Everything You Need To Know About Merchant Cash Advances
March 5, 2023
Being the owner of an eCommerce business isn’t easy. You need to market and sell your product while managing an entire supply chain that is fast, functional, and doesn’t face stockouts. Funding all of this can be a major challenge. Many online retailers turn to an MCA (Merchant Cash Advance) to fund their operations. This type of eCommerce financing provides more direct and streamlined access to cash, particularly compared to traditional bank loans.
ECommerce sellers looking to step up their operations and improve cash flow can seriously benefit from getting an MCA. In this article, we will discuss what this entails and whether it can be a good fit for your company.
Table of Contents:
- What is a Merchant Cash Advance?
- MCA Terms You Need to Know
- How Does a Merchant Cash Advance Work?
- Traditional Merchant Cash Advance
- Automated Clearing House MCA
- The Benefits of Getting an MCA
- Possible Downsides of MCAs
- What You Need to Obtain an MCA
- Is a Merchant Cash Advance Right for You?
- Growth Capital
An MCA is different from a traditional loan in that it is seen as a commercial transaction. In essence, a business buys its own future revenue, which it then pays back through a percentage of future sales. In order to qualify, you provide your revenue history to demonstrate your ability to raise the necessary funds. It is different from going to a bank for funding since MCAs usually require a lot less paperwork, don’t involve a credit score, and can be completed in less time.
Businesses seek out this option because having a lump sum of cash now can be worth larger profits in the long term. Many online sellers need significant funds to order batches of inventory months in advance to avoid running out of stock. Other companies simply want to invest in additional revenue streams, like a new product or an expanded marketing campaign. An MCA opens many doors while avoiding drawbacks like fixed monthly payments, compounding interest, and rigid terms that come with a traditional bank loan.
Here are a few terms that are important when talking about MCAs:
Factor rate – The factor rate is used in place of interest to calculate how much you have to remit after receiving an MCA. This number is a multiple, usually 1.1-1.3 times the initial amount, but can be as high as 2.5. It provides the full cost of the deal and gives you a clear idea of when your remittance duties are fulfilled. Interest is generally compounded monthly, meaning the sum you owe goes up. With factor rates, your balance only decreases when you make payments without any additional costs or fees.
Capital – Capital is the amount of money lended to finance a specific purpose. Capital can also be considered the principal amount of the loan.
Credit card processor – The credit card processor acts as a middle man between the customer and the business. They receive and process payments from the retailer’s customers.
Lockbox – This is a third party account that is used to receive the payments that businesses earn when selling their goods. This income is then split between the MCA provider and the business. Normally, around 5-18% of each day’s income is transferred to the MCA provider this way. A lockbox is handled by them in order to ensure that their remittance payments come in regularly.
Stacking – Stacking involves taking out multiple cash advances on top of each other. If you are making repayments reliably, some MCA lenders will front additional capital after you have paid part of your initial sum. You can take out as many MCAs as the lender is willing to give you.
UCC – The Uniform Commercial Code is the complete set of laws that govern commercial transactions to protect all parties involved in MCAs.
A business starts this process by reaching out to an MCA provider with a report of its sales history, in order to get approved for financing. Once both sides agree on the cost of capital, or the extra amount the lender will have to pay back, the business receives the capital up-front in a lump sum. The factor rate is applied on top of this amount to give both the business and the financing provider the final sum this transaction will amount to. All transactions are handled and processed by the credit card processor, which will have been approved by both parties in advance.
Next, the business starts paying remittances. This can start as early as the next day, although some MCA providers offer a grace period. From this point on, all revenue from debit or credit card transactions is evaluated by the credit card processor. A percentage of this income goes to the financing provider every day until the entire sum, including the cost of capital, has been paid back.
Companies receive their payment in one of two ways: a traditional MCA or automated clearing house (ACH) withdrawals. Both have their benefits and downfalls, but it is vital to review your MCA agreement so you know what to expect.
With a traditional merchant cash advance, your revenue is held in a lockbox by the credit card processor. They review your revenue at the end of the day and split the amount according to your MCA agreement. The funding provider is given their payment directly and the remainder is deposited into your business account. Many business owners choose this option because it is fast, easy, and handled without their input. Nothing is ever withdrawn from your account and you don’t have to deal with processing transactions.
Another benefit is that the MCA provider does not get access to your business account and has no need to make deductions. You don’t risk an MCA payment causing an overdraft since they receive their share at the same time yours is deposited. This means you can review your cash flow based on the revenue you receive, which is clear and consistent.
Some MCA providers are open to businesses being in charge of transferring payments from their accounts. In this case, the entirety of your revenue is deposited into your account. The funding provider will have to review your sales and deduct their percentage as an automated clearing house withdrawal. Both parties can come to an agreement to deduct a fixed sum weekly or monthly with an ACH withdrawal.
