What is an MCA Loan?
An MCA loan refers to an alternative business funding product called a merchant cash advance (MCA). It’s sometimes called MCA funding or simply abbreviated MCA.
Financial services companies that provide merchant cash advance funds are called merchant cash advance companies or merchant cash advance funders. While they’re sometimes called an “MCA loan,” the structure is not a loan in the traditional sense.
The MCA company provides the advance in exchange for a percentage of the business’s future receivables. It’s technically a business-to-business transaction. Traditional merchant cash advance repayment comes from future credit card sales, but more modern MCA options include repayment from all revenue via ACH transfer.
Since repayment comes from your business’s revenue, MCA companies are much more lenient about credit scores and time in business. They’re usually available if you don’t have business credit or a less-than-perfect credit score.
That makes them more accessible for younger companies or credit-challenged small business owners. However, MCAs are one of the most expensive business funding products on the market.
How does a Merchant Cash Advance work?
Merchant cash advances have several components you must understand when pursuing this type of business funding. The general process goes like this:
- Apply to an MCA funder.
- Receive the cash advance as a lump sum.
- Repay the advance with a percentage of your future credit card sales.
The advance amount is how much cash your business receives. Most MCA funders base your advance amount on previous credit card receipts since credit card transactions are the source of repayment.
Some funders base the amount on your average monthly credit card sales. Others might give you a total of your previous three months’ sales. It depends on your MCA company, personal credit score, and financials.
The factor rate is the financing charge for the advance. It’s how the MCA funder makes its money. Factor rates are different from a standard loan interest rate. It’s also sometimes called a capital fee or discount rate.
Unlike interest rates, which are usually a percentage, factor rates are expressed as a decimal. Calculating the amount you’ll owe is easy, but MCA factor rates are often much more expensive than a loan APR.
Factor rates can range from 1.05 to 1.9. The rate you receive is usually based on your perceived credit risk.
The rate is applied at the beginning of the MCA and becomes the new balance owed. That means there’s no way to save money by paying off early like you could with interest on a loan (assuming no prepayment penalties).
To calculate the total owed, multiply the advance amount by the factor rate. For example, if you received an MCA for $50,000 at a factor rate of 1.2, the formula would be:
$50,000 x 1.2 = $60,000.
You’d have to repay $60k for the $50k advance. While you can think of the $10k charge as “interest,” it’s really the MCA funder purchasing $60k in receivables for $50k.
Most MCAs are short-term funding with terms ranging from 2-24 months on average. Each funder has different ranges for terms. Some might only go up to 12 months, while others could go to 36 months, but that’s rare.
The total merchant cash advance repayment amount must be paid by the end of the term. That means you must increase or maintain sales to ensure you’re on pace. Failure to repay the advance within the defined merchant cash advance terms could have costly repercussions.
Sometimes, you’ll have to take out a second MCA to cover the costs. These scenarios sometimes lead to getting trapped in a debt cycle that’s difficult to escape.
Other times, you’ll have to pay extra fees or make “catch-up” payments to get back on pace. In worst-case scenarios, defaulting on the MCA results in the funder filing a lawsuit against your business to get a judgment for the amount owed. The judgment could result in losing collateral or business assets like equipment and inventory.
Some MCA companies charge additional fees in addition to the factor rate charge. Common MCA fees include:
- Application fee: A charge for processing your MCA application. Many MCA funders don’t charge an application fee. Look for ones that don’t charge this fee, as it would mean paying money before you even know if you’ll get the funds you need.
- Underwriting fee: Covers the cost of the funder’s underwriting process. Usually, this fee is only applied when the application gets approved for funds.
- Origination Fees: Many funders charge origination fees for MCAs. It’s also a common fee in standard small business loans (and sometimes personal loans). Origination fees are usually 1%-5% of the borrowing total, although we’ve seen some companies charge as high as 9%. The fee is either deducted from the advance or added to the total repayment amount and is repaid in installments like the principal and factor rate charge.
- Administrative fee: A charge for setting up the MCA account.
- Bank fee: Some funders charge a fee for processing the payment from your bank account.
- Broker fee: This is paid to a broker if you used a third party to help get the MCA.
Most MCAs require frequent payments. They can be daily or weekly but daily is more common. Some companies might offer biweekly payments.
Since repayment comes from future sales, the amount you pay fluctuates with your sales volume. Lower sales days will yield a lower payment, and higher sales days yield a larger payment.
The fluctuation is part of why MCAs are a good fit for businesses that experience an ebb and flow of sales. It makes payment easier as long as the average over the MCA term is enough to repay in time.
Also called a remittance rate, holdback rates are the percentage of your sales that go towards repayment. Most holdback rates are between 5%-20%, but it’s possible to see rates as high as 40%.
The holdback rate is based on your repayment total and terms. Shorter terms would necessitate a higher holdback rate to ensure you pay back the amount owed in time.
Holdback rates are typically processed in one of three ways:
- Split withholding: Your credit card processor splits sales as they happen. The portion of the remittance rate goes directly to the MCA provider, and the remaining total goes to your merchant account.
- ACH withdrawal: The MCA funder deducts the payment from your business bank account with an automated clearing house (ACH) transfer.
- Lockbox or Bank Withholding: Your bank splits payments from credit card sales between your account and your MCA provider.
The first two methods are the most common and typically used for daily payments. A small business owner with a good credit profile is more likely to get weekly or biweekly payment schedules using the lockbox method.
Now that we’ve covered the components of an MCA, let’s look at how they all work together. In this example, the ABC Company received an MCA with the following features:
- Advance amount: $150,000.
- Factor rate: 1.25.
- Fees: 2% origination fee.
- Holdback rate: 15%
- Terms: 24 months.
- Repayment: Daily ACH transfer.
