woman looking over merchant cash advance agreement

How A Merchant Cash Advance Works

Small businesses that need working capital but lack access to traditional financing often seek alternative sources of funding, such as a merchant cash advance (MCA). Business owners receive funding upfront from an MCA provider and pay off the advance with a percentage of their daily sales.  

In the event of default, however, both business and personal assets are at risk. In this situation, it takes a skilled debt relief specialist to reconcile a merchant cash advance. This article is a brief discussion of how this alternative funding product works.

How does a merchant cash advance work?

An MCA provides funds to a small business owner in exchange for a percentage of the business’s credit card and debit card sales over time. Payments are typically made daily through automatic ACH deductions as the business generates sales. The pricing of an MCA is based on a factor rate, a multiplier generally based on a business’s financial status. This is expressed as a decimal and usually ranges between 1.2 and 2.5. 

A factor rate is not the same as an interest rate or annual percentage rate (APR) that are associated with traditional loan products (e.g. business loans, mortgage loans, auto loans). When the factor rate is converted into a corresponding APR, however, the figure can rise to triple digits. Ultimately, this is an exorbitant cost of funding and may explain why businesses are at such a high risk of defaulting on a merchant cash advance. 

An MCA does provide business owners with a number of benefits, however, such as: 

  • A simple application process
  • Approval within 1 business day
  • High approval rate
  • No collateral required 
  • Immediate funding (within 1 or 2 days)
  • A convenient method of payment

Terms and rates you can expect from a typical merchant cash advance depend on several factors, including:

  • Amount of the advance
  • Factor rate
  • Deduction percentage (percentage of sales, daily transactions)
  • Payment period/term (3 mos, 6 mos, 1 yr)
  • Payment frequency (daily or weekly)

In sum, MCAs are a good option for businesses that receive payments through credit card and debit cards, have a high volume of sales, need funding quickly, or may not qualify for a traditional business loan.

How to Qualify for a Merchant Cash Advance

Qualifying for a merchant cash advance is relatively easy. MCA providers typically offer a user-friendly online application process with quick turnaround times. Applying takes a few minutes, and an answer is given within one or two business days.

Unlike traditional business loans, applicants for an MCA do not necessarily need to have a long operating history and good credit to qualify, although these factors can result in more favorable payment terms and lower factor rates. 

The key factor that MCA providers consider is whether the business has consistently high sales. To apply, merchants must submit: 

  • Information about the business structure
  • Annual business income
  • Estimated future income growth
  • Bank account statements
  • Credit card and debit card processing statements

It is important to be aware that MCA agreements typically include onerous terms such as a Confession of Judgment (COJ) and a personal guarantee that put both the owner’s business and personal assets at risk. 

The Consequences of Defaulting on a Merchant Cash Advance

If the merchant defaults on an MCA, the COJ and personal guarantee allow the funder to obtain a judgment and quickly begin seizing both the owner’s business and personal assets, in which case one option may be to seek bankruptcy protection.

On the other hand, a properly structured MCA agreement will include a reconciliation clause that requires the provider to restructure the repayment plan if the business experiences a receivables shortfall. Given the challenges of reconciling a merchant cash advance with a potentially recalcitrant funder, it is wise to consult with an experienced debt relief specialist.