Starting and running a small business often requires a constant influx of capital.
Whether for daily operations, unexpected expenses, or expansion plans, access to funds can make or break a business's success.
Merchant cash advance offers a quick and relatively hassle-free way for small businesses to secure funds without going through the rigorous process associated with traditional bank loans.
However, before diving into an MCA agreement, as a business owner, you must understand what it entails and whether it's the right choice for your needs.
Stay tuned as we explore what a merchant cash advance is, how it works, pros and cons, and the types of businesses that can benefit from it.
A merchant cash advance, often abbreviated as MCA, is a financial product that specialized lenders offer to small businesses.
Instead of relying on your credit history and collateral (like traditional loans), MCA lenders assess your business's daily credit card sales and project how much you can repay.
The terms and conditions of an MCA are laid out in a contract, specifying the advance amount, payback amount, holdback rate, and any associated fees.
The interest rates for MCAs vary widely among lenders, and the state where your business is based may impose additional restrictions on interest rates.
While securing an MCA is more accessible than a traditional bank loan, it is not a no-strings-attached financial arrangement.
The process of an MCA involves several key components:
Determining your business's actual funding requirements is crucial before accepting the MCA amount proposed by the lender.
Taking more money than necessary would lead to a higher repayment burden.
Depending on your business's requirements, the advance amount can be less than, equal to, or even greater than your monthly sales.
Assess your business's financial needs accurately to avoid any inconvenience in the future.
The payback amount includes the advance amount and an additional fee known as a "factor." This fee is a significant component of the total cost of the MCA.
It can sometimes be higher than the interest rate associated with traditional loans.
Throughout the repayment period, a certain percentage of your credit card transactions on a daily basis is retained and paid directly to the MCA lender.
The holdback rate is specified in the contract, and it's essential to evaluate whether your business can smoothly handle this daily deduction.
Remember that holdback and the interest rate associated with a merchant cash advance are different things.
The overall cost of an MCA varies based on factors such as the lender, terms, and your business's location. Well-established companies with strong financial profiles typically receive more favorable terms.
There are two primary categories of MCAs to consider:
The most prevalent type of merchant cash advance involves deducting a fixed percentage from your credit card processing earnings.
This fixed portion, known as the holdback amount, typically falls within the 10-20% range.
This MCA variant offers a high degree of flexibility, as repayment amounts automatically adjust based on your business's performance.
If your sales soar in a given week, your repayments will increase accordingly, helping you pay off the debt faster.
Conversely, suppose sales dip in the following week.
In that case, repayments will scale back, allowing you to preserve cash flow during slower periods.
Overall, the percentage of revenue option is well-suited for merchants with fluctuating cash flows, providing more repayment flexibility.
Another approach involves setting fixed payments based on an estimate of your monthly sales.
In this scenario, the repayment duration is predetermined, resembling a traditional bank loan.
Fixed payments are more suitable for businesses with more predictable cash flows who wish to repay the advance over a specified period.
Suppose a coffee shop owner needs urgent funds to repair an espresso machine despite having a consistent monthly cash flow.
In such a situation, the owner might choose the fixed payment option offered by a merchant cash advance.
This option can help the owner clearly understand when the debt will be fully repaid.
An important distinction is that MCAs do not charge interest rates; instead, MCA providers make money by applying a premium known as the factor rate.
Factor rates typically range from 1.1 to 1.5 and are influenced by several factors, including:
Higher factor rates are assigned to riskier businesses, similar to how traditional lenders charge more interest to risky borrowers.
To assess the overall cost of borrowing, you can compare obtaining an MCA with other financing alternatives, such as term loans.
To do this, multiply the cash advance amount by your factor rate to determine the total repayment amount.
For instance, if you intend to borrow $10,000 with a factor rate of 1.2, your total repayment would be $12,000.
Additionally, you need to consider the repayment speed, which depends on your business's credit card transaction revenue and the holdback percentage.
In the example provided, let's assume you earn $15,000 monthly in credit card transaction revenue, and the holdback is set at 10%.
With these figures, you need to pay approximately $50 per day, taking you 240 days to repay the cash advance and factor fees.
This results in an effective interest rate of 57%, which is significantly higher compared to most small business loans or lines of credit.
However, if you can negotiate a lower factor rate of 1.1, your effective interest rate will drop to 32%.
This highlights the importance of understanding your factor rate and its long-term impact on your repayment.
Before opting for an MCA, weighing its advantages and disadvantages is crucial to determine if it aligns with your business's needs.
Pros:
✅ MCAs provide swift access to capital, making them ideal for businesses with urgent financial requirements.
✅There is no need to provide collateral to secure funding.
✅ MCA lenders often offer flexibility in repayment, allowing businesses to adjust their daily holdback rates during slow sales periods.
