. Of course, we realize there are times when a merchant cash advance is your best bet (more on that soon), but we think those times are few and far between.

To better explain why we’re so suspicious of MCAs, let’s dive deeper into retrieval rates, factor rates, and repayment terms.

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As we mentioned above, merchant funding has two key rates you need to understand: retrieval rates and factor rates. These rates, plus your advance amount and your credit card revenue, will help determine your repayment term.

Let’s look at how those all work together.

Typical merchant cash advances
Min./max. advance amountFactor rateRetrieval rateRepayment term
$2,500/$500,000
1.2–1.510%–20%6–12 mos.

Advance amounts

Typical advances fall between $2,500 and $500,000, though those aren’t hard and fast numbers. Some companies offer advances that go into the millions of dollars.

Note, though, that you shouldn’t expect to automatically qualify for the largest advance amount a provider offers. Your advance amount will depend largely on your business’s credit card sales (and maybe some other factors).

Most MCA lenders will cap your advance size at 250% of your monthly credit card sales. So if you make $20,000 in sales each month, you can get a $50,000 advance.

Of course, your advance amount is only part of what you have to repay. You’ve also got to consider fees.

Factor rates and fees

When you get a merchant cash advance, you agree to repay your MCA provider the full cost of your business cash advance, plus your provider’s fees.
You’ll know the full cost of your advance from the beginning, thanks to your factor rate. It includes the cost of both the advance and your fees.

You should understand that a factor rate is not an interest rate. Interest gets accrued over time, while your factor rate is a flat fee. That’s very important to remember, especially when we start talking about how MCAs have a high APR (annual percentage rate).

In many cases, your factor rate will fall somewhere between 1.2 and 1.5. No, those are not percentages (because again, a factor rate is not an interest rate). To figure out your total cost, you multiply your factor rate by your advance amount.

Total amount formula

Amount you repay = advance amount × factor rate

For example: $50,000 × 1.2 = $60,000

For example, let’s say you get a $50,000 advance with a factor rate of 1.2. When you multiply your factor rate by your advance amount, you’ll see that you’ll have to repay a total of $60,000―$50,000 in principal and $10,000 in fees.

It’s easy enough to do the math. But factor rates are tricky, because they can make your fees look much lower than they are.

Take the example above. Let’s say that instead of a 1.2 factor rate, you have a 1.5 factor rate. Suddenly, you owe $25,000 in fees ($75,000 altogether). That’s an extra $15,000 in fees from a factor rate increase of just 0.3. The way factor rates are expressed hides how even a small increase can make a big difference.

Put simply, math matters a lot with merchant cash advances.

So how do you go about paying back your advance and fees, anyway? That’s where your retrieval rate comes in.

Retrieval rates and credit card revenue

Retrieval rates, as we said, are a fixed percentage of your credit card revenue that goes to your MCA provider to repay your advance.

Your specific retrieval rate (also called a holdback) will depend on factors like your business’s projected revenue and your advance amount. In general, though, you can expect a retrieval rate in the range of 10% to 20% of your daily revenue.

In most cases, your merchant cash advance provider will take their percentage by either providing you with a new credit card reader or helping you program your existing one. Either way, it means that the amount specified by your retrieval rate will automatically go to your MCA provider each day.

Put another way, you don’t get a choice in whether or not you make payments. So make sure your budget can handle that kind of daily payment. Because in some cases, you could end up making payments for quite some time.

Terms

Unlike a term loan, repayment on a merchant line of credit doesn’t have a fixed term. Instead, you pay your retrieval rate until you’ve repaid your advance and factor rate fees.

For example, let’s assume you have to pay back $10,000, which includes all fees. The lender sets a retrieval rate of 10% of your daily revenue, which averages around $500. If we apply your retrieval rate to that revenue, you’ll pay about $50 a day. That means you’d end up with a term of 200 days, or a little under seven months, to repay your $10,000.

Usually, the merchant cash advance company will choose a retrieval rate so you repay your advance and factor rate between six months and one year. But again, your repayment depends on your daily revenue, so the actual length will be unpredictable. If your credit card sales sag, you could keep making monthly payments for much longer than you initially expected.

That’s why we suggest you use the worst-case scenario for your planning. Don’t assume you’ll have six great months and pay off your MCA in no time—assume you’ll have low sales and a lengthy repayment term.

That way, you can be pleasantly surprised if you do pay it off quickly, instead of unpleasantly shocked when you don’t.

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MCAs and effective APR

Now that you know the basics of merchant cash advances, let’s talk about how they stack up against other types of business financing. The easier way to do that? APR.

As you may know, APR (annual percentage rate) is a way to describe the total cost of a loan over the course of a year, including interest and other fees. If you need a refresher on how it works, our guide to APR will tell you all you need to know.

Now, the best small-business loans have starting APR of less than 10% (though those numbers can climb up to 30% or more). So how do merchant cash advances compare?

Well, it’s tricky to say. Because as we said above, MCAs don’t have an interest rate. That makes it impossible to calculate a true APR for them.

However, we can use their factor rate to calculate what’s called an effective APR. Let’s see it in action.

Say, for example, you get a $10,000 advance that has a 1.5 factor rate. That means you’re paying back $15,000 in total. Now imagine you make $15,000 in monthly credit card sales. How would your retrieval rate affect your APR?

Retrieval rates and effective APR
Retrieval rateTime to repay Effective APR
10%
10 months106.10%
15%
7 months158.96%
20%
5 months211.69%

A higher retrieval rate means you pay the advance back faster―but it also means you have a higher effective APR.

