Business LoansHow Does a Merchant Cash Advance Work?

Merchant Capital: What It Is and Where to Find it

When you need cash fast, it may be tempting to take a chance on a risky financing option. Merchant capital often represents a simple way to get money for your business, but you could become overwhelmed when it comes time to repay your debt, and that time could come sooner than you think.

In this guide:

What is merchant capital?

Merchant capital is funding you could use to cover your business’ working capital needs, and often comes in the form of a merchant cash advance. You could obtain a merchant cash advance (MCA) from merchant cash advance companies that offer a lump sum of money in exchange for a percentage of your business’ future receivables.

A merchant cash advance company would take a portion of your daily sales as repayment, either making a withdrawal from your business bank account or receiving a percentage of each credit card transaction. These repayments would be made daily or weekly until you’ve paid back the advance. Because the payments are based on your sales, the higher your sales volume, the faster you’ll pay back the full amount.

Merchant cash advance companies do not require business owners to unconditionally repay advances, as repayment is based on the business’ ability to make sales. Merchant cash advances are not considered loans because the repayment process is conditional — business owners are only required to continue running the business to the best of their ability. If the business fails despite your best efforts, you are not required to repay the advance and the merchant cash advance company suffers the loss.

Merchant cash advances do not have a fixed payment schedule, but they do have interest rates. These rates can be high because merchant cash advances are a high-risk product for providers, which makes the cash advance expensive. Interest rates are typically displayed as factor rates, which are written as decimal figures. To find out how much the cash advance costs, you would multiply the amount of the advance by the factor rate. For example, a $10,000 advance with a factor rate of 1.25 would cost $2,500 and you would ultimately pay a total of $12,500.

Where can I get a merchant cash advance?

Merchant cash advance providers operate online, so you wouldn’t be able to walk into a brick and mortar location to obtain a cash advance. The application and approval processes are completed online as well.

Independent sales organizations, or ISOs, act as brokers for merchant cash advance companies and may sell you a cash advance. They often work with a number of companies and usually rely on commission, which could lead them to use pushy sales tactics.

Is merchant capital bad for my business?

Merchant capital advances help you get cash quickly, but the cost could be difficult to handle. Here are a few pros and cons of merchant capital.

Pros Cons
Simple application and fast approval – Minimal requirements speed up the underwriting process. High cost – Cash advances tend to cost more than other financing options.
No repayment obligation – If the business fails for reasons beyond your control, you don’t have to pay back the advance. Possible limitations – You may not be allowed to change aspects of your business while paying off the advance.
Automatic payments – You don’t have to take time to manually make payments, reducing the likelihood of late fees. No regulations – Cash advances are not subject to legal regulations, including interest rate caps.


Differences between merchant capital and traditional business loans

A merchant cash advance and a traditional small business loan both provide business funding, but the features of the two products differ.

Unlike loans, merchant cash advances do not require a business owner to provide a personal guarantee or collateral when applying. Merchant cash advances also do not require any liens and do not have a fixed payment schedule, which are both characteristics of business loans. Generally, there aren’t any restrictions on how a business owner could use their merchant cash advance, while a business loan may come with certain use guidelines or limitations.

Loans typically come with a promissory note of repayment, obligating the borrower to repay the loan in full. Merchant cash advances don’t carry a repayment obligation since the cash advance company assumes the risk. A merchant cash advance provider could require you to include a personal guarantee, which would assure the company that you wouldn’t take any action to prevent the business from making sales, such as filing for bankruptcy. A personal guarantee would make the merchant cash advance appear more like a loan to give borrowers an extra incentive to make payments.

Another difference between the two products is price. Factor rates tend to represent a much higher cost than loan interest rates because merchant cash advance companies take on more risk than traditional lenders. High factor rates make MCAs a more costly financing option.

What’s in the merchant cash advance agreement?

When you sign a contract with a merchant cash advance provider, you agree to continue running your business as best as you can, so the company can continue collecting a portion of your daily sales. This is your primary obligation when taking on a merchant cash advance.

