Still Using Merchant Cash Advances? It’s time to think AR financing

Author Team Coral Capital

At one point or another, every small to middle market business owner is faced with a situation where they are in need of additional capital to move their business forward.

Unfortunately, banks today are quick to deny many SMBs and startups due to their “risky” nature. This lack of support from the banking community has given rise to various alternate financing options.

One of these options is a merchant cash advance. A merchant cash advance is a financing option for small businesses in which a merchant account provider pays a one-time lump sum to a business in exchange for a percentage of their future credit card receipts.

AR financing in place of Merchant Cash Advances

How do Merchant Cash Advances Work?

  • The Qualifications — Unlike other types of financing, a merchant cash advance, or MCA, is not considered a loan—it’s an advance payment against the borrower’s future income. This means that in order to be approved, a business must have a steady and reliable income.
  • The Advance — The amount provided is most often determined by a company’s annual income or credit/debit card sales. The specific advance amount will vary depending on the company and will be determined after being carefully reviewed by the merchant advance provider.
  • The Repayment — Like most alternate forms of financing, repayment begins as soon as the company receives the advance. When it comes to the repayment, the borrower has two options. The first is to pay the provider through future credit and debit sales. The second, and oftentimes the most popular option, is to pay through fixed monthly or weekly debits from the company’s bank account.

What are the Advantages of Merchant Cash Advances?

  • Widely Available — Merchant cash advances have evolved in recent years. They were originally considered to be only for small businesses whose revenue comes from credit and debit card sales. Today, they are open to all SMBs and startups, even those who don’t rely on credit and debit sales. Beyond that, unlike many forms of financing, those with little-to- no credit can still qualify for a merchant cash advance. This is due to the fact that the ability to get approved focuses on successes and consistent credit card sales rather than debt or credit history.
  • Easy to Access — Applying for a merchant cash advance is considered a fairly straight-forward process, especially in comparison to other types of funding such as traditional bank loans or VC funding. A business owner can apply for an advance entirely though a merchant provider’s website; no in-person meetings are necessary. All that is needed to apply for an advance is basic paperwork, including the application, tax returns, and bank account statements.
  • No Collateral — One of the biggest downfalls with traditional bank loans is that they require some sort of asset to be used as collateral against the loan. Merchant cash advances are considered unsecured, meaning that they do not require any sort of collateral.

What are the Downfalls of Cash Advances?

  • High APR — Merchant cash advances are considerably more expensive than any other type of financing options. According to a recent article by NerdWallet, “the annual percentage rate, or total annual borrowing cost with all fees and interest included, typically ranges from about 40% to 350%.” This sort of APR can be higher than even a high interest rate bank or credit card loan.
  • High Costs — For small businesses who are in need of immediate cash due to an uptick in business, cash advances may end up working against them in the long run. Because repayment is most often dependant on a fixed percentage of credit sales, those who show success will oftentimes pay extremely high daily fees as a result. This means that those companies who choose to use a merchant cash advance may end up spending more than they had even taken in the first place. Many times, using a merchant cash advance ends up being more costly than it’s worth.
  • Risky and Unregulated — Because they are considered commercial transactions and no t traditional loans, merchant cash advances are not subject to federal regulations. As a result, merchant cash advance providers have full freedom to charge extremely high interest rates, and those who use them risk losing more than they bargained for.

Is there an Alternative to Merchant Cash Advances?

Accounts receivable or AR financing is a great alternative form of financing that provides fast working capital to small businesses without the risks associated with MCAs.

AR financing comes from a company’s invoices and is immediately advanced to the small business in as little as 24 hours after approval. Holding no risk to the company, even small to middle market businesses that are unsuitable for bank loans may qualify. This is due to the fact that being approved for AR financing depends on the strength of clients’ customers credit, not the client itself. AR financing allows small businesses to get much-needed cash for working capital, which allows them to regulate cash flow mismatches and frees them to focus on their core business.

Unlike merchant cash advances, there is little risk or inflated costs when it comes to AR financing. This is due to the fact that merchant cash advances charge the company based on their “projected” sales—which can become detrimental if the company does well—while invoice factoring is based on existing invoices. In addition, while merchant cash advance providers charge a sky-high interest rate, most AR financing firms only charge a small percentage, leaving the company in a good place to move forward and focus on the bottom line.

While merchant cash advances do come with a few benefits, many consumer advocates and non-profit lenders consider them to be “a last case scenario” for companies searching for financing. Before considering a merchant cash advance, it’s extremely important to be conscious of the short and long term impacts. And while every company and every situation differs, AR financing is the more assured option for companies looking for a cost effective and long term pathway towards success.