By Tricia Tetreault | Financing, Working Capital |
Small business owners typically seek alternatives to merchant cash advances (MCA), such as small business loans or lines of credit, due to the extreme costs associated with MCAs. An MCA, which is a lump sum payment in exchange for a fixed percentage of your daily credit card receipts, can have APRs in excess of 200%.
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4 Reasons to Consider a Merchant Cash Advance Alternative
Most see a merchant cash advance (MCA) as quick financing to fund working capital needs like purchasing equipment or preparing for busy seasons. However, an MCA can be expensive, hard to understand, and based on credit card revenue. Further, some borrowers ladder them when there are better long-term options. For these reasons, business borrowers should consider other alternatives.
“A merchant cash advance can be appealing to small business owners with poor credit or who process a lot of face-to-face transactions, but they’re very expensive. An MCA can have huge rates and you don’t have control over how much of your receipts are deducted as part of the fees you owe each week. This can be a huge percentage of your daily or weekly sales, which could cripple your business and prevent you from growing—the reason why most businesses want access to financing to begin with.”
The top four reasons you should consider an MCA alternative are:
1. An MCA Is Expensive
An MCA is a very expensive form of working capital financing. The average annual percentage rate (APR) of a merchant cash advance is between 80% and 120%. This is because while the daily payments and total cost of capital are fixed, repayment timelines are variable. The longer the repayment, the higher the APR.
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Many borrowers agree to the cost due to poor personal credit or because of an MCA’s funding speed. However, due to the high cost, some business owners are unable to keep up with payments. This leads to many defaults and creates credit issues for the borrower.
And defaulting on an MCA isn’t the only concern for small business owners. As Greg Powell notes:
“Even those small businesses that don’t default on their MCA can face significant issues due to their high costs. For example, businesses can find that while they are able to keep current on payments, the MCA is siphoning off too much of their revenue, leaving the business owner with no funds to re-invest and grow their business.”
By contrast, there are many MCA alternatives that offer APR rates from 10% to 50%, all of them with a much lower total cost than an MCA. What’s more, repayments are typically weekly or monthly, which puts less of a financial strain on a borrower than the daily repayments required by an MCA.
2. MCAs Can Be Difficult to Understand
MCAs can be difficult to plan for because many of the costs and terms are variable. For example, your true APR, your daily repayment amounts, and your overall timeline for repayment are not transparent. This makes it hard to budget and plan for the future.
Cost of Capital
With an MCA, your cost of capital is predetermined and based on a factor rate ranging from 1.1x to 1.4x the amount borrowed. For example, if you borrowed $10,000 with a factor rate of 1.3x, your total repayment would be $13,000, regardless of how quickly the amount is repaid.
Fluctuating Daily Payments
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After you receive your MCA, you’ll pay the provider back every day through a holdback percentage (between 8% and 30%) of your daily credit card receipts. If your holdback percentage is 15% and you make $1,000 in one day in credit card sales, your payment for that day will be $150. If your credit card receipts for the next day are $2,000, your daily payment for that day would be $300. Repayments are automatically taken out of your daily credit card receipts.
By contrast, alternative financing options are more transparent with total costs and terms. You can receive the same funding amount as an MCA and also know your exact repayment terms, including the APR, total cost of capital, repayment amount, and repayment timeline. This helps you better budget and plan for the future of your business.
3. MCA Funding Is Typically Based on Credit Card Receipts
An MCA is one way for a small business to access a large lump sum payment for working capital needs, but businesses without sufficient credit card sales may not qualify. For those small businesses that do qualify, the historical amount of your sales will dictate the size of the advance you receive.
This can cause multiple issues:
- If you don’t have monthly credit card sales around $10,000 per month, you may not even qualify for a traditional MCA.
- If you do have enough credit card sales to qualify, the historical amount of your sales will dictate the size of the lump sum payment you qualify for, thereby limiting your ability to borrow and the effectiveness of an MCA.
In addition to traditional MCAs, some lenders will also provide ACH Cash Advance (aka a Bank MCA or Bank Only MCA). These lenders will take into account more than just your credit card sales, which opens the option up to more borrowers, but does nothing to alleviate the expensive, complicated nature of MCAs.
