A merchant cash advance, often abbreviated to MCA or a MCA advance, is a unique type of loan that provides businesses with quick access to working capital. A merchant cash advance is not a typical loan, but instead is a cash advance against future credit card sales, that is paid back from the ongoing sales of the company.
Merchant cash advances have the benefit of being approved quickly and having a short turnaround time, as owed money can be used as collateral.
In this article, we will be outlining the origin of merchant cash advances, how they work, the advantages and disadvantages of them, as well as common uses for this unique type of loan.
If you’re looking for a loan for your business, but you’re not sure where to start, then you can get a quote from us at Rise Funding. It’s completely free and will not affect your credit score.
Origins of merchant cash advances
The concept of a merchant cash advance was founded in 1997 by Barbara Johnson, who was an entrepreneur overseeing four Gymboree Playgroup & Music franchises. Struggling with a lack of capital for a summer marketing campaign, Johnson had the idea to borrow to fund this campaign and use future credit card sales as collateral.
Parents bringing their children back for classes after summer was a guaranteed bet, so by using these future sales as collateral, Johnson was able to remedy cash flow problems in the present.
This started an industry practice, which grew in popularity in 2005 and then again following the 2008 financial crisis, as many businesses were struggling with their cash flow.
How merchant cash advances work
Merchant cash advances work via providers of the loans. A business will go to a merchant cash advance provider and agree to sell a portion of their future credit card sales at a discounted rate to the provider.
In return, the provider will give the business owner a lump sum payment upfront. This is usually structured as a percentage of daily or weekly credit card sales, and continues until the agreed-upon amount, plus fees, is repaid in full.
Here is an overview of the process:
Determining the funding amount
The business will receive funding from the provider in the form of a lump sum. This amount will be dependent on the revenue of the business, and also the provider’s evaluation of the repayment capacity of the business. Essentially, the provider is looking to see how much the business earns, and how likely they are to be able to pay back the money.
Receiving a factor rate
Once the information has been provided, the provider will come up with a factor rate, which will be a number that determines how much the business pays back. This will be something like 1.2 or 1.3, which then tells the business how much they will be paying back.
For example, if a business borrows £10,000 as a merchant cash advance, the provider may give a factor rate of 1.3, which would mean that the total repayable amount will be £13,000.
The typical merchant cash advance factor rate range in the UK is anywhere from 1.2 to 1.5. When calculated as a percentage, the percentage is known as a split percentage.
How merchant cash advances are repaid
A unique factor of merchant cash advances is that they are not paid back in the same way as traditional loans, such as with fixed monthly payments.
Repayment for merchant cash advances is done by taking a percentage of the business’s credit card sales, or other revenue streams. The merchant cash advance essentially becomes a tax on the company profits, until the agreed-upon amount has been paid.
Payments are taken automatically too, so businesses don’t need to worry about missing payments. Many providers also have a variable rate of repayment, which will adapt depending on the business’s sales volume. If the business is taking fewer payments, the repayable amounts will be slower, and vice versa.
Advantages of a merchant cash advance
Merchant cash advances carry many great benefits that lots of businesses take advantage of. They are generally useful for businesses that are seasonal, and that have predictable cash flow in certain parts of the year.
Quick access to funds
You can receive the funds for a merchant cash advance normally within a few days. As you provide your future credit card sales as collateral, the provider can be assured that you will have money coming in, and as this is how you pay the loan, they can be assured you will start repaying straight away.
Automatic & flexible repayments
With merchant cash advances, your payments are made by first agreeing on a factor rate, and then taking these payments automatically. This means that payments are automatic, so you won’t need to be worried about missing payments.
The payments will also adjust based on how much you are bringing in, so the repayment terms won’t put a chokehold on your current earnings.
Unsecured loans
As merchant cash advances are unsecured loans, they do not require any direct collateral, apart from future sales. This means that no assets are at risk.
High approval rates
If you are a business with bad credit, then merchant cash advances are an accessible type of business financing. As you must demonstrate sales and future sales, providers have very high approval rates, sometimes as high as 90%.
Disadvantages of a merchant cash advance
As with any type of borrowing, there are financial disadvantages. Before taking on any kind of loan, it is always important to ensure that you know exactly the product you are buying, and also that you have sufficient financial stability to repay the loan.
High costs
Although the repayment terms and style of a merchant cash advance can seem manageable, the overall expense of borrowing in this way can be high.
For example, if we use the same example of borrowing £10,000 with a factor rate of 1.3 at £13,000, if this is paid over 6 months, then the APR is approximately 79.6%, which is relatively high compared to the UK average.
Reliant on sales
Merchant cash advances can add even more pressure to get sales, as this is the way that the loan is paid back, and the quicker it is paid back the better. This could potentially put even more pressure on businesses and could cause further issues.
Doesn’t build a credit score
As merchant cash advances are quick, and go via your existing sales, the providers do not report your payments to credit bureaus. This means that despite diligent payments, your repayments will not alleviate any bad credit scores.
Common uses for merchant cash advances
Some of the best uses for merchant cash advances are:
- Purchasing inventory that will sell in future
- Covering operational expenses that can assist with sales
- Investing in marketing campaigns in slower seasons
- Managing any out-of-the-blue expenses
For example, a manufacturing business might need new inventory to begin producing a new product. The current cash flow might not allow a large purchase, but with a merchant cash advance, ordinary operations can continue, and the loan can be paid off with reliable sales.
Businesses that operate primarily in summer, or over the Christmas period, might also benefit from a merchant cash advance when they are in slower periods but can rely on spikes in future.
Are merchant cash advances available in the UK?
Yes, merchant cash advances are available in the UK. They are popular with SMEs, a sector that the UK government is making attempts to boost with schemes such as its Growth Guarantee Scheme.
You can get a merchant cash advance via Gov.uk, which is organised by 365 Finance. There are also many providers in the UK that offer merchant cash advances, all with their own unique benefits.
There is also the British MCA Association which provides guidance for UK businesses on their merchant cash advance loans.
What happens if you can’t pay your merchant cash advance back?
If you can’t pay your merchant cash advance back, then some providers will allow you to refinance to extend the repayment period. This can be costly and should be avoided if possible.
As your loan is paid back through company sales, and also is flexible, then it’s unlikely that you will be unable to pay back anything. Merchant cash advance providers will simply extend the conditions of the agreement, but you will always need to pay back the amount in full.
It’s important that you check the terms of your agreement with your provider before taking on any loans, so you know exactly the steps to take if you unfortunately cannot pay your loan back.
Conclusion
While merchant cash advances are a viable option for businesses that need quick funding, they should be used cautiously due to their high cost.
Despite the convenience of the repayment structures and availability of the loans, remember the relatively high overall cost from the APR calculation.
If you’re not sure of the funding that you need, then Rise Funding will help you find the exact funding you need for your business.