Now, let’s look at sales instead. We still get a $10,000 advance with a 1.5 factor rate, but this time we have a 10% retrieval rate. Here’s how our monthly sales affect APR:

Monthly sales and effective APR
Monthly salesTime to repay Effective APR
$15,000
10 months106.10%
$20,000
8 months141.36%
$25,000
6 months176.55%

The more you make each month, the higher your APR.

Now, let’s make sure we’re on the same page about what all this means.

First, as you’ve surely noticed, the effective APR on a merchant cash advance is way, way higher than the APR on even a bad business loan.

To be fair, that’s largely because merchant cash advances have shorter repayment terms. In other words, a sky-high effective APR shows that you’re paying tons in fees over a short period of time. Regardless, MCAs are an expensive financing option.

Second, fast repayment might benefit the MCA company, but it effectively penalizes you. Since you’re not accruing interest over time, you have no reason to repay your MCA early (except for peace of mind, of course).

With all that mind, let’s tackle the real question that brought you here: should you get a merchant cash advance?

Is a merchant cash advance best for your business?

We can’t tell you whether or not you should get an MCA. You know your business and your finances better than we ever will. But we can offer some general guidance.

Why you shouldn’t get an MCA

You may have noticed we’ve given you several warnings about getting an MCA. That might seem overdramatic, but there are plenty of reasons you should be wary of a merchant cash advance.

Merchant cash advance lenders have received lots of criticism for promising quick cash without clearly explaining the potential pitfalls. They’ve been accused of taking advantage of desperate business owners who don’t understand what they’re getting into.

Improving your credit

Merchant cash advances are not a loan or form of credit, so they will not build your business or personal credit.

In fact, many people, including Chicago Mayor Rahm Emanuel, have called for the federal government to start regulating the industry and have urged small-business owners to avoid MCAs altogether.

These people have a point. The merchant cash advance industry has far fewer regulations than the small-business loan industry, and many people don’t understand what they’re signing up for when they get an MCA: fast cash that comes with a high APR and a volatile repayment schedule.

And honestly, we’d say that other types of business financing have many of the same benefits that a cash advance offers, but without the drawbacks.

(We’ll show you some of those alternative options in a minute.)

So in the vast majority of cases, we suggest you don’t get a merchant cash advance.

Best Merchant Cash Advance Companies
Lendio
Kabbage
OnDeck
Fundbox
QuarterSpot

Why you might want to get an MCA

While we don’t love merchant cash advances, we recognize there are some valid reasons for wanting one:

High borrower approval rate

  • Low credit requirements
  • Fast funding turnaround
  • No collateral requirements

Those are all good things. But when it comes down to it, merchant cash advances are too expensive to get without having a clear plan for your financing.

So we suggest that you only get a merchant cash advance if you meet the following criteria:

  1. You can’t get other forms of financing
  2. You have lots of credit card transactions
  3. You will use the money to grow your business

The first two are pretty self-explanatory, but let’s talk about the third point.

Merchant cash advances should be used to develop your business―not to save it. In other words, you should use it for investments that will bring additional revenue to your business, like these:

  • Taking advantage of a short-term sale to build inventory
  • Buying equipment that will quickly expand business opportunities
  • Purchasing new technology or software to increase efficiency
  • Adding more space or seating to improve your business’s capacity
  • Marketing events that will boost your sales

So you really shouldn’t get an MCA for things like making payroll or paying bills. We know those things are important. But they won’t increase your revenue, and getting an MCA will only add another bill to pay.

So sure, there’s a chance that your advance could smooth over a period of unsteady cash flow―but there’s just as much of a chance that you get trapped in a debt cycle. And given that most MCA providers require a personal guarantee, that could end up putting your personal assets at risk.

We just want to see you and your business succeed. So exercise some caution with merchant cash advances. You don’t want to make your situation worse than before you got the advance. And if you do decide to get a cash advance, make sure you understand all the rates, terms, and fees associated with your MCA.

So if you shouldn’t get a merchant cash advance, what kind of financing should you get instead?

For most business owners, we think a business line of credit (LOC) offers the best alternative to merchant funding. Like a merchant cash advance, a business line of credit can help you quickly access the funds you need and improve your cash flow. But an LOC has a few advantages.

A business line of credit gives you revolving credit—you can repay it and then use it again—so you won’t have to reapply whenever you have cash flow issues like you would with a merchant cash advance.

Plus, the relatively low interest and fees on a line of credit make it a better deal APR-wise than a merchant cash advance. And an LOC actually builds your credit, so you can get approved for better business financing in the future.

Merchant cash advance vs. business line of credit
FactorMerchant cash advanceBusiness line of credit
Average APRHigherLower
Access to fundsOne-time up-front sumReusable, revolving credit
Credit buildingNoYes
Funding timeAs fast as same-dayAs fast as same-day
Credit requirementsAs low as 500sAs low as 500s

Now, a traditional business line of credit will have stricter application requirements than a merchant cash advance. But thanks to the rise of online lenders (also called alternative lenders), lines of credit are more accessible than ever. (In fact, several LOCS made our list of the best business loans for bad credit.)

The takeaway

Merchant cash advance providers pitch MCAs as an easy way to get the money you need even with bad credit—but that’s only part of the truth.

With shockingly high APRs and the potential to worsen your money problems, merchant cash advances should be used only if you have no other options and can use it to grow your business. Otherwise, expect your merchant cash advance to create just as many problems as it solves.

Interested in getting a line of credit instead? Find the best one for your business with our rankings of the best business lines of credit.

Disclaimers

At Business.org, our research is meant to offer general product and service recommendations. We don’t guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.