Is a Merchant Cash Advance a Loan?

If you own a business, regardless of how small or large, you’ve probably heard of the concept of a Merchant Cash Advance.

Merchant Cash Advances are a relatively recent development in the financial world, although they started to gain traction around 2005.

During the financial crisis of 2008, Merchant Cash Advances were instrumental in helping businesses that would otherwise have had their applications for lines of credit and business loans rejected to stay afloat. 

However, it is important to note that a Merchant Cash Advance is not the same thing as a loan. Because Merchant Cash Advances involve the injection of a repayable amount of cash into a business, many business owners make the mistake of assuming that a Merchant Cash Advance is a form of loan, which can cause a lot of confusion.

Read on to find out what a Merchant Cash Advance is, and how it differs from a traditional loan.

What is a Merchant Cash Advance?

The first thing to clear up in relation to Merchant Cash Advances is exactly what they are and how they work.

A Merchant Cash Advance, put simply, is basically an advance payment of the revenue that a business would make over a certain period of time.

The merchant (business owner) is required to pay the sum of money back incrementally through customers’ debit or credit card transactions.

The minimum Merchant Cash Advance you can receive as a business is $5,000, while the maximum is $500,000.

So, as you can see, Merchant Cash Advances are versatile and flexible and can benefit a wide range of businesses, whether they make a small or significant amount of revenue annually.

How is a Merchant Cash Advance Different from a Loan?

Now we know what a Merchant Cash Advance is, but how does it differ from your traditional business loan.

Although Merchant Cash Advances and business loans share some similarities (they are both designed to provide repayable funding for businesses, for example), there are several differences between the two types of funding.

For one thing, a traditional business loan is not repaid in the same way as a Merchant Cash Advance.

While business loans will usually require regular, monthly payments to be made up until the end of the loan period (unless, of course, you are able to pay off your loan early through larger installments), this is not the case with Merchant Cash Advances.

Paying back a Merchant Cash Advance is normally either done automatically through your business’s card terminal or via direct debit payments.

If you choose to go via the card terminal route, a portion of your customers’ card transactions will automatically be withheld and transferred to your lender as opposed to your business bank account.

Alternatively, there is the option of having weekly or daily debit payments taken from your business account.

Merchant Cash Advances also use something called a Factor Rate for repayment as opposed to an Interest Rate.

When you borrow money for your business in the form of a business loan, your lender will calculate an appropriate Interest Rate according to your business’s financial status.

An Interest Rate is given as a percentage of the amount of money borrowed and may change depending on how quickly you repay the sum of borrowed money.

For example, when taking out a business loan, you might borrow $15,000.

If your lender specifies a 10% interest rate over a period of one year, this would mean that your interest rate is 10% APR (Annual Percentage Rate), and you will be required to pay $1,500 in interest.

Therefore, by the end of the year, you would be required to repay a total of $16,500.

If, however, you repay your loan early, you usually will not be required to pay the full amount of interest.

Say you manage to repay the whole sum of money that you borrowed within 8 months as opposed to a year. If your loan comes with simple interest, then you will be eligible for a deduction of 4 months’ worth of interest.

With a Merchant Cash Advance, none of the above applies. Instead of an interest rate, your Merchant Cash Advance will come at the cost of a Factor Rate.

A Factor Rate, unlike an Interest Rate, is expressed as a decimal figure and not a percentage.

For example, if you took out the aforementioned $15,000 as a Merchant Cash Advance, you might be given a Factor Rate of 1.5.

To work out how much you would need to repay in total, you would multiply the borrowed sum by the Factor Rate: 15,000 X 1.5 = 22,500. So, in total, the amount to repay would come to $22,500.

Unlike an Interest Rate, a Factor Rate is charged when the initial payment of the money is made, and the rate is fixed. This means that there is no flexibility in terms of early repayments as there is for traditional business loans.

However, on the other side of the coin, the amount that you are required to repay daily on your Merchant Cash Advance is flexible based on how much revenue you have made on that day, so what MCAs lack in interest flexibility, they make up for in this way.

Is a Merchant Cash Advance Better Than a Loan?

Whether a traditional business loan or a Merchant Cash Advance will benefit your business more entirely depends on the nature and financial status of your business.

One reason why a Merchant Cash Advance might be a better choice for your business than a traditional loan would be if your business doesn’t have the best credit.

It can often be very difficult to secure a business loan with bad credit because lenders don’t want to loan money to businesses that are unlikely to be able to repay it.

Credit scores are typically a good indicator of how likely an individual or business is to repay borrowed money.

However, with a Merchant Cash Advance, your lender will be more concerned about the revenue that your business earns daily, monthly, and annually than with your credit score.

So, as long as your business generates enough revenue, you’ll probably be eligible for a Merchant Cash Advance regardless of your credit score.

Merchant Cash Advances also don’t demand collateral in the form of assets, so if you don’t have physical assets to use as collateral, a Merchant Cash Advance will be a more realistic option for you.

Unlike loans, Merchant Cash Advances take the amount of revenue your business makes daily into account when charging you for repayments.

If your business has fewer card transactions one day, you’ll be required to pay less on that day. This is another big advantage of Merchant Cash Advances over loans.

With that being said, Merchant Cash Advances come with significant financial risks. The Factor Rates for MCAs tend to be much higher than the Interest Rates for business loans, which means that you end up repaying more than you would on a loan.

You also can’t repay your Merchant Cash Advance early, as you would usually be able to do with a loan, which means that you also can’t get a deduction on your Factor Rate in exchange for early repayment.

It’s important to note that many business owners also end up having to take out another advance to compensate for the high repayment rates, which can lead to a cycle of debt.

Therefore, a Merchant Cash Advance is only truly beneficial if your business is financially stable.

Final Thoughts

Merchant Cash Advances can be very useful tools for businesses with bad credit that need fast funding.

These advances differ from traditional loans in the sense that they are based on a business’s annual revenue and are repaid through daily withdrawals from a business’s card terminal.

They also have fixed Factor Rates that are usually higher than the Interest Rates for business loans and are charged at the time of payment. This means that there is no early repayment flexibility.

Unlike traditional business loans, Merchant Cash Advances don’t usually require the provision of collateral in the form of assets and don’t typically rely on credit history for eligibility.

Although a Merchant Cash Advance is an easy and convenient way to borrow and repay funding for your business, it can be risky due to the high Factor Rates and fast repayment plans.

Therefore, taking out a Merchant Cash Advance is a decision that should be made after careful consideration of your business’s financial situation.