Overview of Merchant Cash Advances

A Merchant Cash Advance (“MCA”) is a type of financing instrument that provides businesses with quick access to capital, without the need to take a short-term business loan or obtain a small business line of credit, through the purchasing and selling of future receipts of the business. An MCA is different from a traditional loan in that an MCA involves a financing source purchasing a portion of a business’s future revenue at a discount or with an additional fee charged to the seller, rather than lending money to the business with interest. The magnitude of the additional fee may depend on the expected repayment schedule, the business’s financial position, the industry that the business operates in and other factors.

MCA financing is ideal for businesses, especially small businesses, because MCA financing can provide quick access to capital with minimal paperwork and can provide financing for businesses that otherwise may not qualify for a traditional bank loan or line of credit. With MCA financing, a business can use the capital it receives to purchase inventory or invest in marketing and other growth opportunities. Additionally, MCA financing is often more flexible than traditional loans for a business because the business can limit its periodical repayment obligation as a fixed percentage of, or with a fixed repayment schedule based on, the business’s revenue. MCA financing is unsecured, so businesses do not have to put their assets at risk in order to obtain the financing they need. MCA financing can also be ideal for financing providers because MCA financing, if structured correctly, can bypass usury laws limitations and other legal restrictions related to traditional loans, allowing financing providers to potentially receive higher returns than traditional loans would.

An MCA can either be structured as a transaction providing only a single advance or providing recurring advances. An MCA featuring a single advance is a one-time purchase of the future receipts of the business, while an MCA featuring recurring advances allows the business to request advances multiple times over the lifetime of the MCA agreement between the business and the financing provider.

Repayment of MCA

Two common MCA repayment methods are: repayment (i) as a percentage of the business’s revenue (commonly called a “factor”) until the MCA is repaid or (ii) as a fixed amount of payment on a recurring basis, subject to an amount cap, which can be based on the revenue or gross profit.

The first option of repaying a percentage of the revenue until the MCA is repaid allows the business to make repayments based on the business’s current sales and cash flow. This means that when the business’s revenue is slow, the repayment amounts will be low and the time it takes to repay the MCA will increase, and when revenue is high, the repayment amounts will also increase and the time it will take to repay the MCA will decrease. This option provides a flexible repayment schedule that better matches the revenue generation of the business. This method can be beneficial for a business that has variable income streams or seasonal fluctuations in its sales. By basing the repayment on actual cash flow, a business can reduce the risk of default by repaying smaller amounts when its cash flow is low and larger amounts when its cash flow is high.

On the other hand, the second option of repaying fixed payments with a cap allows the business, on each repayment date, to pay the lesser of (i) a predetermined fixed payment or (ii) the maximum amount of the revenue. This option provides the business with more certainty about its repayment schedule and helps the business to budget better for its business expenses, meanwhile, protecting the business from unexpected drop in revenue or gross profit by limiting the payment to the amount of revenue or gross profit for that payment period.

Key Items to Consider

Before receiving an MCA, it is important for a prospective MCA recipient to consider the following key items:

First, the business should determine whether the MCA will be cost efficient for the business, as MCA financing can be one of the most expensive forms of financing. Specifically, it is important to review whether the potential benefit of the MCA and the growth spurred by the MCA outweighs the cost of the MCA. Given MCA financing is not federally regulated and such financing is made to companies that may qualify for other loans, the factor on the repayment amount is often much higher than interest would be on a bank loan.

Second, the business should carefully evaluate the risks associated with the MCA and consider whether such risk can be tolerated. While MCA repayment terms are usually more flexible than that of traditional loans, MCA repayment terms may nonetheless place operational burdens on businesses. A business should consider the impact of potential recessions, material business changes or other scenarios on the business’s ability to repay the MCA.
Third, the repayment frequency required under most MCA financings in addition to the high cost can negatively impact the cash flow of a business and make it challenging for the business to pay off its debt without requiring even additional debt to stay afloat.

Lastly, the business should consider the administrative requirements that come with the MCA. Administrative burdens associated the MCA may include having sufficient operational bandwidth to monitor and track the business’s revenue stream and timely manage the accurate repayment of the MCA. Additionally, each MCA documentation should be thoroughly reviewed and understood, as different financing provider may offer different MCA terms and conditions.

The considerations above should be taken into account when deciding whether or not to receive an MCA. By understanding these factors, business owners can make informed decisions on whether an MCA is right for their particular businesses.