Should You Use a Small Business Cash Advance for Fast Funding?
Small business cash advances, often called merchant cash advances (MCAs), are attractive to many company owners because lenders can transfer the capital they need straight to their bank account within 24 hours of applying. However, while there are advantages to this type of business funding option, it is important to also consider the drawbacks.
In this article, you’ll learn what merchant cash advances are, how they differ from more mainstream small business financing packages, and their pros and cons.
What Is a Merchant Cash Advance?
Similar to a traditional bank loan, you receive an upfront lump sum of capital with a merchant cash advance. However, that’s where the similarities end. Merchant cash advances take a much different approach compared to standard types of financing.
Let’s look now at how merchant cash advances and loans differ across several different factors to help you decide if it’s a suitable option for your company.
1. Loan Amounts
You can borrow up to $5 million with a standard bank term loan – potentially more with an SBA loan. How much you’re actually offered will depend on the size of your company and what you intend to use the loan for.
Merchant cash advance companies base how much they’ll lend you on an estimate of your future credit card sales. The formula lenders use varies, but in general, the maximum you’ll be offered will be 1.5 times your average monthly credit card and debit card sales.
So, if the average amount you brought in through debit and credit card transactions over the last few months was $20,000, you may be able to borrow up to $30,000.
2. Repayment Methods
You agree on a repayment schedule for a traditional bank loan with your lender, pledging to pay off a part of your loan once a month for an agreed period of time. Your lender may require you to set up autopay so they can collect payments from your business bank account.
The amount you pay each month will stay the same if you take out a loan with a fixed interest rate. With a variable interest rate, what you pay goes up or down based on changes in the market interest rate, such as the prime rate or the lender’s benchmark rate.
MCA providers offer more flexible repayment terms because the amount you repay is based on your debit and credit card transactions. They generally take payments from you once a week or every business day when you receive a remittance from your card payment processor.
Let’s say that you agree to let your lender collect 10% of your card sales. This would mean that on a day when you had $10,000 in card transactions, you’d get $9,000, and $1,000 would go toward repaying your merchant cash advance.
3. Cost of Finance
Banks and other financial institutions charge interest on business loans. As mentioned earlier, some banks and credit unions offer fixed interest and variable interest loans.
Small business cash advance lenders don’t charge interest; they apply a factor instead of between 1.2 and 1.5. The total cost of this type of funding is the amount you borrow multiplied by the factor.
Let’s say that you apply for a funding amount of $100,000, and the factor rate is 1.3. The total amount you’ll repay is $130,000.
4. Collateral and Personal Guarantee Requirements
Collateral are assets like real estate and accounts receivables that your lender can take possession of if you default on the loan. They then sell your collateral to try to clear the outstanding balance on your loan.
A personal guarantee is a legally binding promise you and other shareholders make to repay the lender what’s left on the loan if you default.
Small business loan lenders typically require collateral and a guarantee, while most merchant cash advance lenders require only a guarantee.
5. Eligibility Requirements
Credit history is very important to banks when assessing eligibility. They’ll check both your personal and business credit scores to assess your risk as a borrower.
This is also true for SBA loans, where you need a business credit score of above 155 on the FICO Small Business Scoring Service. When it comes to the required personal credit score, it varies based on the SBA loan type:
SBA Microloans: 620
SBA 7(a) loans: 650
SBA 504 loans: 680
Bad credit means you’re likely to be turned down for a loan. If you’re not, they could charge you a higher annual percentage rate, making the advance more expensive.
Merchant funding providers are far more relaxed on credit history, with approval rates exceeding 90%. Applicants whose credit score is in the 500s are typically accepted.
6. Application Process
Small business owners often find the application process for a bank loan, even a short-term loan, onerous. They need to spend time preparing a detailed business plan, financial forecasts, and other documentation (like bank statements and tax returns), which can take weeks.
In comparison, the approval process for a small business cash advance can be as little as 24 hours. Very little paperwork is required, and you can apply online and get an answer in minutes.
7. Down Payments
Some loans, especially larger loans and loans involving the purchase of commercial real estate, require a down payment of a percentage of the advance amount you’re applying for.
For example, if you’re purchasing a factory for $1 million, your lender may require a down payment of 20%. This means you need $200,000 in ready capital just to apply.
Merchant cash advance lenders don’t require you to cover a down payment to borrow capital from them.
Example Use Cases for a Small Business Cash Advance
Merchant cash advances may be suitable for companies in the following situations:
Funding a new business: Most banks want to see at least two years of business history, but many MCA providers only need six months. That gives startups a way to get funding before they’ve built up their credit rating or time in business.
Purchasing inventory: A merchant cash advance can help you restock fast-selling products or bulk-buy seasonal goods while they’re on discount. The capital you need gets there fast so you can act before supplier deals disappear and your competitors raise the cash.
Filling cash flow gaps: You can use an MCA to cover rent, payroll, or utility bills during quieter months or when customers pay late. That keeps the business running without you having to dip into your savings or delay supplier payments.
Covering emergency expenses: If your equipment breaks down or your pipes burst and flood your shop floor, an MCA gets the cash to you quickly. You don’t need to wait for insurance or tie up credit you rely on for day-to-day costs.
Pros and Cons of Merchant Cash Advances
There are upsides and downsides to taking out a small business cash advance. Let’s take a look at the primary advantages and disadvantages.
Advantages of Cash Advances
Quick access to capital: Most MCA providers are online lenders whose systems are set up to approve applications fast — with little or no paperwork.
Variable payment amounts: You repay a fixed percentage of your daily card sales, so if your sales drop, your repayments drop too, preserving cash flow.
Bad credit friendly: MCA providers often approve applications from businesses with poor credit that banks won’t consider.
No prescribed uses: While some term loans can only be used for specific purposes, business cash advances typically allow you to utilize the funding for any business need — such as purchasing inventory or meeting your wage bill.
No collateral needed: You don’t have to risk losing important assets — like machinery, equipment, or real estate — if you default on the loan.
Disadvantages of Cash Advances
Intense payment schedule: Instead of making monthly payments, you make daily or weekly payments that can pull heavily on your cash flow.
Short repayment period: Because MCA lenders take large cuts of your card transactions every day, you pay back the funding in weeks or months compared with the years you have to pay back a standard business loan.
Very expensive: The total amount you pay back above the loan amount is often much higher than you’d pay on a standard business loan or business credit card.
No credit rating impact: MCA providers don’t report to credit bureaus, so even if you repay in full and on time, it won’t improve your business credit score.
Personal guarantee needed: Although it’s good that you don’t need to offer collateral, you will still be personally liable for repaying any outstanding balance if your business defaults.
Consider Other Fast, Flexible Funding Options
Qualifying for a small business cash advance is much easier than for standard financing options like a business loan. If you need capital in a hurry, the speed with which lenders approve and disburse advances makes them an attractive option.
Be careful though. If your profit margin is smaller than the cut your lender takes from card sales, you could run short of cash fast. And if revenue drops, you might not be able to cover the basics — like wages, rent, or stock — without borrowing again.
There are other options for businesses that want access to collateral-free fast funding. Backd offers the following two options:
Working capital advance: Access between $25,000 and $2 million (minimum one year in business required).
Business line of credit: Borrow between $50,000 and $750,000 (minimum two years in business required).
To be eligible for our lending solutions, you must be based in the U.S., have established business credit, have a brick-and-mortar address, a minimum credit score of 625, and a minimum monthly revenue of $100,000.
Apply now and be funded within as little as 24 hours.
