A merchant cash advance is a financing method in which a business owner sells a portion of their future business income. The merchant cash advance provider gives you a lump sum as an advance against this future income.
This is not technically a loan. Instead, the provider collects a portion of your daily business income until the advance, plus the factoring rate, is fully repaid.
The percentage of your business’ income that is collected by the advance provider is referred to as the ‘holdback.’ The holdback may be anywhere from 5% to 20%, based on your average sales, the repayment period, and the size of the advance.
The amount you repay on a daily basis is entirely dependent on the number of transactions you make during a given day. If your business makes less, the advance provider collects less. If your business makes more, the provider collects more.
Merchant cash advances are repaid over a predetermined amount of time. Repayment terms for merchant cash advances can be anywhere from 90 days to 18 months.
How Much Can You Borrow?
Since you are borrowing against your future income, the amount you can borrow is dependent by your business’ average credit and debit card sales.
Your advance provider will review your receipts from the past three to six months to determine how much you are eligible to borrow. Typically, the amount you can borrow will range from 50% to 250% of your business’ transactions.
Merchant Cash Advance Costs
The total cost of a merchant cash advance depends primarily on the factor rate, which is the amount that you will repay. This rate is typically expressed as a decimal point. Factor rates are typically between 1.1 and 1.15
For example, if you receive a $75,000 advance with a factor rate of 1.5, you would have to repay a total of $112,500.
The amount that you repay per day is dependent on the holdback. If you take out a $75,000 advance with a 15% holdback, you would pay your provider 15% of your daily sales until the advance is fully repaid.
Pros & Cons
Merchant cash advances have several pros and cons that businesses should consider before choosing this financing option.
Advantages of merchant cash advances include:
● Easy application process
● Quick funding
● Easy to qualify
● No collateral is required
● Flexible repayments
● High borrowing limits
Since repayment is based on your daily sales, merchant cash advances can be paid off very quickly if your business experiences a large volume of credit card transactions.
Disadvantages of merchant cash advances include:
● High factor rates (often higher than APRs on traditional loans)
● No benefits for paying advances off early
● Borrowing limits are dependent on daily income
The primary disadvantage is the cost. Factor rates are typically higher than interest rates on business loans, and cannot be reduced by paying back the advance early.
How to Apply for a Merchant Cash Advance
Applying for a merchant cash advance is typically more straightforward than applying for a business loan.
In order to apply, you’ll need to provide:
● Bank and credit card statements
● Your business lease
● Your business tax ID number
● Your SSN
● Business tax returns
● Business receipts
● Personal Identification
Every provider has different rates, terms, and requirements. It’s important to compare multiple advance providers to find the one the meets the needs of you and your business.
Applications for merchant cash advances are typically approved very quickly. Once approved, you can expect to receive your funds in as little as a few days.
If quick funding isn’t a priority, or you’re worried about the high costs of merchant cash advances, there are several suitable alternatives.
Traditional business loans are a great option that meets the financing needs of most businesses.
Like most other types of loans, you can borrow a set amount to be repaid over time with a set interest rate.
Funds can be used for nearly any business-related expense, and loan limits can be very high — up to $5 million in some cases.
Business Lines of Credit
Business lines of credit (LOCs) can be a great method of financing.
With an LOC, you receive a lump sum disbursement that is repaid on a weekly or monthly basis. Once paid off, your LOC resets, and you can continue to borrow money as needed without reapplying.
Business Credit Cards
Lastly, business credit cards are a great resource for businesses who need additional financing to cover daily operational expenses.
Interest rates are typically high but are avoidable as long as you repay your credit card balance every monthy.
This option is also a great way for businesses to build their credit scores.