E-commerce has had a steep growth curve for the past two decades. In 2021, global e-commerce grew by 16.3 per cent and will continue to grow exponentially for the foreseeable future.
This exponential growth gives rise to several problems for e-commerce businesses, be it increasing your inventory, your staff, and, with it, increased wages, marketing budget, and whatever it is you need to survive and grow. And the solution to these problems is financing your e-commerce business.
Now you can finance your e-commerce business in several ways. One of the easiest ways is to go for the Merchant Cash Advance (MCA) as a financing option. And the reason is that most of the revenue of an e-commerce business comes in the form of credit card payments.
In fact, out of the $4.9 trillion sales worldwide, 76.6 per cent of the payments were made by credit/debit cards and digital wallets. And that cash inflow is one of the essential requirements for Merchant Cash Advance (MCA) to be approved.
Hence MCA might be the perfect solution to the financing problem of your e-commerce business. But what is a Merchant Cash Advance (MCA), how does it work, and what are the benefits of MCA? Let’s find out.
What is a Merchant Cash Advance (MCA)
Table of Contents
A merchant cash advance (MCA) is a short-term, unsecured loan that can be used to finance the cost of buying inventory or other business purposes. It is debt financing, where the lender provides a business with a specific amount of cash today and receives back payments in the form of a pre-set percentage of the future card payment receipts of the said business.
So, it is a type of loan that suits businesses with a high volume of credit/debit card payments, hence an excellent option for e-commerce.
MCA is usually easier to get as compared to conventional financing solutions. Businesses with an insufficient credit history or very few assets can comfortably get a merchant cash advance. Also, the small businesses that the traditional funding institutions might have rejected may still be eligible for the merchant cash advance.
So it is an excellent opportunity for the e-commerce businesses turned down by other types of debt financing. They can still qualify for the MCA.
How does MCA Work?
With MCA, a business owner can access the cash for its needs as early as the business gets approved for a predetermined amount by the merchant cash advance company. The said amount is then repaid with interest through a pre-set percentage of the revenue of the said business.
To thoroughly understand how a merchant cash advance works, let’s take the example of an online e-commerce store. Due to an abrupt growth, they are short of cash in hand and need to increase their inventory to cope with the increased demand.
So the e-commerce business approaches a merchant cash advance company seeking business funding. So what then happens is the lender asks for a few months of the business’s bank statements. This bank statement ensures that the e-commerce business can easily repay the required cash.
The MCA generally has a swift application process. No collateral is required, and the application is usually completed in a few minutes with minimal paperwork.
After the initial application and underwriting, a capital dispersal only takes a few business days. To collect their money, the MCA providers usually use two ways, described as follows:
Percentage of debit/credit card sales
This method is how the repayments in an MCA are usually structured. A merchant cash advance lender deducts a percentage of your daily/weekly debit/credit card sales until the cash lent is paid back. The said percentage is usually around 10%.
An MCA doesn’t have standard repayment terms compared to other business loans. The unconventional payment structure is the reason for non-typical repayment terms, as the time period to pay back your loan depends on your sales.
Mostly the repayments are made over the timeline of 18 months. However, you can repay the loan faster, as the higher number of debit/credit card sales you make, the quicker you will be able to repay the principal with interest.
Fixed withdrawals from a bank account
The alternate method for paying back your lent cash in an MCA is the merchant cash advance lender withdrawing funds from your business bank account directly. Simply put, you make fixed repayments daily or weekly from your bank account. Those repayments do not depend on your daily sales; instead, they are based on the estimated monthly revenue of your business.
Unlike the “Percentage of debit/credit card sales” method, this repayment structure has a predetermined timeline for the payback of your loan. This predefined timeline is possible because you can calculate the time it will take to pay back the advance due to the fixed cash withdrawals from your business bank account.
This repayment structure suits businesses that do not depend much on debit/credit card sales.
