Should I consider a merchant cash advance for my business? Getting a bank loan in this situation may seem like an obvious solution, but it might prove difcult if, for example, you’ve got bad credit. That’s where this special type of fnancing may be able to help — business owners with low credit scores might fnd they have a better chance of getting a merchant cash advance, or MCA. Merchant cash advances provide an upfront sum of cash that’s repaid over time from future credit card sales. But like any fnancial product, MCAs have their pros and cons. One upside is an immediate improvement in your business’s cash fow. You’ll have money on hand to pay overdue, current and new bills. But one major downside is that MCAs are expensive and repaying them may make your business’s fnancial situation worse in the long run. Let’s take a closer look at merchant cash advances to fnd out if it’s a potential solution for your small- business cash fow problem. What is a merchant cash advance? An MCA converts anticipated debit and credit card sales into immediate capital. These cash advances technically aren’t loans, since there’s no bank, no interest rate and no set repayment period. Instead, a fnancing company supplies a sum of money upfront in exchange for a specifed percentage of sales over time — also known as receivables — as the form of repayment. These receivables are primarily paid to your business through debit and credit card purchases. What a merchant cash advance costs A merchant cash advance has three components. 1. Cash advance The cash advance is the amount of cash you request and receive upfront. 2. Repayment amount The repayment amount is the total amount you’ll pay back for the merchant cash advance. Since a merchant cash advance isn’t technically a loan, it doesn’t have a true annual percentage rate. But that doesn’t mean MCAs don’t come with additional costs. In fact, this type of fnancing can involve a variety of fees, which are added to the total repayment amount. If an equivalent APR were calculated, it could be more than 80%, depending on how quickly you repaid the merchant cash advance. The most signifcant MCA fee is the factor rate, which is the primary way an issuer determines the cost of your cash advance. When using factor rate to calculate the total repayment amount, your lender multiplies your cash advance by the rate, which typically ranges from 1.1 to 1.5. For example, if you received a $10,000 cash advance with a 1.4 factor rate as the only thing determining your borrowing cost, your total repayment amount would be $14,000, making your fee $4,000 — that’s essentially a 40% fee on your cash advance. Your factor rate depends on a number of things, such as your industry, business’s health and credit card sales history, all of which help determine your level of risk to the fnancing company. 3. Holdback rate The holdback rate is the percentage of daily debit and credit card sales used to pay back your cash advance. Holdback rates vary, but can range from 5% to 20%. Say you received a merchant cash advance with a repayment amount of $65,000 and a 10% holdback rate. On these terms, repayment would begin after the MCA and then continue until 10% of your daily credit card sales totaled $65,000. So if your daily debit and credit card sales average is $5,000, and assuming you’re open for business every day, it could take more than four months to pay back the $65,000 advance. While your total repayment amount never changes, your payments will vary day-to-day as your sales volume fuctuates. When your sales increase, you’ll owe more toward your balance for that day. When your sales decrease, you’ll owe less. Pros and cons of a merchant cash advance While the idea of getting cash quickly for your business can be tempting, consider the benefts and drawbacks of merchant cash advances before you decide it’s for you. Pro: You don’t have to ofer up collateral Merchant cash advances are unsecured, which means you won’t have to pledge your home, car or other assets. Pro: Your odds of approval may be higher Chances of being approved for a merchant cash advance tend to be higher. The Federal Reserve’s 2017 Small Business Credit Survey found that 79% of businesses that applied for an MCA were approved, compared to 54% that were approved for a Small Business Administration loan or line of credit and only 50% that were approved for a personal loan. Companies that ofer merchant cash advances typically consider the age of your business and your credit card sales when determining your eligibility. Con: MCAs can come at a high cost A merchant cash advance can be risky for small businesses. It consumes a chunk of the cash that comes in — even when sales are lower than usual, which could put additional strain on cash fow until the advance is paid of. Also, the factor rate for an MCA is fxed, and is applied to the entire cash advance upfront. This means that paying it of early won’t lower the cost of the MCA, which is unlike how interest on a typical loan works. With a personal loan, for example, you may be able to pay less to borrow the funds overall by paying your balance of early. Con: You could fall into deeper debt Some merchant cash advance companies will ofer an advance to businesses that already have one. This practice, which is known as “stacking,” can trap businesses in debt. Applying for multiple merchant cash advances means having multiple repayment demands from your incoming cash, which could prove too costly for the business to manage. Con: They’re complicated and not federally regulated Compared to other types of business fnancing, merchant cash advances are complex. A 2018 Federal Reserve report revealed that consumers found MCAs overall to be confusing for a number of reasons, including … •The true cost was difcult to determine. •Descriptions of merchant cash advances were vague or confusing. •Industry jargon associated with MCAs was perplexing. •Mistakes and assumptions about merchant cash advances are likely, based on consumers’ past experiences with traditional bank loans. Part of why there’s so much confusion around merchant cash advances is because this form of fnancing isn’t federally regulated. Instead, it’s regulated by each state’s Uniform Commercial Code. This means that merchant cash advances aren’t subject to banking laws like the Truth in Lending Act, which helps protect consumers against inaccurate and unfair lending practices by requiring lenders to provide loan cost details. Alternatives to a merchant cash advance There are lots fnancing options out there (some potentially less expensive than MCAs) — so a merchant cash advance isn’t the only way to get funds for your business. One such option includes unsecured personal loans, which ofer fxed terms and interest rates typically between 4% and 36%. Another option is a business credit card. And if your card reports to the credit bureaus, you’ll have the added beneft of being able to use the card to build your business credit. It may even ofer benefts like free employee credit cards or cash back rewards on business purchases. Bottom line A merchant cash advance comes with signifcant risks. Its high fees and complicated terms could leave you in need of more money. Take some time to shop around and consider all the options available to you. Ask questions and read the fne print. The more you know, the easier it can be to choose the right solution for your business.