Merchant Cash Advance: How it Works, Brokers, Regulations, and Alternatives

Dane Panes

September 26, 2021

 

Key Takeaways

  • A merchant cash advance (MCA) is a helpful resource in helping businesses resolve cash flow gaps. It is a type of financing wherein the business borrows money against their future credit or debit card transactions.
  • The business can then pay the MCA in one of two ways: either the MCA company automatically deducts a percentage of the business’ credit or debit card transactions, or the MCA company withdraws the repayments directly from a merchant’s bank account on an agreed-upon schedule.
  • Merchant cash advance providers don’t follow the same usury laws as other small business loans. Rather, they are regulated by the UCC and Dodd-Frank Act.
  • As MCA can be expensive, financing companies often work with merchant cash advance brokers to help them sell their services to businesses.
  • Alternative to MCA include business line of credit, online term loans, invoice factoring, and SBA Express Loans.

Many businesses experience cash flow gaps. To avoid having said gaps turn into bigger issues like missed monthly payables or business closure, the business may turn to alternative small business financing to get the additional cash injection needed to keep the company afloat.

One popular financing choice is a merchant cash advance (MCA). While this is not formally considered a loan, it’s widely used as such – particularly among companies that handle large volumes of credit and debit card transactions every month.

If you’re a business owner considering a merchant cash advance for your company, it’s important you understand how the process works. In this article, we’ll explore the basics of merchant cash advances – everything from the regulations associated with obtaining one, to merchant cash advance brokers and how you can find the right one for you.

 

 

How Does a Merchant Cash Advance Work?

A merchant cash advance (MCA) is a type of financing that gives a business access to capital in exchange for a portion of its future revenue. The repayment for the advanced cash can be done in one of two ways. Either the financing company takes an agreed-upon percentage out of the business’ daily credit and debit card transactions, or the merchant cash advance company withdraws the repayments directly from the merchant’s bank account on an agreed-upon schedule.

Unlike conventional loans, MCA companies do not charge an interest rate. Instead, they use a factor rate (which is expressed as decimals) for their cash advances. Similar to interest rates, the factor rate will depend on the risk the business poses to the financing company. The less risky the business is as a borrower, the lower the factor rate will be.

To calculate the total amount you’d need to repay to merchant cash advance company, you must multiply the advanced amount by the factor rate. For example, if you receive a $50,000 cash advance from a merchant cash advance company at a factor rate of 1.5, the total repayment amount will go up to $75,000.

The exact terms for merchant cash advances will vary based on the financing institution you work with, but here’s a ballpark look at what you can typically expect:

  • Advance amount: $2,500 to $500,000
  • Factor rate: 09 to 1.5
  • Deduction percentage: 5% to 20% of the daily debit/credit sales
  • Payment period: 3 months to 2 years
  • Payment frequency: Daily or weekly

Merchant cash advances can be expensive, as seen in the calculation above. That is why most financing experts only recommend the financing as a last resort – in the event the business needs access to cash fast and can’t qualify for traditional loans.

 

Merchant Cash Advance Uses

Merchant cash advances, like any other financing options, offer some spending flexibility to its users. In general, a merchant applies for MCA for the following purposes:

  • Additional working capital
  • Bridging temporary cash flow gaps
  • Buying equipment at a discount
  • Large inventory reordering
  • Refinancing existing debts

 

Merchant Cash Advance Regulations

With MCA’s expensive nature, you may wonder whether it’s legal to charge that much of a fee for financing.

The simple answer is that it is legal. Since an MCA isn’t considered a business loan, there aren’t as many regulations associated with the financing. They don’t follow the same usury laws (the law that limit the interest rates on financings) that other financing companies adhere to.

This doesn’t mean they aren’t regulated at all. Below are the two regulations that MCA companies follow in their operations:

1. Non-Interest Rate Regulations

MCA companies abide by the Uniform Commercial Code (UCC). The UCC is a set of laws that govern all commercial transactions in the United States. Though not considered as federal law, it is a uniformly adopted state law. With it, businesses can enter into contracts and get the assurance that the terms will be enforced and honored within the American jurisdiction. The same regulation protects merchants in case any issues arise with the merchant cash advance.

It is worth noting that the UCC filing does not impact the interest rates the merchant cash advance companies charge.

