Business Expansion

Why Is a Merchant Cash Advance a Popular Option When Looking for a Small Business Loan?

Last updated on March 13, 2020

Jacques Famy Jr

Merchant cash advances, also known as a future purchase sales receivables agreements, has become a very popular business financing product for businesses that accept credit card sales from their customers. There is also a sister product called a business cash advance, a better option for businesses with a lower amount of credit card transactions. 

Why has a merchant cash advance become so popular? The two main reasons are simple: qualifications and flexible repayment structure. 

Merchant cash advances allow for lower credit standards, lower cash flow requirements, lower standards of bank account health, and less paperwork for approval. Quite simply, it is much easier to get approved for a merchant cash advance than a business loan.

The other reason for the popularity is the repayment structure. Payments are flexible in that you pay back a lump sum monthly by taking a fixed percentage of future sales. So if business sales fluctuate, so does the payments you must make. This protects the business from being saddled with a fixed payment that does not adjust to sales.

This type of product is very popular with industries such as restaurants, auto service centers, retail stores, and many other small businesses.

How Does It All Work? Merchant Cash Advance Explained

So let’s get into the details of how a merchant cash advance works. Like a business loan, a merchant cash advance is structured as a lump sum of money that is provided to a business at time of consummation. It differs from a loan in that it is NOT repaid with a fixed payment over a fixed term and you are not charged a principal and interest rate. 

Repayment is determined by a fixed percentage of future sales, which is then auto-deducted from the business bank account either daily, weekly, bi-weekly or monthly until it is paid back in full. There is no specific term limit to pay back on a merchant cash advance. Occasionally, there are restrictions and limits, which are spelled out in a merchant cash advance agreement, but generally, repayment is flexible, unlike a business loan.

Merchant cash advances function on a fixed cost basis using a factor rate and not principal and interest, which is another big difference between a business loan and a merchant cash advance.

For example:

Advance Amount (Purchase Amount): $20,000

Payback Amount (Specified Amount): $25,000

Factor Rate: 1.25

Percentage of Future Sales (Specified Percentage): 10%

Notice that there is no term or duration listed or a fixed payment that is deducted from your business bank account. So if your sales on Monday were $1,000 then (based on 10% of future sales in the example) a deduction of $100 would be made from the credit card sales or business bank account to start repaying the advance. If the next day there is no sales then there is no payment.  

Application and Requirements for a Merchant Cash Advance

The requirements and qualifications to apply for a merchant cash advance are slightly different from a business cash advance. However, the requirements are much less stringent than traditional business loans that require two years of tax returns, six months bank statements, profit, and loss, and balance sheet statements, as well as accounts payable/accounts receivable reports (if applicable).

Let’s break down the requirements and qualifications for both merchant cash advance and business cash advance.

Qualifications for a Merchant Cash Advance

  • At least 6 months in business
  • Revenue/deposits in a business bank account of at least $10,000 per month
  • Frequent daily credit card sales on a monthly basis of over $10,000
  • All credit types from excellent to poor (credit scores above 500 preferred) 
  • Healthy bank statements, but allows for as little as $1,000 as an average daily balance in a business bank account (there are some funders who will go as low as $500 average daily balance)

Requirements for a Merchant Cash Advance

  • 1-page application
  • 3 months of merchant processing statements
  • 3 months of business bank statements

Qualifications for a Business Cash Advance

  • At least 6 months in business
  • Revenue/deposits in a business bank account of at least $10,000 per month
  • All credit types from excellent to poor (credit scores above 500 preferred) 
  • Healthy bank statements, but allows for as little as $1,000 as an average daily balance in a business bank account (there are some funders who will go as low as $500 average daily balance)

Requirements for a Business Cash Advance

  • 1-page application
  • 3 months of business bank statements

As you can see, very little paperwork and very lax qualifications are required for approval compared to those of business loans. I think you can see why the popularity of merchant and business cash advances has been continuously growing. 

Is a Merchant Cash Advance Right for Your Business?

Although a merchant cash advance is easier to get approved for and more flexible in repayment, it is important for the business owner to evaluate the costs and benefits of taking on this type of business finance product. Merchant cash advances cost more than business loans and repayment duration can be shorter in length. 

While considering a merchant cash advance, following a cost-benefit analysis would be a smart move. You must ask yourself, does the benefit of acquiring the money by way of a merchant cash advance outweigh the costs to acquire it? It sounds like an oversimplification, but many times it boils down to just that because if you are considering a merchant cash advance it is most likely because you don’t qualify for a small business loan

Common Questions

What is a Factor Rate?

The factor rate (money rate) is a fixed cost multiplier, not a principal and interest rate nor does it operate like one. 

