For many small business owners, cash flow challenges are a reality. When unexpected expenses arise, or growth opportunities demand immediate capital, business owners often consider alternative financing options. One increasingly popular option is a Merchant Cash Advance contract (MCA).
While MCAs promise fast access to funds, there are important details in a merchant cash advance contract that many business owners are unaware of.
Key Takeaways
- Merchant cash advances are not traditional loans: They are structured around a percentage of future credit card sales rather than fixed monthly payments, making them accessible for businesses with weaker credit.
- Repayment can impact cash flow: Auto-debit from daily sales can strain business operations, especially during slower sales periods.
- High costs and hidden fees: Factor rates, underwriting, and administrative fees can make MCAs significantly more expensive than traditional bank loans.
What is a Merchant Cash Advance?
A merchant cash advance is not a traditional loan. Unlike traditional bank loans, which have fixed monthly payments and strict credit score requirements, an MCA provides a lump sum of cash advance upfront in exchange for a percentage of your future credit card sales or future receivables.
This repayment structure makes it appealing to businesses with less than perfect credit, as merchant cash advance providers often approve financing based on sales volume rather than a strong credit history.
How Merchant Cash Advance Agreements Work
When you sign a merchant cash advance agreement, you agree that the MCA company will automatically withdraw a percentage of your daily credit card receipts from your merchant’s bank account until the advance amount plus fees is repaid.
The repayment is directly tied to credit card transactions, which means that during slower business periods, the payments decrease—but during peak periods, you may pay more.
While this sounds flexible, MCA contracts often include additional fees and a factor rate that makes the effective interest rate much higher than what you would pay on a traditional bank loan. Unlike traditional loans, MCA agreements are not governed by the same protections under the uniform commercial code, leaving some businesses vulnerable to predatory lending practices.
What Small Business Owners Don’t Always Know
- Associated Fees Can Be Substantial – Many MCA agreements include underwriting fees, administrative fees, and fixed payments, which can significantly increase the total cost of the advance.
- Repayment Obligations Can Strain Cash Flow – The auto-debit from your business bank account can interfere with regular operations, especially if your business’s sales performance declines.
- High Cost Compared to Traditional Loans – With factor rates and usurious loans sometimes being disguised as merchant cash advance pros, the actual repayment amount can far exceed the original advance amount.
- No Credit Score Benefits – Unlike a traditional bank loan, repaying a merchant cash advance does not improve your credit score.
When a Merchant Cash Advance Can Help
Despite the downsides, there are situations where a Merchant Cash Advance can be a helpful tool:
- When you need to cover unexpected expenses quickly without going through the lengthy approval process of traditional loans.
- You can access immediate capital for a business in financial difficulty or during slower business periods.
- It helps you obtain financing when you have bad credit or less than perfect credit, as approval depends on daily credit card sales rather than credit history.
Key Considerations Before Signing
Before entering any MCA agreement, small business owners should carefully review:
- Repayment terms and repayment period
- Total associated fees and interest rate
- Whether personal guarantees are required
- How the advance will impact cash flow during slower business periods
- The Merchant Cash Advance provider’s reputation and history with predatory lending
Conclusion
A Merchant Cash Advance can seem like an easy way to get immediate capital, but Merchant Cash Advance contracts often hide costs and repayment obligations that can strain business operations. Small business owners must carefully evaluate future credit card sales, business revenue, and sales volume before signing.
Understanding the full implications of your MCA agreement can help you avoid financial strain while still leveraging the flexible repayment terms that MCA providers offer. Contact SB Legal if you are struggling to pay your MCA debt. We can help you discuss your options to get yourself and your business back on track!
Frequently Asked Questions
Can a merchant cash advance help businesses without a credit history?
Yes. MCA providers primarily assess sales volume and daily credit card receipts rather than credit scores, making it a potential option for businesses with little or no credit history.
Are merchant cash advances regulated like traditional loans?
No. Unlike traditional bank loans, MCAs are not strictly regulated under the uniform commercial code, which can leave businesses vulnerable to predatory lending practices.
Can an MCA be used for long-term business growth?
MCAs are generally better for short-term cash flow needs or covering unexpected expenses, as the high costs and fast repayment schedule make them less suitable for long-term financing.