Some businesses prefer this option as it gives them more oversight and control over their cash flow. It makes accounting processes easier, as you see every detail of revenue and expenses. Additionally, it can allow you to ensure that deductions are accurate, whereas with traditional MCAs you don’t oversee the division of funds. Payment records have to be requested in a traditional merchant advance but ACH deals provide full access to all information directly.
Fast funding. Unlike with traditional loans, you don’t need to wait for an extended period of time to get funded. Applications can take minutes to fill out. Once approved, you receive your capital advance within 24 hours with most MCA providers.
Receive a lump sum upfront. Receiving a sum in the short-term that might have taken you up to a year to earn enables you to fund projects and goals right away. This kind of investment can result in major gains in the long-term. For example, getting a better deal by ordering inventory in bulk.
No interest or unexpected fees. Since your factor rate is set from day one, you don’t have to worry about unexpected costs. There is no interest that compounds, which means you have a clear idea of where you stand financially without having to get into deep calculations.
No credit check required. Unlike with traditional loans, where your credit score controls everything from interest rates to whether you will even qualify, you don’t need a credit check for an MCA. The financing you get is based on your sales history and projected revenue, meaning your credit is much less important than your ability to pay the advance back.
Great flexibility. With traditional loans you are likely to be locked into fixed monthly payments for the term period, while more interest accrues each month. Getting an MCA means you never pay more than you make, since your remittances are based on your sales. If your revenue slows during a given month, so will your payments to the MCA provider since they are tied to your income.
No restrictions. While other types of loans require you to use the advance for a specific purpose, MCAs leave that decision up to you. Whatever vision or project you may have in mind, it is entirely up to you if you want to invest in it.
No collateral needed. Another benefit an MCA has over traditional loans is that you don’t need to offer anything as collateral. Since MCAs are commercial transactions, personal assets are not eligible as collateral either.
Potential for high cost. Since MCA providers aren’t allowed to charge any form of interest and depend on a company’s income for remittance payments, they can set high factor rates instead. This means a business can be tied down for a long period of reduced income due to remittance payments. Whereas the cost of a traditional bank loan will hover at around 10%, MCAs often reach factor rates of 1.3 or 1.5, meaning costs of 30% or 50% of the initial advance.
No early payoff incentive. With traditional loans you can save several thousand dollars in interest if you transfer loan payments early. Every such payment leaves a lower balance that will accumulate interest. With MCAs, paying remittances sooner does not reduce costs or fees.
Not federally regulated. There are zero federal regulations when it comes to MCAs. These commercial transactions do fall under the Uniform Commercial Code and are subject to each state’s usury laws in the US. However, many MCAs are offered online and you have to look up where the lender is based to understand what laws will apply to your deal.
Conditions generally vary based on the lender, but some are constant. For one, you have to prove that you have income in order to even apply for an MCA. Your revenue history has to be extensive enough to back up your promise to make repayments. In most cases, you should already have been selling for six months to two years. You will also have to provide statements that show a minimum of $10-15k in monthly earnings during the required time period. That means that an MCA might not be the right solution for startup business looking for funding.
The conditions of your cash advance will be based on previous sales and a detailed forecast of the market and customer habits. Just like revenue history proves your business plan is working now, your forecasts show the MCA provider what kind of sums you are likely to raise going forward.
There are a lot of eCommerce funding solutions out there, and MCAs are not for every business. You have to meet specific requirements, such as proving revenue history, and then deal with having a share of your income siphoned away until your remittance is fully paid. For the businesses that meet these requirements, a cash advance is a great funding option. More than anything, it offers simplicity. Rather than having to calculate how your interest is accruing or keeping an eye on hidden fees, you get a factor rate and stick to that from beginning to end.
Other financing options, such as traditional bank loans, come with fixed terms and monthly payments. MCAs guarantee you will never make a payment that amounts to more than your revenue. Some funding options, such as inventory financing, limit you to only procuring inventory, whereas MCAs allow you to use the money any way you see fit. It can be the fuel for you to launch your next project, scale your business, improve your marketing, or acquire new inventory.
If you want to get funded in a way that doesn’t impede your cash flow, you might want to check out an 8fig Growth Plan. This means receiving cash injections that you can invest in the projects and products that grow your business. And the best part about it is that our remittance schedule is highly adaptable, so you maintain maximum cash flow at all times. You also get access to 8fig’s platform that makes overseeing and planning your supply chain straightforward. It integrates with your store and helps you monitor its performance. Sign up with 8fig and fund sustained growth for your business.
Julian writes about the ins and outs of eCommerce at 8fig. He is passionate about exploring and covering the dynamic and fast-paced world of online retail.