Starting a business can be exciting and lucrative as long as you have funding to kickstart your business. One way to obtain working capital is by taking a merchant cash advance. Unlike a traditional business loan, you don’t need an established business history or even good credit to obtain an MCA, but there are risks.
What Is a Merchant Cash Advance?
The first thing to know is that a merchant cash advance is not a loan, but the purchase and sale of future receivables in exchange for lump-sum cash upfront. For a startup, an MCA can provide working capital for all types of business needs, such as:
- Purchasing inventory
- Obtaining equipment
- Meeting payroll
- Paying unplanned business expenses
But an MCA is only right for your startup if you have strong daily sales. The MCA provider will make an advance your business a lump sum payment in return for a percentage of your future debit and credit card sales through daily ACH payments. That percentage is based on:
- The advance amount
- The payment term
- Prior monthly sales
Be forewarned that the cost of funding is typically much higher than a bank loan or line of credit. An MCA is not tied to an interest rate or Annual Percentage Rate (APR), but rather a factor rate that is multiplied against the advanced funds. Factor rates range from 1.2 to 1.5, but these values are misleading. For example, if the advance amount is $50, 000 with a 1.2 factor, the amount you repay is $60, 0000 ($50,000 x 1.2).
Ultimately, the cost of funding is determined by a combination of the factor rate and the term of the advance. If the payback period is three months, that is a very high cost of funding if it is calculated on an annual basis, resulting in an APR in the triple-digits.
What If My Startup Defaults on a Merchant Cash Advance?
If your startup does not meet its sales projections and defaults on an MCA, both your business and personal assets will be at risk. A merchant cash agreement typically includes onerous provisions such as a Confession of Judgment whereby you accept liability for the advance and waive any legal defenses. In the event of default, the funder can automatically file a judgment in court and levy your business assets. Also, the MCA provider will likely require you to sign a personal guarantee, which means your home, bank accounts, and other personal assets will be at risk.
A merchant cash advance is one way to fund your startup, but it is crucial to weigh the risks and rewards. Whether you are considering an MCA or you have taken one and cannot be the repayment terms, it is wise to consult with an experienced merchant cash advance attorney.