A merchant cash advance, otherwise known as an MCA, provides alternative funding for a business that suffers from credit issues and cannot go to its local banks. Unlike traditional small business loans, an MCA provider lends funds upfront in exchange for a piece of the company’s future sales and is not bound by laws that regulate lenders and limit interest.
How can MCA be used?
In the beginning, an MCA was only used for businesses that generated income through credit card sales, such as retail shops and restaurants. Nowadays, an MCA can be used for any type of business with advances anywhere from $5,000 up to $2 million. It is by far the fastest-growing industry in the past 10 years.
What is a factor rate, and how is it calculated?
An MCA lender will typically lend a sum upfront and will get repaid by withdrawing funds, via ACH, on a daily or weekly basis. There is a fee, known as the factor rate, connected to this advance which is based on the merchant’s ability to pay back the loan. The factor rate, ranging from 1.25-1.50, is determined by the lender upfront and is typically dependent on the gross monthly sales and the risk assessment. The higher the risk category, the higher the factor rate.
As an example, if a company does $100,000 in gross monthly sales, the lender will lend the company $100,000. After conducting a risk assessment, the lender determines a factor rate of 1.25. Therefore, the payback on the advance is $125,000. Opting for daily payback, Monday through Friday, the merchant is responsible for paying $496 a day for 12 months.
Understand the pros and cons of MCAs.
Some may say that an MCA is expensive money, and it is! However, there are many advantages to this type of loan, and as the adage goes, “If you are going to make money with the money, it’s worth it.”
An MCA loan works best for any business that has strong sales but cannot qualify for a loan because they have no collateral or a low credit score. Businesses include restaurants, retailers, drug stores, florists, beauty shops, tanning salons, etc. The main benefit of this loan is the speed of approvals and access to capital.
MCAs are typically quick and easy, with a 90% approval rating with minimal documentation. Approvals are based on the cash flow of the business, and funds can be provided as quickly as 24 to 48 hours. An advance is usually calculated by looking at the last 3-6 months of bank statements—no personal guarantee or collateral required. Individuals with FICO scores as low as 500 can be approved. If there is consistent cash flow and enough room to cover the daily payments, the lender will most likely approve funding. Payment options are flexible and can be structured to be taken via ACH daily, weekly, or semi-weekly. Also, this loan does not affect personal credit, even if a payment is missed.
That said, MCAs are often the last option for companies since the rates are so high, and there may be a better alternative for funding. So an MCA is typically only the best option if a company cannot qualify for another type of loan, such as equipment financing or accounts receivable financing.
MCAs are also ideally useful to companies waiting for funding on a different loan. This type of advance can be used to bridge financing while waiting for underwriting on another type of loan, such as an SBA loan. It can also help with temporary cash flow, the purchasing of inventory, unplanned expenses, paying off debts that are due or working capital. An MCA is meant to be a short-term solution until a long-term solution can be found, as terms typically run between 3 and 36 months.
Consider your options.
When a small business owner has a high volume of sales and needs funding quickly, rather than going to a local bank, consider an MCA. It could really come in handy.