Example A: Merchant Cash Advance Terms

Advance Amount (Purchase Amount): $20,000 

Payback Amount (Specified Amount): $25,000

Factor Rate: 1.25  

Percentage of Future Sales (Specified Percentage): 10%

To calculate the factor rate divide the payback amount (specified amount) by the advance amount (purchase amount).

$25,000 payback amount / $20,000 advance amount = 1.25 which is the factor rate

The total cost of this funding is calculated by subtracting the payback amount (a specified amount) from the advance amount (purchase amount)

$25,000 payback amount – $20,000 advance amount = $5,000 in total costs

How Are the Payments Made for a Merchant Cash Advance vs. Business Cash Advance?

Merchant Cash Advance Payments 

Merchant cash advance payments are made by taking the percentage of future sales (specified percentage) which is a fixed percentage of every future credit card sales batch. That can be achieved by the merchant processor directly by splitting the sales and payment to the funder. The funder monitors the merchant processing sales and then deducts that percentage by an ACH deduction directly from the business bank account. Additionally, a lockbox can be created into which all merchant processing sales deposit, then the funds are split between the funder and the business bank account automatically. 

Example A: Merchant Cash Advance Terms

Advance Amount (Purchase Amount): $20,000 

Payback Amount (Specified Amount): $25,000

Factor Rate: 1.25  

Percentage of Future Sales (Specified Percentage): 10%

Business Cash Advance Payments 

Business cash advance payments are made by taking the percentage of future sales (specified percentage), which is a fixed percentage of monthly sales that is taken by daily, weekly, or bi-weekly ACH payments established in the agreement. At the end of every month, the merchant has the option to provide the previous month’s business bank statement, which is reconciled for the fixed payments that were deducted the prior month against the set percentage of monthly sales to be taken. If the amount taken was more than the set percentage of monthly sales on the agreement a refund is issued back to the merchant for the overage paid. 

Example B: Business Cash Advance Terms 

Advance Amount (Purchase Amount): $20,000 

Payback Amount (Specified Amount): $25,000

Factor Rate: 1.25  

Percentage of Future Sales (Specified Percentage): 10%

Weekly ACH Fixed Payment: $695 

What Are Typical Origination Fees?

Funders charge as little as nothing to 7% of the advance amount on origination fees. Never agree to pay any up-front fees to get business funding prior to drafting an agreement. 

How Long Will It Take to Pay off a Merchant Cash Advance?

You can ask a merchant cash advance funder what their estimated time to repay your business advance, based on current sales volumes, would be. Typically they are set up for repayment in 6 to 18 months but remember there is no fixed term. The repayment period is determined based on a prediction of future sales by looking at your past ones.

The calculation to figure out your estimated time to repay a merchant cash advance is to take your average monthly sales deposits and multiply by the percentage of future sales (specified percentage) to get your monthly payment outlay then divide by your payback amount (a specified amount).

So assume monthly sales are $27,000 in Example A 

Advance Amount (Purchase Amount): $20,000 

Payback Amount (Specified Amount): $25,000

Factor Rate: 1.25  

Percentage of Future Sales (Specified Percentage): 10%

$27,000 monthly sales x 10% Percentage of Future Sales = $2,700 in monthly payments / $25,000 Payback amount = 9.25 months to repay

Who Qualifies for Merchant Cash Advance or Business
Cash Advance?

Most business owners can get approved for a merchant cash advance and business cash advance if they meet the qualifications and requirements.

What Industries Use Merchant Cash Advances the Most?

The most common industries that use merchant cash advance are restaurants, auto service repair, retail stores, construction contractors and e-commerce online businesses. Most industries can get funding, but there are some restrictions. 

What Are the Benefits of a Merchant Cash Advance?

  • Flexible repayment terms
  • Fast and easy process (money in as little as same day)
  • All credit accepted from excellent credit to poor credit
  • No fixed payments. Payments based on a percentage of future sales
  • Use the money however you’d like
  • Does not report to personal credit 
  • Does not require assets or personal collateral
  • Limited paperwork requirements

The Bottom Line

As stated earlier in this article, the two main reasons that merchant cash advances and business cash advances are so popular are the simple requirements/qualifications and the easy and flexible repayment structure.

Remember, no matter what business financing product you are talking about, you must always evaluate the costs versus the benefits and shop for multiple quotes to make sure you are getting the best available terms for your business.

* All loans made by either WebBank, an FDIC-insured Utah industrial bank, or Bank of the Internet Federal Bank, an FDIC-insured federally chartered thrift located in California. In connection with the loans, the Banks' underwriting conditions and terms apply.