So, for e-commerce businesses, the “percentage of debit/credit card sales” repayment structure is better than the ” Fixed withdrawals from a bank account” repayment structure because a large portion of their revenue comes from debit/credit card sales.
Is a Merchant Cash Advance Good for an E-commerce business?
If your E-commerce business is seeing a rapid boom in its growth rate, or even if you are struggling to survive, you can not wait for the lengthy lending approval processing times of conventional business loans. It would help if you had the instant cash in hand to run your e-commerce business.
So the perfect solution would be an MCA, which is that you will get the funds needed quickly with MCA. The funds can be approved within 24 hours—however, some things to consider before applying for the merchant cash advance are:
The Cash Flow limits MCA Approval.
Suppose you want an MCA lender to lend you $10,000. However, suppose the monthly revenue of your e-commerce business is only $2,000. In that case, you won’t be able to get approved for the merchant cash advance as the amount you are asking for is too much, considering your total monthly revenue.
The general rule is that you will likely get approved for a loan equal to your monthly revenue. So for the case above, your chances for loan approval will be high if you ask for the money in the $2,000.
Only Suitable for E-commerce Businesses with Debit/Credit Card Payment Method
If your E-commerce business uses the following payment methods, then you might not get approved for an MCA:
- Buy now, pay later
- Gift cards
- Cash on delivery (COD)
So the only suitable payment method would be the debit/credit card payment method if you want to get an MCA.
The MCA Lenders Have Preferred Terminals
Payment terminals are another point to consider when applying for an MCA. When you apply for an MCA, they only work with the terminal providers that they have specified.
So make sure that your MCA lender works with your terminal provider. If not, you might have to change your MCA company or work with another terminal provider.
Merchant Cash Advance vs a Traditional Bank Loan
An MCA has several edges over a traditional bank loan. These edges are as follows:
- Unlike a bank loan, a business plan is not required for an MCA.
- In contrast to the fixed loan repayments with a conventional bank, the MCA repayments are based on your sales. Hence, if your revenue is down, you will have to make a lower repayment to your lender.
- The application processing time for an MCA is far lower than the approval time of a traditional bank loan.
- No collateral is required with an MCA, which is not the case with a traditional bank loan.
- Once you are approved for an MCA, there is no need for you to change your lender.
So an MCA is superior to a traditional bank loan in many ways. However, all of it does come at a cost which we will discuss later in the article. So please keep reading.
What Businesses Use an MCA?
Any business with debit/credit cards as the primary method of payment collection can easily use an MCA as a business funding option.
Following are the types of businesses that have debit/credit cards as the primary method of payment, hence having the merchant cash advance as a viable source of business funding:
- Ecommerce stores
- Hotels
- Beauty salons and hairdressers
- Pubs and bars
- Restaurants and takeaways
- Garages
What Can You Use an MCA in Your E-commerce Business for?
You can use an MCA in your e-commerce business for multiple legal business purposes, which include:
- Paying VAT
- Purchase of inventory/stock
- Large order funding
- Purchase of office equipment
- Marketing bills for your e-commerce business
- Large order funding
- Website development
- Product launches
- Expansion
How much does an MCA cost?
When it comes to the cost of the merchant cash advance, it is the interest rate (factor rate) you have to pay on the principle you receive. The interest rate (factor rate) depends on some factors. These factors include but are not limited to the following:
- Business turnover
- Average monthly credit card sales
- Your business’s industry sector
- Personal credit history
- Length of time in business
This factor rate is set as a fixed percentage of the money borrowed. Usually, the factor rates vary anywhere from 7 per cent to 35 per cent, depending on the factors mentioned above. These factor rates will typically be denoted as 1.07 and 1.35, respectively.
For example, if your e-commerce business gets approved for a loan of $10,000, and the factor rate is set at 1.35 (35 cents per $1 borrowed), you will have to pay back $13,500.
