Merchant cash advances: how they work and what they really cost

A merchant cash advance (MCA) gives you a lump sum now in exchange for a larger, fixed amount taken from your future sales. It is quick and leans on your deposits more than your credit, but it is usually the most expensive mainstream way to fund a business per year of use. The factor rate looks small; the APR it hides usually isn't.

How an MCA works

You agree three numbers: the advance (what the provider pays you), the factor rate (the fixed multiple you pay back) and how repayment is collected. The total payback is the advance times the factor rate, and it is fixed on day one.

An MCA is generally structured as a purchase of future receivables rather than a loan. The provider buys a slice of the money your customers will pay you, at a discount. California's commercial financing law describes this kind of deal as an "accounts receivable purchase transaction", where the business agrees to sell the provider a portion of the cash it collects during a set period or up to a set amount. New York calls a deal repaid "as a percentage of sales or revenue" sales-based financing.

That structure matters in three ways:

1. No interest rate. The price is a factor rate, so the usual comparisons don't line up until you convert it.
2. Early payoff often doesn't help. The payback is fixed, so paying early may save you nothing unless the contract says it does.
3. Different rules. Because it isn't a loan, many lending rules don't apply in the same way. Read the contract, not the sales pitch.

Holdback, daily debits and weekly debits

There are two common ways an MCA is collected.

• Holdback (a percentage of sales). The provider takes a fixed share of your card sales or deposits, the holdback, until the payback is reached. Busy month, you pay faster; slow month, you pay slower. There is no fixed term, only an estimate.
• Fixed debits. The provider takes the same amount from your bank account every business day or every week. The term is fixed, but the payment doesn't fall when your sales do.

A holdback example: a $100,000 advance at 1.35 means $135,000 to repay. If the business takes $150,000 a month and the holdback is 15%, the provider collects about $22,500 a month, so the advance runs about 6 months. If sales drop, it runs longer, and the APR falls, because you hold the money for longer at the same fixed cost.

A fixed-debit example: the same $100,000 at 1.35 over 6 months, collected daily (21 business days a month), means 126 payments of $1,071.43. Collected weekly, it's 26 payments of $5,192.31.

What it really costs

The canonical example: $10,000 at a 1.35 factor over 6 months, paid daily, means $13,500 back in 126 payments of $107.14. The cost is $3,500, and the APR is about 126%. The amount doesn't change the APR; the factor rate and the term do.

APR here is the nominal annual rate on the amount you actually receive, the same way our MCA APR calculator works it out.

Fees push it higher. On a $10,000 advance at 1.35 over 6 months daily, a $500 up-front fee means you receive $9,500 but still repay $13,500, and the APR rises to about 149%.

State disclosure laws

Two of the largest states now require MCA providers to show the cost up front.

• California (SB 1235) requires providers to disclose the total funds provided, the total dollar cost, the term or estimated term, the method, frequency and amount of payments, and the prepayment policy on commercial financing offers of $500,000 or less, including accounts receivable purchase transactions.
• New York requires sales-based financing offers to disclose the financing amount, the finance charge, an estimated annual percentage rate, the total repayment amount, the estimated term, payment amounts, other fees, prepayment terms and collateral requirements. The law doesn't apply to individual deals over $2,500,000.

Outside those states you can still ask for every one of those numbers in writing. A provider who won't give them has told you something.

Who it suits, and who it doesn't

An MCA suits a business with strong, regular deposits, a short and specific need, and a clear return that beats the cost: buying stock at a discount, covering a gap before a confirmed payment, or keeping a busy season staffed.

It doesn't suit a business that is losing money each month, a need that will last longer than the advance, or a long-lived asset. For those, look at a line of credit, equipment financing or a term loan.

What providers look at

• Average monthly deposits over recent bank statements.
• Lowest daily balances, negative days and returned items.
• Time in business.
• How many advances are already running. Each one takes a slice of your deposits first.
• The owner's personal credit, usually checked even though the money is for the business.

Red flags

The FTC has taken action against MCA providers that, it alleged, advertised "no personal guaranty" when their contracts required one, withheld undisclosed up-front fees from the money they sent, took more from accounts than the agreements allowed, and used confessions of judgment to seize business and personal assets.

Watch for:

• No total payback or term in writing.
• Fees that appear only in the contract.
• A confession of judgment clause, which lets the provider get a court judgment against you without a hearing.
• A stacking offer: a second or third advance while the first is running.
• A "renewal" that mostly pays off the old advance and leaves you little new cash.

Sterling's take: run the offer through the offer checker before you sign. If the numbers don't come out the way the salesperson said, believe the numbers.

How it compares