Other than the Universal Commercial Code, federal entities like the Dodd-Frank Act and Federal Trade Commission also protect MCA transactions. The Dodd-Frank Act allows the collection of borrower demographics, while the Federal Trade Commission regulates and handles any deceptive activities that might take place.

The Borrowers’ Bill of Rights outlines six fundamental financing rights of small businesses as well as the practices that lenders must comply with.

2. Self-Regulation

The merchant cash advance company should abide by the Small Business Borrowers’ Bill of Rights. This helps protect small businesses from predatory small business lending practices and ensures transparency and accountability across all small business lending sectors.

The Borrowers’ Bill of Rights are as follows:

  • The Right to Transparent Pricing and Terms
  • The Right to Non-Abusive Products
  • The Right to Responsible Underwriting
  • The Right to Fair Treatment from Brokers
  • The Right to Inclusive Credit Access
  • The Right to Fair Collection Practices

When considering a merchant cash advance provider, working with companies that honor these rights is always ideal. Don’t be afraid to ask if the MCA company adheres to these rights before signing the deal.

 

What is a Merchant Cash Advance Broker?

As mentioned above, merchant cash advances can be expensive. They typically have a higher factor rate than traditional business loans. The financing’s expensive nature is why it’s recommended as a last resort option (i.e., when the business cannot qualify for conventional loans because of a poor credit score or other reasons).

Moreover, its high cost could also be why many MCA companies have a hard time getting merchants to sign up for their merchant cash advance service. For that reason, they turn to merchant cash advance brokers for help.

A merchant cash advance (MCA) broker is a person or company that connects MCA companies, SMEs or “merchants.” Most MCA companies rely on brokers to connect cash-strapped businesses to their company and sell their high-interest, short-term business financing. Brokers typically have good interpersonal skills and have a rich knowledge when it comes to MCA and other types of financing. In most cases, these brokers not only handle merchant cash advances, but also have experience with other types of small business financing.

Merchant cash advance brokers are usually paid on a commission basis. Most can earn up to 11% of the advanced amount if customers sign up for their merchant cash advance services. That means that if a company advances $25,000, the broker could get $2,750 in commission.

 

How to Pick the Right Merchant Cash Advance Broker

It’s important to note that when you do choose to work with an MCA broker, it’s vital to check their qualifications and capabilities. Merchant cash advances, like other financing options, are large investments, and applying for one is a major decision for the company. You want to work with only the best and most reputable brokers in the industry.

That said, when looking for or researching merchant cash advance brokers, you want to check for the following:

  • Educational background and experience
  • References and reviews
  • Fees compared to other brokers
  • Interpersonal skills
  • Licenses

1. Educational background and experience

One of the first things to check when considering a broker is his or her educational background and experience in financing. You want to work with someone who has an extensive knowledge of the industry, and ideally has been a business lender before.

Working with a merchant cash advance broker with extensive experience also makes the application process smoother. He or she can answer your questions and clarify things that you might be confused by.

2. Reference and reviews

Before fully committing, ask your prospective broker if he or she has references. If they don’t or refuse to give you a list, that’s a red flag. If they do provide you with a list of references, do your due diligence and call them to inquire about the broker’s performance and professionalism and whether or not the individual recommends them.

You should also conduct an online search. Does the broker have a website you can check out? If so, does the site has client testimonials? Are there online reviews you can access? If you conduct a search and are unable to find anything about the individual or company, that’s also a red flag.

Moreover, the brokers should be able to prove they work with an MCA company that honors the Small Business Borrowers’ Bill of Rights.

3. Compare fees with other brokers

Beware of brokers that charge upfront fees. All brokers charge a fee at closing, but you should not have to pay anything before receiving the loan. If you do work with a broker but your loan doesn’t reach closing, the broker should not be charging you. Ask all prospective brokers if they plan to charge any upfront fees, and how much their fee will be at closing. This way you can compare and make an informed decision as to which one you will choose.

4. Interpersonal skills

Merchant cash advance brokers should present themselves professionally. They should have good interpersonal skills that allow them to communicate and educate their clients about the financing. Regardless of what background their clients or potential clients come from, they should be able to speak to them professionally and confidently.

5. Licenses

Some states will require financing brokers – including merchant cash advance brokers – to obtain a license to operate or open a brokerage business. If your state does require them to get a license, ask about it. If they can’t present one, they may not be the best fit for your business.

You can double-check if a broker is licensed by checking the member organizations in the banking industry, or by inquiring at your local Small Business Administration branch.