The factor rates are generally set at the time of underwriting. The factor rate does not reduce or increase as the borrowed money is being paid. Even if your sales are booming and the loan is being paid back faster than expected, the factor rate will be the same and will not reduce.
Advantages & Disadvantages of MCA for Businesses
Like any other type of business funding, a merchant cash advance has advantages and disadvantages. Let’s discuss those.
The Advantages of an MCA for Your Business
Merchant cash advances have many benefits. These include:
- Accessibility: A merchant cash advance is usually approved within 24 hours of receiving the application. The processing time does, however, depend on the lender you are working with, so make sure that the lender has a fast processing time before you apply for an MCA.
- Unsecured Loan: Merchant cash advances are a form of unsecured business funding, which means that, unlike the traditional bank loan, you do not have to worry about putting forward collateral. So your assets are at a lesser risk as compared to conventional funding.
- Flexibility: With an MCA, you only have to make payments when you make a sale through a debit/credit card, which means that the repayments are directly proportional to your revenue. In case of a bad sales month, you do not have to worry about making a huge fixed payment like in traditional financing.
- Easy and Automatic Repayments: Making repayments on your merchant cash advances is as easy. With MCA, you don’t need to worry about late payment fees. Payments on your loan are effortless as the MCA lender works directly with your card terminal provider. Hence the percentage of the sales is deducted directly at the source, not from your business bank account. The money will be deducted automatically until the loan is paid off, which means it is a painless setup for the business owner. As a business owner, you can spend time running your e-commerce business instead of worrying about the repayments like in any other type of financing.
- Other Types of Financing can be Used Simultaneously: Another excellent argument in favour of an MCA would be that you can use a different type of funding while using an MCA. For example, if you have already taken out a loan for a piece of new equipment. You can still get an MCA for more cash in hand.
- Low-Risk Funding: As the repayment is only deducted when a sale is made, there is a lower chance of your business defaulting compared to the conventional loan, for which you have to make a fixed payment periodically.
- Credit Rating: When you finance your business with an MCA, your credit rating is usually not considered as your business’s expected future sales back the funding.
- Smooth Application process: For a conventional bank loan, you will need a business plan as a requirement for the loan approval. However, this is not the case with the merchant cash advance. The lender looks at your sales history, usually of the past three months, and if everything is fine there, VOILA! Your MCA is approved.
- Transparency: Unlike many other financing options, the amount you have to pay back is fixed at the time of the underwriting and doesn’t change over the period of you paying back the borrowed money.
The Disadvantages of an MCA for Your Business
Like any other form of business funding, the merchant cash advance does have some disadvantages, which include:
- Higher Cost: This is the biggest con of an MCA. The cost of an MCA is higher than that of a traditional bank loan. Still, when we see it from the perspective of the MCA lender, it is understandable as they are taking a considerable risk lending you the money without any collateral. So as the risk grows, so does the cost of capital; that is the general rule of doing business.
- The Factor Rate is Fixed: This is both an advantage and disadvantage. The rate doesn’t go up through the course of payback. However, it doesn’t decrease either, even if you pay back earlier than expected due to increased sales, which is not the case with traditional bank loans.
- Only Debit/Credit Card Payment Method is Acceptable: If you employ any other method of receiving payments instead of the debit/credit card, you will not be eligible for a merchant cash advance.
- Limited Principal Amount: An MCA lender will only lend you an amount equivalent to your card payment turnover. Most lenders typically only offer you funds equal to 1-2 times your monthly card payment turnover. So if you are looking for a sum relatively larger than your monthly card payment turnover, you need to look for other financing options than an MCA.
Wrapping it up
So merchant cash advance is an excellent business financing option, especially for an e-commerce business, due to its payment structure.
Whatever the financial needs of your e-commerce might be, an MCA can cover them.
It does have pros and cons like any other business financing option, and we discussed that in this article.
If you want to apply for an MCA, we wish you good luck with the approval, and on that note, see you in our next blog.