Some MCA contracts have a confession of judgment attached to your the contract, which would give the cash advance provider the right to file a judgment against you if you violate any terms of the contract, such as not paying back the advance. The cash advance provider wouldn’t have to take you to court to prove you violated the agreement because a COJ means you’ve already admitted guilt. COJs are permitted in just a few states, including Texas, Maryland, Virginia, Illinois, Ohio, Pennsylvania, New Jersey, Michigan and Minnesota.

Your cash advance agreement also includes the percentage of your daily sales that the cash advance provider will collect as repayment. The agreement will clarify how the company plans to collect repayment, generally either through the credit card processing system or with daily withdrawals from your business checking account.

Be sure to check the contract for the date when payments begin. A cash advance provider could begin taking payments as quickly as the next business day after you’ve received the funds.

How to refinance a merchant capital advance

If you find you aren’t happy with the terms of your MCA, refinancing may be your best option. You could replace your cash advance with a more sustainable form of financing to avoid spending too much money on payments.

Refinancing your merchant cash advance means you would increase the terms of the advance or reduce the factor rate, either giving you more time to pay back the advance or decreasing the overall cost. It’s also possible to consolidate your cash advance, which would require combining two or more advances into a single advance or a separate business loan.

You may be able to qualify for a business loan from an alternative non-bank lender to refinance your cash advance. A lender would look at the profitability of the business and may require you to agree not to take on any future merchant cash advances.

It’s also possible to refinance your cash advance with another advance. However, a cash advance company could charge interest twice on the same amount of money, a practice is known as “double-dipping.” Some business owners take out multiple cash advances at a time to pay off other advances, which could lead to a mountain of debt.

State restrictions

Most states in the U.S. have usury laws that regulate loan transactions. The laws typically cap the rate at which lenders can provide funds to borrowers. Merchant cash advances, however, are not loans, so usury laws don’t apply. Some lenders may offer cash advances specifically to get around these laws.

Merchant cash advances are exempt from usury laws because repayment is conditional. Unlike a loan, which you usually have to pay back no matter what, cash advance payments are based on your business’ capacity to generate sales. If the business fails, you’re no longer required to repay the advance.

Is merchant capital right for me?

Your options are going to be fairly limited if you find yourself in a situation where you need funds fast. The application process for a bank loan takes a few days to weeks, and you may not even qualify if your credit is in rough shape.

Instead, you could be approved for an MCA in a matter of hours and see the funds in a day or two. The minimal credit requirement for a cash advance gives you a better chance of qualifying if you have poor financial history.

Businesses that process a large number of credit card transactions would be best suited for a merchant cash advance, especially if the cash advance provider plans to take a percentage of each transaction. Frequent repayments could threaten cash flow, so make sure your business has enough cash coming in to cover daily remittance.

Small and mid-size businesses often use merchant cash advances to purchase equipment, inventory or seasonal merchandise, as well as business remodels or expansions. A cash advance could also be used to pay taxes or as emergency funding. Due to high interest rates and fast repayment, business owners sometimes end up “stacking” cash advances – taking out another advance to pay for the current one. Be sure to avoid this pattern, as it could lead to a downward spiral further into debt.

Bottom line

Merchant capital may seem like a simple, quick solution to your money problems, but it may be a risky product to take on. Cash advances are typically more expensive than the standard business loan and fast repayment could impact your cash flow.

When shopping for a merchant cash advance, watch out for deceptive marketing. These products are unregulated and issuers may participate in unsavory practices. Merchant cash advance providers may not be transparent about fees and rates. Look for penalties and fees that are not disclosed upfront, as those could make your cash advance more expensive.

Despite these dangers, some business owners may be able to handle a merchant cash advance with no problem, and they may find the repayment process to work in their favor. Payments are based on your sales and you would pay less when business slows down. But if your sales volume is high, you could pay off the advance in a short period of time and quickly become debt-free.


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