Luckily, MCA alternatives are typically more flexible during the application process and qualify you based on either your personal credit and/or your business history. If you have a strong overall business or have a high personal credit score, it’s usually easier to qualify for larger amounts of financing with alternative options.
4. You Really Need Long-Term Capital
Many businesses get an MCA to fund a short-term need but end up requiring a longer repayment term. Further, some find that an MCA is too expensive, forcing them to take on additional debt or to refinance with another provider. The result is greater business debt than was originally planned for.
By contrast, merchant cash advance alternatives can offer longer repayment terms from the start if you need a longer-term option. If you don’t know how much you need or when you’ll be able to repay, a short-term line of credit, for example, might be the alternative for you since it’s revolving.
Merchant Cash Advance Alternatives for Small Businesses
There are merchant cash advance (MCA) alternatives that are probably more suited for your borrowing needs. These alternatives include short-term loans, lines of credit, and long-term loans. What’s more, many of them can fund within one to three days. Ultimately, the right financing option for you will depend on your needs and your borrower qualifications.
Common Merchant Cash Advance Alternatives
| MCA Alternatives | Best For |
|---|---|
| Short-Term Small Business Loan | Businesses needing repayment terms up to 3 years for larger purchases |
| Small Business Line of Credit | Businesses needing revolving access to funds for working capital needs |
| Long-Term Small Business Loan | Businesses needing up to $10,000,000 and 10-year repayment terms |
| Payment Processing Company Financing | Businesses needing up to $125,000 that use a payment processor |
The four primary merchant cash advance alternatives are:
1. Short-Term Small Business Loan
A short-term loan is a lump sum payment borrowed as an alternative to traditional bank loans because of the fast funding speed. These loans are often unsecured business loans provided by lenders that will look at the combination of your credit history and business performance to approve you for a loan up to $500,000.
Some of the standard costs you can expect with a short-term small business loan are:
- Interest Rate: 9% to 20%
- Loan Origination Fee: 2.5% to 6% of the loan amount.
A short-term loan is a good alternative to an MCA because it’s a more affordable lump-sum financing arrangement with fixed repayment terms and greater transparency. You can borrow up to the amount you qualify for and typically have weekly or monthly amortized payments over the life of the loan. You’ll know exactly how much you’ll pay during each month of repayment, and you won’t have to make daily payments like with an MCA.
Who a Short-Term Small Business Loan Is Best For
A short-term business loan is best for small businesses with one-time working capital needs like equipment purchases, or simply additional working capital. If you need additional money later, you’ll have to re-apply and go through the underwriting process again. Short-term small business loans are great for owners who need financing up to $500,000.
Short-Term Small Business Loan Terms
The terms for short-term loans vary by lender, but the standard repayment terms can range from three to 36 months. Loan amounts are generally between $5,000 and $500,000, with interest rates ranging from 9% to 20%. Your lender will also likely charge a loan origination fee equal to 2.5% to 6% of the loan amount.
The typical terms that you can expect from a short-term small business loan are:
- Loan Amounts: $5,000 to $500,000
- Funding Speed: One to three days
- Repayment Terms: Three to 36 months
- Payment Schedule: Weekly or monthly
- Expected APR: 30% to 50%
Short-Term Small Business Loan Minimum Qualifications
The qualification parameters for short-term small business loans are slightly less restrictive than medium-term small business loans. Generally, a lender will require that your business has been operational for a minimum of one year, that you have at least $50,000 in annual revenues, and that your personal credit score is above 550.
The basic qualifications for short-term alternative business loans are:
- Credit Score: 550+ (check your credit score for free)
- Time in Business: At least one year
- Annual Business Revenue: $25,000+
Short-Term Small Business Loan Costs
Short-term small business loans will typically be fully amortized, but the total cost will vary by the lender depending on the fees and interest rates your lender charges. The commonly quoted cost that you’ll see with these loans is your annual percentage rate (APR), which typically will fall within the range of 30% to 50%.
What a Short-Term Small Business Loan Is Missing
A short-term business loan is great if you need a large amount of capital for a one-time need, but if you need additional funds in the future, you’ll have to reapply. If this is the case, you might benefit more from a line of credit so you can avoid the application process repeatedly.
