A merchant loan advance isn’t a loan at all. It’s a way to borrow against your future earnings. More commonly known as a Merchant Cash Advance (MCA), this type of financing is typically for those who cannot receive a bank loan. With an MCA, you get your money relatively quickly, and then you pay it back over the next several months through a portion of your credit card sales.
Last June, a New York Supreme Court Justice determined that an MCA is not a loan. The defendant had said their MCA provider committed civil and criminal usury. But the judge ruled that since an MCA is not a loan, usury cannot exist.
The defendant had argued that you could convert the outcome of the agreement into a usurious interest rate, but the judge said that this type of conversion requires “unwarranted speculation.”
So, when you talk about MCA fees, it can all get a little confusing.
You calculate some of the MCA fees by multiplying your “factor rate” by your loan amount. Factor rates for this type of funding tend to be around 1.14 to 1.48. That means if you were to take out a $50,000 MCA, you’d need to pay back $57,000 to $74,000. Your rate could vary depending on the provider you end up using, your credit and business history, the amount of money you are borrowing, and other variables.
We should also point out that the factor rate is just one part of the equation. Your provider may add other fees on top of the factor rate.
You’ll pay the MCA back using a percentage of your future credit card sales, usually around 10-percent to 20-percent.
The average funding term for an MCA is usually around nine months, but you should be able to guess your loan term without too much trouble. First, try and estimate your factor rate taking your credit history into account. Multiply that by your desired loan amount, and then look at your sales history to figure out how long it would take to pay that off with 10-percent to 20-percent of your credit card sales.
Let’s continue our example from earlier. If you needed to take out $50,000 and you had a factor rate of 1.48, then you’d need to pay back $74,000. Let’s say your business generated $40,000 a month in credit card sales. 15-percent of that would be $6,000. If you were paying back $6,000 a month, it would take a little over 12 months to pay back your MCA.
The approval process for an MCA is known for being much faster than other types of small business financing. In fact, from what we’ve heard, the bottleneck usually ends up being the merchant needing to send in the required documentation. So, you can speed up the process by having that ready as soon as possible.
Business owners without an established credit history may have trouble qualifying for a bank loan. In some situations, it makes sense for these people to avoid taking on credit. When that’s not an option, an MCA can be a viable solution.
The main benefit of this type of funding is that it can be a way to get working capital when other financing options are not available.
This type of funding is expensive. Before you take out an MCA, you need to know your business can survive on 80% of your credit card sales for the better part of a year. If it can’t (or even if it’s too close to tell for sure), then you shouldn’t get this type of funding.
The risk is that if you can’t survive on a fraction of your credit card sales, then you’ll eventually go out of business. If you’re worried that this might happen to you, then we recommend seeking out an SBA loan made for struggling businesses.
Your MCA provider will not report your payments to any of the credit bureaus, meaning that if the reason you couldn’t get a bank loan was your credit history, it won’t be any better because you paid off your MCA.
Because they are expensive, we hesitate to endorse merchant loan advances (which aren’t loans at all) for those looking for anything other than emergency cash. If you need the money fast, the factor rate ends up being reasonable, and you’re confident that you’ll be able to afford the agreement, then this could be the right option for you.