A Business Owner's Guide to Merchant Cash Advance

Introduction

Availability of working capital is essential for the sustenance and growth of any business. However, those who operate at a smaller scale or are relatively new in the market, trying to expand the customer base, find it difficult to make huge profits and often need funding to keep the business afloat. One can opt for a business loan but the lenders usually check applicant’s credit score or demand collateral. So, what should the business owners, who lack both but urgently need funds, do? Well, there is always a way out. If you have a positive cash flow, then you can consider taking a Merchant Cash Advance. Let us learn more about this form of funding.     

A Look at Merchant Cash Advance (MCA)

This is a relatively new method of funding for business owners. An MCA is not exactly a loan; it is an advance payment against your business’s future income. It is an upfront capital given in return for a percentage of the business's daily credit and debit card sales volume. For example, you sell INR 50,000 of a portion of your future credit card sales in lieu of an immediate INR 40,000 lump sum payment from a lender. Now, the lender will collect the portion from every credit card/ debit card sale until the entire INR 50,000 is collected.

How does it work?

Firstly, the MCA provider checks the daily credit and debit card receipts to verify if the business has positive cash flow and is in a position to pay back the funds on time. If the applicant is eligible, then the MCA provider and the former formulate an agreement specifying the advance amount, payback amount, and other terms of the advance. After that, the sum is disbursed to the business’ bank account in exchange for a future percentage of credit card receipts that is deducted on daily basis. The more credit card transactions a business can do, more is the probability of repaying the advance sooner. And, on a slow sales day, the draw from the merchant account would be less as the payback is relative to the incoming cash flow.

Terms in MCA

• ACH:  

As we know MCA is mostly needed by small business setups that mostly get their payment via credit or debit card as a percentage of sale volume goes in repayment. This percentage is paid from the owners’ business bank account through ACH (Automated Clearing House) withdrawals. It is a centralised clearing service that provides interbank money transactions that are repetitive in nature.

• Factor Rate:

An MCA does not have a fixed monthly payment as it is based on a factor rate and not interest rate. Generally, factor rates range from 1.1 to 1.5. For example, if you borrowed one lakh rupees with a factor rate of 1.3, your total payback amount would be INR 1,30,000.

• Retrieval Rate:

It is the percentage of daily receipts that is used to repay the advance. Average retrieval rates are between 5% and 15% but can be higher. Just to clarify, the retrieval rate is what you pay daily while the factor rate is set on the entire advance.

Features of Merchant Cash Advance

    Pros

• High-Borrowing Limits: Mostly, an advance can range from 50% to 250% of your business credit card transactions, which can be a sizeable amount.
• Flexible Repayment: Repayments depend on your businesses’ daily credit/debit card receipts making it manageable until the advance is paid back in full.
• Lesser weightage of Credit History: The eligibility criteria for MCA does not involve a good credit score. Lenders are more concerned about operational history, minimum monthly transactions, positive cash flow, and experience of the business owner.
• Quick Application Process: Unlike traditional business loans, MCA requires less paperwork and has easier eligibility criteria. The funds are disbursed sooner, sometimes within a day.
• Negotiable Terms: While the repayments are done automatically, you do not feel the stress of keeping a tab on the remittance date or writing cheques. MCA is done in a completely transparent manner and offers businesses to take a top-up between the repayment processes in case more capital funding is required.
• Collateral-Free: You don’t have to propose any collateral like a real estate property or other assets to receive MCA.
• No Charges for Pre-Closure: When it comes to MCA, there are no penalties for early closure of the loan.

Cons 

• No Impact on Credit Score: This type of funding will not help you build your business credit score even if you repay the advance on time as merchant cash advance providers do not report to credit bureaus.
• High Interest Rate: Though calculated on factor basis, the interest charged for an MCA is much higher than other traditional loans. It may vary from lender to lender and the applicant must understand the terms and conditions well before signing the agreement.

Conclusion

The lending scenario has gone through a sea change. Today, a business owner has more options than a decade back and especially with the Government's push towards digitalization of finance; funding options like MCA have found many new takers. If your financial need is quite pressing and you don’t have any collateral other than the cash flow of your business, opting for an MCA could prove to be a wise decision. You can use the fund to make the best of a growth opportunity and take your business to new heights.