By Content Team
Updated on: April 24, 2024
In recent years, merchant cash advances (MCAs) have emerged as a popular type of financing solution for small businesses looking to finance short-term projects and unexpected expenses. Small businesses face various financial challenges, from bad credit to managing cash flow to financing short-term projects and unexpected expenses. Bank loans may not always be the best option for small businesses due to long application processes, strict eligibility requirements, and the need for collateral.
Before we dive into the short-term financing benefits of MCAs, let’s first define what they are. An MCA is a type of financing that provides a lump sum of cash to a business upfront in exchange for a percentage of the business’s future revenue.
This means that MCA providers are not lenders and MCAs are not loans. Instead, MCA providers purchase a portion of the business’s future sales at a discounted rate known as a factor rate. The repayment period for MCAs is typically short-term, with repayment terms* based on a percentage of the business’s future sales and less emphasis placed on a business’s credit score which means the approval process is much faster than with a business loan.
Many financial institutions won’t give small business loans to companies in certain industries Not so with MCAs: if you’ve got a business bank account and a few months of bank statements, you’ll likely be able to find an appropriate advance no matter the type of business you’re operating.
Each day or week, businesses repay a merchant cash advance by sending over a portion of revenue. That means when a business makes less money, it makes smaller payments ensuring your business’s cash flow stays healthy. Because the payment may go down if your revenue decreases, there is no set period of time that the advance must be repaid.
Factor rates are typically used in short-term financing, such as merchant cash advances or invoice financing. A factor rate is a decimal figure that represents the total cost of financing, which includes the principal amount advanced plus the fees charged by the advance provider.
For example, if a business is advanced $10,000 at a factor rate of 1.2, it will need to repay $12,000 to the advance provider, representing the size of the advance ($10,000) multiplied by 1.2.
On the other hand, interest rates, which are more commonly used with small business loans and equipment loans, are the cost of borrowing expressed as a percentage of the principal amount borrowed. Interest rates are charged on the principal amount borrowed and are calculated based on the loan term’s length, the borrower’s creditworthiness, and the prevailing market conditions.
For example, if a business borrows $10,000 at an interest rate of 10%, it will need to repay $11,000 over a set period, usually with monthly payments.
One of the biggest benefits of MCAs for small business owners, be it a start up or well established company, is that they provide quick and easy access to working capital. The application process is often much faster than bank loans, and funding can be available within a few business days. This makes MCAs an ideal financing option for small businesses looking to finance short-term projects and unexpected expenses that require immediate attention.
Another benefit of MCAs is their flexibility in the use of funds. Unlike bank business financing, there are no restrictions on how the funds can be used. This means that companies can use the funds to finance a wide range of business needs and initiatives, from purchasing new equipment to covering unexpected repairs.
Real estate collateral is not required for MCAs, which can be a major advantage for small businesses that may not have the collateral required for bank loans. Additionally, repayment terms for MCAs are based on a percentage of revenue rather than fixed monthly payments. This means that if the business’s sales slow down, the repayment amount decreases as well.
Choosing the right MCA provider is essential to ensure that you get the best funding options for your business’s needs. There are many MCA providers out there, and it can be overwhelming to choose the right one. Here are some factors to consider when evaluating MCA providers:
Fees: MCAs typically have higher fees than traditional bank loans. It’s important to carefully review the terms and conditions of the financing to understand the total cost of the financing.
Reputation: Look for MCA providers with a good reputation in the industry. Check customer reviews and ratings to get a sense of how the provider treats its customers.
Advance Amount: How much are you being offered in business funding? If you’ve got a specific project in mind, you’ll need to ensure you’re getting the right amount.
Customer Service: Good customer service is essential when it comes to financing. Look for providers that offer excellent customer service and are responsive to your needs.
Repayment Terms: Review the repayment terms carefully to ensure that you understand the total cost of financing and the repayment period.
Factor Rate: The factor rate determines the total cost of financing, so it’s important to carefully review this rate to ensure that you’re getting a good deal.
While MCAs can be a valuable financing solution for small businesses, they’re not the only option. Here are some alternatives to MCAs:
Business Credit Cards: Business credit cards are an option for small businesses that need financing for short-term expenses. They offer flexibility in use of funds, but come with an exceptionally high interest rate and any unpaid balance will accrue compounding interest so this is something you should be aware of.
Business Line of Credit: A business line of credit is a type of financing that allows businesses to borrow money as needed. It’s similar to a credit card but has higher credit limits and lower interest rates.
Short-Term Loans: Short-term loans are a type of financing that provides a lump sum of cash to a business, typically with a repayment period of less than one year. They can be a good option for businesses that need financing for short-term projects or unexpected expenses.
SBA Loans: The Small Business Administration (SBA) offers a variety of loan programs for small businesses, including short-term loans and lines of credit. SBA loans typically have lower interest rates and longer repayment terms than other types of financing.
MCAs can be a valuable financing solution for small businesses that need financing for short-term projects and unexpected expenses. They offer quick and easy access to working capital, flexibility in using funds, daily payment installments, and no collateral requirements. However, it’s important to carefully evaluate the terms and conditions of the financing and choose the option that best fits your business’s needs and financial situation. By carefully evaluating your financing options, you can ensure that your business has the funding it needs to succeed.
*Repayment in this context describes the process of repurchasing a merchant cash advance. It does not describe the process of repaying a loan. MCAs are legally distinct from loan products.