Where to Get a Short-Term Small Business Loan
You can get a short-term loan through online lenders like Fundbox. They offer up to $100,000 in financing without requiring a personal credit check to get started.
Greg Powell, Head of Product Marketing at Fundbox, says:
“Fundbox wants to be your partner for the long term, so we have a transparent flat fee structure. You’ll know exactly how much you’re going to pay each week before you draw, regardless of what happens to your revenue. This helps you budget your actual costs and if you repay early, we’ll waive the remaining fees for any weeks you had left. Since the fees are flat, you can save a significant amount of money by paying it off early.”
Their application process typically takes place entirely online in about 10 minutes. You’ll get a quick approval if you qualify and can then be funded within one to three days.
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2. Small Business Line of Credit
A small business line of credit (LOC) operates much like a credit card. You will get approved for a maximum borrowing amount, which you can then draw against and repay over and over again. You will only pay interest on the amount borrowed. After you repay, you can reuse your credit line because it’s revolving.
Some of the standard costs you can expect with a small business line of credit are:
- Interest Rate: 9% to 20%
- Lender Fees: Vary by the lender, but may include loan origination fees, maintenance fees, or ACH processing fees
These short-term lines of credit products are typically found via online lenders who can fund quickly. These lines of credit products are better than MCAs because they’re revolving, so you can use them over and over again as you repay what you borrow. They’re also more affordable and don’t require you to have a lot of credit card receivables.
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Who a Small Business Line of Credit Is Best For
A small business line of credit is best for businesses that may need to borrow money more than once or businesses that want to prepare for unexpected expenses because you don’t have to use the funds until you need them and only have to pay interest on the part of the line you have used.
Additionally, a small business line of credit can be a good fit for those companies that want to steadily invest in their growth over time. For example, businesses that want to fund marketing campaigns, buy materials in advance of their next big project, or expand their line of inventory may find a short-term line of credit a very useful tool.
Small Business Line of Credit Terms
The terms of your line of credit are going to vary by lender, but typically you can expect something similar to these terms:
- Loan Amounts: $2,000 to $500,000
- Funding Speed: One to three days
- Repayment Terms: Six to 12 months
- Payment Schedule: Weekly or monthly
- Expected APR: Starting at 20% to 30%+
Small Business Line of Credit Minimum Qualifications
You’ll be in a good position to qualify for a short-term line of credit if you meet these minimum standards:
- Credit Score: 550+ (check your credit score for free)
- Time in Business: At least one year
- Annual Business Revenue: $50,000+
Small Business Line of Credit Costs
The costs for a short-term line of credit vary based on the fees and whether or not the financing is fully amortized. Some providers require you to pay the same amount of interest and fees, regardless of when you pay off the loan, while others will allow you to save money by paying off early.
The common cost that you’ll see with this line of credit products is your annual percentage rate (APR), which typically starts in the range of 20 to 30%.
What a Small Business Line of Credit Is Missing
A short-term line of credit is great for recurring working capital needs, but the total amount of capital you’re approved for is typically less than what you would get with a short- or long-term loan. If you need more than $500,000, then a short- or long-term loan may be more beneficial to you.
Where to Get a Small Business Line of Credit
There are several online lenders where you can get a business line of credit. Fundbox is one of our recommended small business lines of credit providers and can provide up to $100,000 of financing. Fundbox has no minimum credit score requirement, and they only require that your business has been operational for at least six months. Plus, they can fund in as soon as one day.
3. Long-Term Small Business Loan
A long-term loan has a repayment term of up to 10 years. These loans are typically originated by a traditional bank or an SBA lender and are more difficult to qualify for than the other financing options on this list. Long-term loans have a longer application process and can take 30 to 90 days to get funded.
A long-term loan is much more affordable than an MCA, with interest rates less than 10% and repayment terms of 5 to 10 years. This is a better option if you need long-term capital, are looking to make a large business purchase, or if you are trying to consolidate or refinance existing debt.
