Merchant Cash Advance
What is a merchant cash advance (MCA)?
In a merchant cash advance—a company receives a lump sum payment in exchange for making fixed monthly payments in the future. Merchant cash advances are a form of receivables financing and revenue based financing. These two financing methods are the most founder-friendly way for startups to fuel their growth as there is no debt or dilution. Historically, MCAs have been thought of as a tool for traditional "main street" retailers rather than fast growing tech companies, but the structure can be very fitting for fast growing startups as well.
This type of financing is designed for businesses that have a need for immediate capital and don’t have time to go through the typical 2-3 month process of venture capital or venture debt. Funding from merchant cash advances is often used to manage cash-flow shortages, cover a variety of short-term expenses and accelerate a startup's growth to improve their business fundamentals.
Is a merchant cash advance a loan?
No, merchant cash advances aren’t technically loans. Instead, MCA providers purchase your future sales at a discount, and you pay it back over a specified period of time. MCAs aren't considered loans because of where they sit on the capital structure (below securitized debt).
How does a merchant cash advance work?
There are two forms of merchant cash advances including:
- Percentage of debit/credit card sales - in this scenario the MCA provider automatically deducts a daily (or weekly) percentage of your sales until the advance is repaid in full. One important note: your business performance affects your repayment. When your sales are higher, you pay more, and when your sales are lower, you pay the baseline amount.
- Fixed withdrawals from a bank account - in this scenario the MCA provider withdraws a fixed amount of funds directly from your business bank account regardless of your sales.
In either case, you receive the capital upfront and repay it over usually 3-18 months.
When are merchant cash advances typically used?
MCAs are often associated with retailers who sell physical products, but due to their flexible nature, merchant cash advances are a good option for any company who needs quick cash to cover some of the following uses cases:
- Temporary cash flow problems — if you’ve had an unexpected downturn in your cash flow and need help covering payroll, utility bills, or your rent
- Unique opportunity arises — if you’ve been eyeing a new office space or the purchase of a complementary business, and the opportunity arises, you can use the MCA to finance the purchase.
- Runway extension — if you are burning more money than you’d like and need a bit of cash to bolster your position before your next raise.
- Accelerate growth — if you are in a position to accelerate your growth but need a bit of capital to pay for a new marketing campaign.
- Strategic hiring — if you’ve found the perfect candidate, but don’t have the capital you need to hire them, an MCA might be a good option.
- Paying off other debts — if you have existing debt with high interest rates (such as maxed out credit cards), you can use the MCA to pay those off.
Are there restrictions on how the cash from a merchant cash advance is used?
No, typically there are no restrictions on how the money from a merchant cash advance is used.
What happens if you don't pay back a merchant cash advance?
Merchant cash advances are a binding financial contract between your business and the lender, failure to meet the payment terms could result in litigation.
How to qualify for a merchant cash advance?
Qualifying for a merchant cash advance is likely the easiest form of financing to qualify for. Unlike most business financing options, applicants don’t need to have years of credit history or collateral. Your banking and accounting history, along with solid sales numbers are typically all you’ll need to get approved (note: some institutions require credit checks, Arc does not.)
Can you provide an example of a merchant cash advance in action?
Example: JJR Inc. has annual recurring revenues of $1.5M dollars. They need $500K to carry them through to their next round of equity financing, which is expected to close in 4-5 months. They receive $500K today, and pay back $550K over the following 12 months (with a monthly payment of $45,833.33). Their total cost of capital is $50K.
What are the benefits of raising capital via a merchant cash advance?
- Fast funding—typically you can apply online, get approved for funding and get funded quickly, often under 24 hours.
- Flexible requirements—the requirements for MCAs are relatively minimal compared to other forms of financing. Typically a business just needs to meet a specified revenue and runway threshold.
- You maintain control—with MCAs there is no exchange of equity. There are no personal guarantees, covenants or warrants. There also typically isn’t recourse in the event of a default (e.g. bankruptcy).
- Transparent pricing & fixed repayments—With MCAs you know what the total cost of your capital is upfront and there are no hidden fees. Additionally, you can typically choose what payback window meets your needs: 3, 6, 12, or 18mo.
What are the drawbacks of raising capital via a merchant cash advance?
- Ongoing repayments—With MCAs you must make monthly payments regardless of how the business is performing.
- No early repayment benefits—With MCAs the discount is taken upon the execution and the repayment is fixed, so there is no benefit for repaying early.
- Can sometimes be costlier— Compared with other types of business loans, like business lines of credit or venture debt, MCAs may come with a higher take rate.
- Repayments tied to revenue (sometimes) - With some forms of MCA, the repayment amount is tied to revenue. In these scenarios, the more revenue you generate, the more money that you owe during that period.
What are the typical terms of a merchant cash advance?
Unlike traditional business loans, most merchant cash advance providers don’t require good business credit or collateral, as it’s based on your cash flow. As such, the terms of most merchant cash advances are fairly straightforward, the application process is quick and easy, and you likely will get funding within a day or two. Most merchant cash advances will come with the following terms, but be sure to review the agreement that you MCA provider presents you:
- Principal — this is the amount you must pay back, it can range from a few thousand dollars all the way up to hundreds of millions of dollars.
- Discount rate — this is the amount the MCA provider “charges”. If you receive $950K and you owe $1M back, the discount rate is 5%.
- Payment period — this can range from three months to two years.
- Payment frequency — this is usually done weekly or monthly.
What are the alternatives to merchant cash advances?
- Online small business loan - online lenders provide both short- and long-term business loans that can meet the needs of a business. These types of loans usually require collateral. Also, the shorter the term, the lower the rate.
- Business cash advance - rather than being based on your revenues, business cash advances are based on your cash flow. It typically has a fixed payment term, a lower interest rate than a merchant cash advance.
- Receivables factoring - the sale of individual invoices at a discount to investors to access cash now rather than waiting for your customers to pay their invoices. You pay back the funding amount over a fixed period of time, like MCAs.
- Receivables financing - investors provide capital based on the value of your receivables, but do not take ownership of them. You pay them back over a fixed period of time, like MCAs.
Our thoughts on merchant cash advances
Merchant cash advances can be a great fit if you need a fair amount of cash in a short period of time to fuel activities such as: a business acquisition, runway extension, or strategic hiring. As mentioned above, with merchant cash advances you can typically apply and receive funding within 24-48hrs. As with most financial products though, you should fully understand the requirements and commitments before you commit to taking the financing.
To learn more and to apply for an Arc Advance (structured similarly to a merchant cash advance), click here.