Merchant cash advances (MCAs) have become an essential alternative for small business financing, especially after the 2008 financial crisis, providing a much-needed lifeline for businesses that traditional lenders, like banks and credit unions, may overlook. With a streamlined application process, quick disbursement, and more lenient approval criteria, MCAs have opened up access to working capital for many business owners who might otherwise struggle to secure funding.
Despite their widespread use and practicality, misconceptions about merchant cash advances still linger. These misunderstandings often stem from a lack of clarity about how MCAs operate. Combined with the misleading practices of some unethical lenders and aggressive brokers, it’s easy to see why MCAs sometimes carry a negative reputation.
In truth, MCAs are a legal financing option that can be incredibly useful for small businesses needing quick access to capital, particularly those with significant credit card transactions.
To eliminate some of the confusion, we’re addressing some common myths about merchant cash advances, such as the beliefs that they carry exorbitant fees, and are inherently predatory. Let’s take a closer look.
Myth 1: Merchant Cash Advances Are Loans
Merchant cash advances provide funding for small businesses, but they are not technically loans. Instead, MCAs are structured as a “purchase of future receivables.” This means that the MCA provider buys a portion of your future credit and debit card sales.
Additionally, MCAs differ from loans in that the amount you receive is based on your projected future sales rather than your credit history and other factors. Unlike traditional loans, no collateral is required for an MCA.
Myth 2: MCAs Have Higher Fees Than Other Funding Options
One of the most widespread myths about MCAs is that they are significantly more expensive than other types of small business financing.
Instead of charging a traditional interest rate, MCAs use a “factor rate,” a simple decimal that determines how much more you’ll owe on top of the original amount advanced. For example, borrowing $1,000 at a factor rate of 1.3 means you’ll repay $1,300. The factor rate is influenced by your business’s risk assessment, so a stronger financial history can lead to a more favorable rate.
While it’s true that MCAs can carry higher costs due to their flexible approval criteria, quick access to funds, and shorter terms, this doesn’t mean they’re always more expensive than other funding options. The total cost of your MCA depends on your business’s risk profile and how quickly you repay the advance.
Myth 3: Merchant Cash Advances Are Predatory
Some unethical lenders may engage in predatory practices like offering multiple MCAs to a single business, leading to a cycle of debt known as “stacking.” However, reputable MCA providers have no interest in lending to businesses that cannot repay their advances because their success is tied to the success of the businesses they fund.
Myth 4: MCA Repayments Are Fixed
Unlike traditional loans with fixed monthly payments, MCA repayments are not fixed in advance. Instead, repayments are based on a percentage of your daily or weekly credit card sales. This means your payments fluctuate depending on your sales volume—lower sales result in smaller payments, while higher sales lead to quicker repayment of the advance.
Some business owners prefer the predictability of fixed monthly payments with traditional loans, but others find the flexible, automatic repayments of an MCA more manageable for their cash flow.
Myth 5: MCAs Are Only for Businesses with Poor Credit
It’s true that MCAs have more lenient approval criteria, making them accessible to businesses with lower credit scores. However, businesses with strong credit and solid financial histories can also benefit from MCA funding.
Even businesses with excellent credit may be turned down by traditional lenders like the SBA. For these businesses, the speed and flexibility of MCA funding can be appealing, making it a viable option regardless of credit score.
Myth 6: MCAs Are Only for Struggling Businesses
It’s a misconception that MCAs are only used by businesses on the brink of failure. In reality, MCA providers typically have minimum monthly sales requirements to ensure businesses can repay the advance. Lending to failing businesses isn’t advantageous, as the likelihood of repayment is lower.
While MCAs can help manage cash flow or unexpected expenses, they are best utilized for growth opportunities. Whether it’s boosting marketing efforts, purchasing inventory in bulk, or acquiring materials for a large project, an MCA can support actions that increase revenue, making repayment easier and quicker. A business seeking growth is not a failing business!
Is a Merchant Cash Advance Right for Your Business?
Many myths about merchant cash advances continue to circulate, but the notion that they are the most expensive, only for failing businesses, or unregulated and predatory is inaccurate. In reality, MCAs offer several advantages over traditional financing options, including a simplified application process, flexible approval criteria, and faster access to funds. For businesses with strong financial histories, as well as those needing quick capital, MCAs can be an attractive option.
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