Who a Long-Term Small Business Loan Is Best For
Long-term loans are best for small businesses looking to refinance or consolidate expensive business debt. For example, many MCA borrowers end up using long-term loans to spread out the debt they incurred from the MCA. These loans are also the best option to use for large purchases like commercial real estate.
Long-Term Small Business Loan Terms
The amount you borrow and how you’ll repay your long-term loan will vary by lender, but typically you can expect something similar to these terms and ranges:
- Loan Amounts: $20,000 to $10 million
- Repayment Terms: Five to 10 years
- Payment Schedule: Monthly
Long-Term Small Business Loan Minimum Qualifications
You’ll typically qualify for a long-term business loan if you meet these minimum standards:
- Credit Score: Prime borrower with 680+ score (check your credit score for free)
- Time in Business: At least one year
- Annual Business Revenue: $100,000+
Long-Term Small Business Loan Costs
Long-term loans are the most affordable financing alternative to a merchant cash advance. These loans will likely have an interest rate for the duration of loan combined with some origination fees. The annual percentage rate will generally range from 7.5% to 10%.
What a Long-Term Small Business Loan Is Missing
While a long-term loan is the most affordable option, it can take a while to get funded. Long-term loans take 30 to 90 days to fund, which defeats the main purpose of getting an MCA—speed. These loans have a lengthy application process involving supplying your lender with a substantial amount of paperwork.
Where to Get a Long-Term Small Business Loan
You can get a long-term loan from a traditional lender like a bank, or from an SBA lender. You’ll likely need to walk in and meet with a potential lender face-to-face with all of your documentation in hand before they’ll start processing your loan application.
4. Financing from Your Payment Processor
Another alternative to an MCA is to obtain financing through your payment processor. If you’re considering an MCA, then you likely process a lot of credit card payments. This could qualify you for financing from other companies, like Square Capital or PayPal, which may already be processing these transactions for you.
Typical costs associated with financing through your payment processor are:
- Borrowing Fee (Factor Rate): 1.1x to 1.16x the amount borrowed
These loans are generally offered to you without you even having to apply, and you can accept them quickly online from within your processor’s dashboard. These loans are for smaller financing needs under $100,000, and they fund within one to three days. You can learn more by reading our review of Square Capital and PayPal Working Capital.
Merchant Cash Advance Alternatives Frequently Asked Questions (FAQs)
A lot of information has been covered in this article about merchant cash advances (MCA), what MCAs are, MCA alternatives, how they compare, and what your best options may be. If you have any questions about any of the information presented here, you can post them here below or go to the contact us page and send us a message.
Some common questions regarding MCAs and alternatives are:
How Do MCAs Work?
An MCA is a short-term financing option, wherein a lump sum payment is given to a company in exchange for a fixed percentage of its daily credit card receipts. Payments are equal to a percentage of a company’s total daily credit receipts, resulting in repayment terms that are under two years.
How Much Does an MCA Cost?
Merchant cash advances are an expensive short-term financing option. The merchant cash advance provider charges a factor rate (typically 1.1x to 1.5x), which is multiplied by the amount advanced to determine the repayment amount. If you borrow $10,000 at a factor rate of 1.4x, you’ll repay $14,000 (plus any origination fees).
Is an MCA a Loan?
An MCA is not a loan. An MCA is a monetary advance on your future credit card receipts. The MCA provider issues you a lump sum payment in return for a percentage (referred to as the holdback percentage) of your daily future credit sales until the advance is repaid.
What Are Some Alternatives to an MCA?
There are a variety of alternative business loans, including short-term loans, small business lines of credit, and invoice financing, as well as more traditional loans like SBA loans, that can all serve as more affordable alternatives to MCAs. The alternative financing option that will work best for you depends on your business needs.
Bottom Line
A merchant cash advance (MCA) is an expensive financing option typically used because of their low qualification requirements or fast funding speed. However, there are many alternatives to an MCA that you can qualify for that will fund faster than many MCA providers and at a lower cost. An MCA should therefore only be used as a last resort.
About the Author
Tricia Tetreault
Tricia Tetreault is a staff writer at Fit Small Business, specializing in Small Business Finance. She holds a Master’s in Business Administration from Champlain College and has spent the majority of her career working in federal government lending.