Alternative to Merchant Cash Advance

If you find merchant cash advance too expensive, and you don’t want to risk experiencing cash flow gaps just to make payments, you might want to consider taking out a loan. Many of them offer spending flexibility, so you can cover almost any business initiative – be it seasonal cash flow gaps, buying equipment, or meeting day-to-day expenses.

Here are some of the financing options you can choose from:

1. Business Lines of Credit

A business line of credit can be a helpful financing resource for cash-strained businesses. Once approved, the company can repeatedly access its credit line whenever the need arises. This can be a convenient financing option if you find yourself constantly experiencing cash flow gaps, especially during slower seasons.

With a business line of credit, you will only have to pay the cash you use, plus interest. As you pay off what you owe, the amount available to you goes back up, and you can use the funds again as long as you don’t exceed the set credit limit.

Just know that if you do get approved for a business line of credit, the lenders may require you to sign a personal guarantee agreement. A personal guarantee agreement is an individual’s legal promise to repay the loan using their personal resources if the business becomes unable to repay the loan.

2. Online Term Loans

Term loans offered by online lenders are among the most accessible financing options for small businesses, especially those that are still in their early stages of operation. Online lenders are usually more flexible regarding the business’ qualifications as they’re not bound by the same regulations that control large banks. That said, they have more freedom in choosing who they want to lend to.

With term loans from online lenders, you’ll receive a lump sum of money upfront. Depending on the length of the term, you can get between $5,000 to $5 million in funding. The proceeds can be used to fund a wide range of business initiatives, including commercial property acquisition, business acquisition, equipment purchasing, hiring staff, and others. You then repay the loan amount in increments (plus interest) within a specific period, or term.

One of the most important things to remember about term loans is that the financing terms you receive will be dependent on your credit standing. Essentially, the more creditworthy you are, the lower your interest rate will be. In contrast, businesses with a less than stellar credit standing may be charged with a higher interest rate.

3. Invoice Factoring

Businesses that offer net term payments to their customers may often find themselves short on cash. For that reason, many of them sell their invoices to factoring companies to free up the capital tied up in their customer invoices. This financing method is called invoice factoring.

With invoice factoring, the business will have to give up control of their accounts receivable ledgers to the factoring company. As the new owner of the outstanding invoices, the factoring company will be responsible for the collection of the unpaid invoices. Since the customers pay the factoring company directly, they will be aware that the merchant is working with a factor.

Once the customers pay the invoices, the factor deducts the advanced amount, plus the fees, and gives the remaining balance back to the business.

4. SBA Express Loans

The SBA Express loan is an extension of the SBA 7(a) loan which is backed by the federal government. As such, it can be used for the same purposes. It could be for equipment purchase, real estate investments, covering cash flow gaps, and others as long as it’s business-related.

Recently the SBA temporarily increased the funding for SBA Express loans from $350,000 to $1 million. However, after September 30, 2021, the maximum amount for SBA express loans will permanently decrease to $500,000.

SBA loans offer one of the best terms for small business owners. This means the interest rates are much lower than what a traditional bank loan without the government guarantee would offer. It’s also why it’s one of the most sought-out business loans.

One downside of SBA express loans is that you need to be creditworthy to qualify. In most cases, banks and other lenders may require a credit score of 650 or better. Other than credit scores, your business should also have at least two years of business history and a solid financial track record.

 

Final Thoughts: Should Your Business Apply for a Merchant Cash Advance?

Overall, merchant cash advances can be a helpful financial resource if you need access to additional capital quickly and you can’t qualify for conventional small business loans. However, if you’re planning to proceed with your application, do so with caution. Otherwise, you might end up with business financing that you can’t even afford in the first place.

Moreover, always do a background check if you’re planning to work with a merchant cash advance broker. Ask about their experience, specifically in your industry. Inquire about their rates and check their references and online reviews. Merchant cash advances are a big decision, and you want to make sure that you’re working with a reputable company and broker.

Dane Panes
Dane Panes started freelance writing in 2017. Since then, she has written about a lot of topics for different businesses. She started writing for SMB Compass in March 2020 and has been a full-time content writer ever since. Now, she focuses mostly on topics related to entrepreneurship and business financing.

Related Articles

How Much Does Instacart Pay?

How Much Does Instacart Pay?

Key Takeaways What is Instacart? How Does Instacart Work? How Much Does Instacart Pay? Pros and Cons of Driving and...