The 2% origination fee on $150k = $3,000. We then add that to the repayment total after calculating the factor rate:
$150,000 x 1.25 = $187,500 + $3,000 = $190,500 in total repayment.
The company has 24 months to repay that amount, with 15% of its daily sales going toward repayment. 24 months = 730 days.
In this scenario, ABC company would have to average approximately $1,740 in daily sales (or $52,200 in monthly sales):
- $1,740 x 15% = $261 in daily remittance.
- $261 x 730 days = $190,530 total (the final day would only require a payment of $231).
Note: The above example is based on sales seven days a week. If your business closes on certain days, you’ll have fewer sales days in the term. You would then adjust your calculations based on total sales days.
What are the benefits of a Merchant Cash Advance?
The primary benefit of an MCA is that it’s highly accessible. So, business owners who can’t get traditional business loans can often still fund their companies with an MCA.
In addition, MCAs are typically quick to fund. You can usually get a decision within 24 hours of applying. Some funders have same-day or even instant decisions.
Once approved, most MCA companies send the funds electronically within 24-72 hours. It might be possible to get same-day funding if everything goes smoothly.
Small businesses can use MCA funds for most business purposes. Business loans are most commonly for a defined purpose, limiting your use of the money.
What are the drawbacks of a Merchant Cash Advance?
The most significant disadvantage of MCAs is the cost. As mentioned, a merchant cash advance is one of the most expensive ways to fund a business.
Most MCAs have short terms and frequent payments. That combination could strain your cash flow if you don’t budget properly.
Finally, there’s no benefit to paying off the advance early. Unlike traditional loans with amortization schedules, MCA fees are all applied at the beginning of the funding agreement. Some funders even charge prepayment penalties if you try to pay it off early (although others might offer an early payoff discount).
MCA Pros & Cons
- Highly accessible for business owners with bad credit.
- Minimal documentation requirements.
- Quick & convenient online applications.
- Typically quick decisions – same-day approval is often possible.
- Fast funding times – usually within 24 hours.
- There are few limits on how you can use the funds.
- One of the most expensive business funding products.
- Usually has short repayment terms.
- Frequent payment schedules could strain cash flow.
- No way to save costs with an early payoff.
Frequently Asked Questions
Here are the most common questions about merchant cash advances.
Is an MCA a Business Loan?
No, MCAs are technically not loans in the traditional sense. It’s a business-to-business transaction that provides funding to support your company. Since MCAs aren’t loans, they’re not governed by the same strict rules as traditional bank loans.
What types of Small Businesses should use an MCA?
MCA funders weight credit criteria differently. Approved businesses we work with typically meet the following criteria:
- Credit score: 550+.
- Time in business: 4 months.
- Annual revenue: $120k.
As the name suggests, merchants are the target audience for MCAs. More specifically, businesses that process a high volume of credit card and debit card sales are usually good fits for MCA products.
They are also intended for businesses that struggle to get traditional financing. Companies often use MCAs to cover emergencies and unexpected costs or take advantage of a time-sensitive opportunity.
Small businesses affected by seasonality can also benefit from MCAs. You could use the funds to cover costs during the off-season, such as stocking up on inventory. With the correct timing, you could use higher sales during the peak season to repay the advance quickly.
When should I use a Merchant Cash Advance?
Considering the expense and risks, MCAs should be used sparingly. However, with proper management and budget, an MCA could help boost your business.
Here are some situations where an MCA could be worth it.
Bridge Financing: An MCA can provide short-term temporary funding while you await a more advantageous business loan.
Emergency Expenses: No one wants to face an emergency situation, but it happens. Since MCAs are quick to approve and fund, they could provide just-in-time money when facing an emergency. It could even offer stop-gap funding while you wait for an insurance payout.
Time-Sensitive Opportunities: Sometimes, you need quick funding to take advantage of a limited-time opportunity. For example, an inventory supplier offers a massive discount if you buy a larger bulk this quarter. The potential profit increase could more than justify the expense of an MCA.
Business Expansion: Let’s say your sales are excellent, and you need to hire more staff and purchase additional inventory to expand your operation. An MCA could provide the short-term capital for those expansion costs.
Last Resort: Sometimes, your business needs funding, and you have no other options. MCAs can be an option of last resort.
These are just a few examples. Ultimately, it comes down to your unique business needs. The important thing is to have a plan for the funds and a repayment strategy.
What are my alternatives to an MCA?
Merchant cash advances are just one form of small business funding. If you’re interested in MCAs because you have poor credit, there are other bad credit business loans to consider.
Businesses selling on credit and issuing invoices would benefit more from invoice factoring. It’s similar in that it’s a B2B transaction where the funder purchases future receivables in exchange for a cash advance. However, it’s specifically for unpaid invoices in accounts receivable rather than anticipated future credit card receipts.
MCAs most commonly take payment from future credit card transactions. A revenue-based loan might make more sense if your business doesn’t do a high volume of card sales. These financing structures are similar to MCAs, but repayment comes from all revenue sources.
Consider a business line of credit if you’re trying to protect against unforeseen costs, such as emergency expenses. Once activated, you draw funds from the credit line as needed, similar to a credit card.
You might also be interested in the following small business loans:
- Business term loans.
- Business loans for women.
- Equipment financing.
- SBA loans.
- Working capital loans.
- ERTC advances.
MCA Loans for Small Business – Final Thoughts
Merchant cash advances can provide funding when your business needs it the most. But the costs and risks involved mean you should use them sparingly.
It’s also best to have a budget for your business to afford the repayments. Ensure you carefully review any MCA agreement before signing. You should understand all the costs and risks involved before committing to the funding arrangement.
Contact us if you have more questions on MCAs or to apply for a small business loan. Our business financing experts can help you find the best funding program for your credit score and business goals.