How Do Merchant Cash Advances Work for Small Business Financing?

female business owner researching merchant cash advances and small business funding options
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There are many different types of small business financing available to business owners in Canada. Each type of financing works differently, with unique qualification requirements and different rates and terms. To make matters more complicated, certain types of financing are better suited for specific purposes, which can make selecting the right funding option feel like an insurmountable challenge.

Traditional bank and government-backed loans like Canada Small Business Financing Program loans get the most attention, with many online resources extolling the virtues of these lenders and the funding types they offer. It’s true that these loans often come with lower rates and longer repayment terms, but they also have some major drawbacks as well, including long application timelines (sometimes months) and extensive paperwork requirements, all with no guarantee of approval.

Available through alternative online lenders, a form of lender that emerged out of the 2008 recession in response to a growing need for accessible working capital funding, merchant cash advances are a much newer form of financing compared to these stalwart lenders. Because of their youth, many myths and misconceptions about merchant cash advances exist, and many business owners still have questions about how they work and when it makes sense to use them.

To help clear up the confusion, this post will explain everything you need to know about a merchant cash advance, including:

  • What merchant cash advances actually are
  • How MCAs work
  • Merchant cash advance qualification requirements
  • Repaying a merchant cash advance
  • Merchant cash advance rates and fees
  • Pros and cons of MCAs
  • Who should apply for a merchant cash advance

Let’s jump in.

What are Merchant Cash Advances?

A merchant cash advance is technically not a small business loan. It’s actually a non-loan form of financing known as an “asset purchase”.

This means that a lender like Greenbox Capital® will purchase a portion of your business’s future revenue in exchange for a cash advance up front. You’ll receive an advance of working capital when you need it, and the lender will receive a portion of your daily credit and debit card sales until the advance has been repaid (along with any fees).

Merchant cash advances are controlled under different regulations than traditional loans and lenders. These regulations vary from state to state and are generally not as strict as those that govern traditional loans, which means that alternative lenders can offer better terms and more flexible funding that is tailored to the unique needs of the borrower.

GREENBOX TIP: Not all merchant cash advances are created equal, and not all lenders are reputable. Do your research and vet your lending partner carefully to make sure your MCA has the best terms for your business. Don’t apply for or accept an advance from a lender that engages in “loan stacking”—a term used to describe when an advance is granted to repay another advance.

How Do Merchant Cash Advances Work?

Merchant cash advances work differently than other types of funding. Here’s what you need to know about how MCAs work:

Lenders: Instead of accessing funding from a bank or other traditional lending institution, merchant cash advances are available from direct online lenders like Greenbox Capital.

Applying: Unlike traditional loans, MCA applications are much shorter and easier to navigate with less restrictive approval requirements, and no collateral is required. Typically, you’ll submit a short form online and a representative from the lender will contact you to continue your application. Depending on how quickly you are able to supply the requested documentation, your advance could be approved and deposited in as little as one business day. This makes merchant cash advances ideal for businesses that need working capital fast and don’t have time to navigate the complicated application process of a bank or the SBA.

Funding: Funding up to $500,000 is available. Unlike traditional loans, which base the amount of funding you’ll receive on your credit history and other historical factors, the amount of your merchant cash advance will be based on your projected future sales.

Repayment: When it comes to repaying your advance, payments will be automatically deducted from your business’s daily or weekly debit and credit card sales. Keep reading to learn more.

Uses: There are no restrictions on how merchant cash advance funding can be used, but MCAs are typically best used to support growth initiatives that will help increase your revenue, such as purchasing inventory or raw materials in bulk, boosting your marketing, investing in training and continuing education, or taking advantage of time-sensitive opportunities to grow.

Merchant Cash Advance Qualification Requirements

The qualification requirements for a merchant cash advance are much less restrictive than other forms of financing. Traditional bank and CSBFP loans are typically only given to wealthy business owners with property or other assets that can be used as collateral, excluding many deserving small business owners and preventing them from accessing the working capital they need to continue to grow.

Alternative small business lenders who provide financing based on the revenue of a business, like merchant cash advances, make working capital available to a greater number of businesses. This is because instead of focusing on your credit score and financial history, MCAs focus on the future potential of your business. Your credit score and bank statements will still be considered, but they’ll be considered alongside other factors like your daily sales and business reputation. Merchant cash advances also do not require collateral.

This makes merchant cash advances ideal for businesses that may not meet the strict requirements of government funding programs or other traditional lenders, such as newer businesses, businesses with lower credit scores, and those in high risk industries.

Repaying a Merchant Cash Advance

With a merchant cash advance, you don’t have to worry about making set monthly payments. Instead, payments will be automatically deducted from your business’s daily or weekly debit and credit card sales. Payment amounts will be based on your sales, so on days with lower sales your payment will be smaller, and on days with stronger sales your payments will be higher.

Merchant Cash Advance Rates and Fees

Because MCAs have shorter terms and are easier to qualify for than traditional loans, they may have higher rates than other types of funding. However, it’s a common misconception that MCAs always have much higher rates than other forms of financing. Ultimately, your fees will be based on your business’s risk assessment and how quickly you are able to repay the advance.

Instead of charging a traditional interest rate, merchant cash advances use something called a factor rate. Unlike interest rates, which can compound as you pay off your loan, a factor rate is a simple decimal figure that shows how much “extra” you will owe on the original amount of the loan. For example, if you borrow $1,000 at a factor rate of 1.3, you’ll owe $1,300. Your factor rate is determined based on your risk assessment, so the stronger your business’s financial history, the lower your rate should be.

Pros and Cons of Merchant Cash Advances

Fast turnaround: Funds can be approved and deposited in as little as 24 hours.Rates: MCAs may have higher rates than traditional collateralized bank loans.
Flexible approval requirements: Your credit score and financial history are considered alongside your business’s future potential. Terms: Term lengths are typically shorter than traditional collateralized bank loans.
Simple application: MCAs require less paperwork than other forms of business financing.Repayment frequency: Some business owners don’t like the daily or weekly repayment frequency.
No fixed monthly payments: Payments are automatically deducted based on your daily or weekly credit and debit card sales.Payment methods: A business must accept credit cards to qualify for a merchant cash advance.
Uses: There are no restrictions on how funds are used.Repayment timeline: If sales are low, it will take longer to repay your advance.
Collateral: No collateral is required.

Who Should Apply for a Merchant Cash Advance?

Merchant cash advances make the most sense for:

  • Businesses that need fast funding to support their growth or take advantage of a short-lived opportunities to grow
  • Businesses that process a lot of debit and credit card transactions
  • B2C businesses that need smaller amounts of funding
  • Businesses with lower credit scores
  • Business owners that do not have collateral, such as real estate and other major assets

Wrapping Up

Because of their relative youth compared to traditional loans offered by banks, credit unions, and the Canada Small Business Financing Program, many questions and misconceptions about merchant cash advances persist. When accessed through a reputable alternative online lender, merchant cash advances can provide a quick infusion of working capital that can help support your business’s growth.

Learn more about merchant cash advances
Jordan Fein
Author: Jordan Fein
Contributor and expert in finance and loans, business and economics