Pros and Cons of Merchant Cash Advance Loans

What is a cash advance loan?

A cash advance allows you to borrow an immediate amount against your future income – the lender is “advancing” you the cash before you are paid. Technically, you are selling your future revenue in exchange for money today, so a cash advance is different from a typical loan. 

Personal cash advance loans are borrowed against your next payday, when the lender debits your checking account for the amount you borrowed – with additional fees. Lenders sometimes have borrowers write a check for the loan plus fees, then cash the check after the borrower receives the money. 

The fees for these loans are often very high and can leave you saddled with significant debt. Cash advance loans are sometimes considered predatory. However, they can provide vital cash flow if you don’t own a credit card. 

There is a specific type of cash advance available – called a merchant cash advance loan – if your company needs immediate funding.

What is a merchant cash advance?

Merchant cash advance loans are a source of short-term funding if you cannot obtain financing from a bank or other source. These advances are borrowed against future credit card sales, and most are repaid – plus the associated fees – within six to 12 months.

To obtain a merchant cash advance, your business must have daily credit card transactions from your patrons and proof of at least four months of credit sales. Many merchant cash advance companies require that your monthly credit card sales be between $2,500 and $5,000 – depending on the amount of the advance. This allows the lender to confirm that you can repay the advance.

How does a merchant cash advance work?

Merchant cash advance companies will most likely work with your business if you rely primarily on debit and credit card sales. This includes retail, service shops and the restaurant industries. However, these are two structures that would allow your company to get an advance if you don’t have high debit or credit sales: 

1. Traditional merchant cash advance: Your businesses would gain an upfront sum with a traditional merchant cash advance. To repay the loan, a set percentage of daily or weekly sales is debited back to the cash advance firm until the advance – plus fees – is repaid. This is also known as a “holdback.” The higher your company’s sales are, the faster the advance is repaid. However, do not encourage your customers to pay in cash to avoid a percentage of their sales going to repayment, as this is a breach of contract and could result in litigation.
2. ACH merchant cash advance: With an ACH merchant cash advance, you would receive a sum upfront and then repay the advance through your company’s checking account. A fixed daily or weekly sum is transferred from your business checking account through an Automated Clearing House (ACH) withdrawal until the advance – plus fees – is repaid. Unlike a traditional merchant cash advance, the debited amount remains the same regardless of your company’s sales. These advances can be paid off more quickly than an advance that is debited against sales, unless your business runs out of available cash, in which case you may be unable to make your daily or weekly payment. 

How much you will pay in fees depends on how much risk the merchant cash advance firm is taking. Generally, the factor rate will be 1.2 percent to 1.5 percent. If you take out a $40,000 advance with a 1.5 percent factor rate, your total payment will be $60,000 (your $40,000 advance with $20,000 in fees).

A merchant cash advance is considerably more costly than traditional financing. It can also create a debt cycle that would force you to take out a second advance to pay back the first – resulting in additional fees.

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Merchant cash advance pros and cons

Taking out a merchant cash advance has these advantages and risks compared to other small business loans:

Alternatives to a merchant cash advance

If you need extra cash but are wary of a merchant cash advance, consider other financing solutions that provide working capital for your small business. There are a variety of small business loan types to choose from. Lines of credit, term loans and payment processor financing are just some of the options.

Business line of credit

A line of credit (LOC) is similar to a credit card. You can apply for and be approved for a set amount, which you can borrow against for the term of the LOC. You can never owe more than the upper limit of your line of credit, but you can repay the amount you owe and borrow again as many times as you need. You can open a line of credit for your company for any amount, often ranging from $2,000 to $500,000. Funding is generally approved in less than a week, and repayment terms are three to 12 months.

Fundbox is one lender that provides business lines of credit. Fundbox’s fast, transparent application; pricing; and approval processes can offer up to $150,000 over three to six months. Fundbox is known for its direct communication regarding how much you’ll pay per week for its services and will automatically withdraw these fees from your bank account. Learn more in our full review of Fundbox.

Short-term loan

A short-term loan is an unsecured business loan offered by a private lender rather than a bank. These loans have lower interest rates and more transparency than a merchant cash advance, though lenders will review your credit history. Short-term loans generally offer up to $500,000 in one-time financing, are approved in less than a week and have repayment terms of three months to three years.

Fora Financial is a top lender for short-term small business loans. With Fora, your repayment period will be at most 15 months, and you can obtain a loan of up to $500,000. You can set your payment schedule to fit whatever terms work for you, and you won’t have to put up any collateral. Plus, the approval process takes just 24 hours, with funding of the loan as quick as 72 hours. You can learn more in our comprehensive review of Fora Financial.

Payment processor financing 

If you use a credit card processing company like Square or PayPal, you may be eligible for financing these companies offer. You can apply for the loans, which are generally under $100,000, through your online account. They usually come with a factor rate of 1.1 percent to 1.16 percent – lower than a merchant cash advance.

Katharine Paljug contributed to this article.