Take advantage of this progressive form of flexible funding built for retailers.
Without time-consuming credit checks and rigid repayment plans, merchant cash advance is perfectly suited to the fast-paced, unpredictable world of retail. Similar to a business loan, but with several important differences, a merchant cash advance may suit any company that receives the majority of its payments by card.
What is a merchant cash advance?
A merchant cash advance is a type of business financing for companies that have a large amount of customer sales — typically credit card sales. Your business gets access to and repays it repay plus a fixed fee with a percentage of your daily or weekly sales.
Merchant cash advances are designed to provide a temporary cashflow solution to business owners who might not be able to qualify for other types of financing. It’s typically fast — especially if your business borrows from a company that already has access to your bank accounts and sales history like Paypal. But it’s one of the more expensive business financing options out there.
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How does a merchant cash advance work?
A merchant cash advance works a lot like a short-term business loan. You apply for a one-time sum, which you pay back plus a fee that your lender determines by something called a factor rate or factor fee.
Instead of making fixed installment payments, your business then pays off the loan with a percentage of each transaction, sometimes called the holdback. Holdbacks typically range from 10% to 20% of each sale. So how long it takes to pay back your loan is determined by your holdback rate and your sales — not a set loan term.
Some companies also have a minimum monthly payment that your business must make even if it doesn’t have any sales. Many have a maximum amount of time your business can take to repay a merchant cash advance, typically around one year.
Factor rates explained
A factor rate is a number above 1 that your lender uses to come up with your total loan cost. It does this by multiplying your factor rate by your loan amount. They typically range from 1.1 to 1.5, though some lender charge factor rates of 3 or even higher.
Let’s take a look at an example. Say your business qualifies for a $10,000 merchant cash advance from a lender at a factor rate of 1.15. Here’s how it breaks down:
- How much your business receives: $10,000
- How much your business owes: $11,500
Can I set up a merchant cash advance for my business?
Merchant cash advances are ideal for retailers and e-commerce businesses. But any business with steady sales from consumers might be able to qualify.
The application is often simple, meaning that it often has a faster turnaround time than other types of business financing. Lenders typically only have a monthly or annual sales requirement and accept all credit types. Some might not even run a credit check for smaller advances.
Once your application has been approved, some lender might ask you to open a separate bank account known as a “pass through” account. You can then use this for processing any transactions and the lender can collect their share. Others might simply ask for access to your business’s bank or Paypal account.
What are the benefits of a merchant cash advance?
- It’s quick and efficient. Unlike business loans that can take months to be approved, a merchant cash advance can provide you with much-needed funds in a couple of weeks or less.
- Collateral isn’t required. You don’t need to provide any business or personal assets to be approved in order to qualify for a merchant cash advance.
- There’s no credit check. While this isn’t guaranteed, advances for smaller amounts can regularly be obtained with a less-than-perfect credit score.
- Repayments are based on sales. The amount you repay changes according to your earnings. This ensures small companies with changing levels of income don’t get caught out with fixed repayments.
Are there any drawbacks?
- It’s expensive. With terms typically hovering around one year, even the least expensive merchant cash advances can cost the equivalent of a triple-digit APR — high compared to other types of business financing.
- You can’t save by prepaying. The factor rate applies no matter how long your business takes to pay back the advance, meaning that paying early won’t save you anything.
- There’s a lack of regulation. Merchant cash advances aren’t regulated by federal banking laws, so regulations vary by state to state.
- It’s not a long-term solution. Merchant cash advance plans usually last no longer than 12 months. Along with the cost, this means they are unlikely to provide positive results other than for a short period.
- It can be risky. While past sales information should be an accurate indicator of future sales, industries such as retail and hospitality can be fickle. If your business can no longer pay off the advance, you will need to find the repayment money elsewhere.
Anything else to watch out for?
With no federal regulation, your lender has a lot more leeway when it comes to how much it can charge you and how it discloses its fees. Watch out for complicated contracts that are difficult to follow — your lender might be trying to hide something. If possible, take some time to review your contract and ask an expert if there’s anything that isn’t clear.
The lack of federal regulation also means that lenders need to meet state requirements to legally offer financing. Double check to make sure your lender is able to lend in your area before applying for a loan.
Merchant cash advance alternatives
Don’t think a merchant cash advance is right for your business? Consider these alternatives instead.
- Revenue-based financing. A lot like a merchant cash advance, revenue based is a loan your business pays off with payments determined by its monthly revenue. This option is meant to help small businesses and startups grow.
- Invoice factoring. Need a cashflow fix but work with other businesses or government agencies? Get an advance on your unpaid invoices by selling them to a factoring company at a discount. There are several different types of invoice factoring.
- Invoice financing. Use your business’s unpaid invoices to back short-term business loan and repay it as your customers pay you.
- Short-term business loans. If your business needs money up front and doesn’t rely on customer sales, many alternative lenders offer short-term loans that work a lot like merchant cash advances but come with repayments in fixed installments.
Bottom line
Merchant cash advances might be an easy way to get cash when your business is facing a seasonal dip in sales. It’s also one of the few options that doesn’t require a credit check. But the high cost and lack of regulation might make you want to consider other options first. You can get started by checking out our business loans guide.