✅ MCAs are relatively forgiving regarding credit scores, making them accessible to businesses with less-than-stellar credit histories.
Cons:
❌ MCAs tend to be more expensive than traditional loans due to the added factor fee, which can result in a substantial financial burden for businesses during slow sales periods.
❌ The payback period for MCAs is typically shorter than that of traditional loans, increasing the daily repayment amount.
❌ Businesses that take out more than they genuinely need may struggle with the high repayment amounts and associated fees.
Merchant cash advances are not a one-size-fits-all financing solution. They are most suitable for specific types of businesses with particular financial needs.
Start-ups and small businesses looking to fund immediate projects, cover unexpected expenses, or seize growth opportunities.
Companies with fluctuating sales may find MCAs beneficial, as they offer repayment flexibility based on daily credit card transactions.
MCAs are more accessible to businesses with imperfect credit histories, making them an option for those who struggle to qualify for traditional loans.
If your business has experienced a significant disaster or shutdown, pursuing traditional bank loans or grants may be a better choice, as MCAs require ongoing daily transactions for repayment.
Businesses seeking long-term capital for substantial investments or expansion plans may find other financing options more cost-effective in the long run.
Companies prioritizing minimizing financing costs should explore alternative funding options, as MCAs can be relatively expensive.
If a merchant cash advance (MCA) is not suitable for your business or you are ineligible for one, there are several alternative financing options worth considering.
Here is an overview of asset-based financing and why it may be a preferable option:
Asset-Based Financing Overview:
Instead of relying on your credit card sales or future revenue, you pledge tangible assets such as accounts receivable, inventory, or equipment to obtain financing.
This type of financing offers several advantages:
1. Lower Costs: Asset-based financing often comes with lower interest rates than MCAs, which can help reduce your overall borrowing costs.
2. Flexible Repayment Terms: Lenders may offer more flexible repayment schedules tailored to your business's cash flow, making it easier to manage your debt.
3. Access to Larger Funds: Depending on the value of your assets, asset-based financing can provide access to more significant loan amounts than MCAs, allowing you to meet more substantial financial needs.
4. Improved Creditworthiness: Since asset-based financing is secured by collateral, it may not heavily rely on your personal or business credit score, making it accessible to companies with less-than-perfect credit.
5. Long-Term Sustainability: Asset-based financing can be a sustainable option for businesses looking for stable, long-term funding solutions, unlike MCAs, which often carry a short-term and costly nature.
Merchant cash advances are a fast and convenient way for small businesses to access the capital they need.
However, it's important to carefully consider the associated costs and repayment terms before applying for an MCA.
Like any financial decision, assessing whether this option aligns with your long-term business goals and financial health is crucial.
With Myos, you can secure the necessary working capital to fuel various aspects of your business's expansion, anywhere between €10.000-2.500.000 for your ecommerce store.
💡 For instance, you can use this funding to purchase more inventory, which grants you the flexibility to respond to changing customer demands, especially during peak seasons when inventory levels may need a boost.
🚚 Transportation costs are another factor that can impact your bottom line. Still, with additional working capital, you can easily cover these expenses, ensuring the seamless flow of your supply chain.
📢 Moreover, investing in marketing campaigns becomes more accessible, enabling you to reach a broader audience and boost sales. You can allocate a higher budget for targeted advertising, attracting new customers, and maintaining customer loyalty.
🛍️ Launching new products is critical in expanding your business but often involves substantial costs. Asset-based financing allows you to reduce these expenses and scale up your product line. More products mean more opportunities to attract and retain customers, ultimately driving growth.
🏢 As your business grows, you may need to renovate or expand your warehouse or storage facilities. Having adequate working capital can fund such logistics improvements, ensuring your business can handle increased demand effectively.
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An MCA is a financial arrangement where a business receives a lump sum of cash upfront in exchange for a percentage of its daily credit card sales plus a fee. It's an alternative financing option for businesses looking for quick access to capital.
With an MCA, a business agrees to repay the advance by allowing the MCA provider to collect a fixed percentage of their daily credit card sales until the total amount, including fees, is repaid.
MCAs are often used by businesses with consistent credit card sales, such as retailers, restaurants, and service providers, with fluctuating cash flows.
Qualification criteria vary among MCA providers, but common requirements include a minimum amount of monthly credit card sales, a certain period of business operation, and a healthy credit card transaction history.
Multiply the advance amount by the factor rate to find the total repayment amount. For example, if you borrow $10,000 with a factor rate of 1.3, you'll repay a total of $13,000.
Some MCAs offer early repayment options. Be aware that prepayment may not necessarily reduce the total repayment amount significantly.
Revenue-based vs Equity-based Financing - What’s the Difference?
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