A merchant cash advance (MCA) can be a quick way for businesses to access cash, especially when traditional loans aren’t an option. Unlike conventional loans, an MCA provides a lump sum of cash in exchange for a percentage of your daily sales. It’s fast, easy to qualify for, and doesn’t require collateral.
But while MCAs offer flexibility, they also come with high fees, daily repayments, and short repayment terms. If used incorrectly, they can drain your cash flow and trap you in a cycle of debt. To make sure you use an MCA wisely, it’s important to avoid common mistakes that can cost you money.
This guide highlights the most common mistakes business owners make with merchant cash advances — and how to avoid them.
1. Not Understanding the True Cost of a Merchant Cash Advance
One of the biggest mistakes business owners make is underestimating the true cost of an MCA. Unlike traditional loans, which charge interest rates, MCAs use a factor rate — a multiplier that determines how much you’ll repay. This can make it difficult to understand how much the advance is actually costing you.
Why It Matters
The factor rate is typically between 1.1 and 1.5, which means if you borrow $20,000 at a 1.3 factor rate, you’ll owe $26,000 ($20,000 x 1.3). This is significantly more expensive than a traditional loan with interest. Unlike interest rates, the cost of an MCA does not decrease as you pay it down.
How to Avoid This Mistake
- Ask for the APR Equivalent: Request that the lender calculates the Annual Percentage Rate (APR) so you can compare it to other financing options.
- Review the Total Repayment Amount: Don’t just focus on the factor rate — understand how much you’ll repay in total dollars.
- Compare Other Financing Options: Explore other loans or lines of credit with lower APRs before committing to an MCA.
Example
You take a $30,000 merchant cash advance with a factor rate of 1.4. The total repayment is $42,000 ($30,000 x 1.4). If the repayment period is 12 months, your effective APR could be as high as 70% to 200%, depending on repayment speed.
2. Overborrowing More Than You Need
It’s tempting to accept a larger advance than you actually need. After all, it’s quick, and having extra cash feels safe. But this decision can backfire, as larger advances result in larger daily or weekly payments, which can squeeze your cash flow.
Why It Matters
Since repayments are tied to daily or weekly credit card sales, higher loan amounts result in larger payments. If your sales slow down, you’ll still be required to make payments, potentially leading to cash flow problems.
How to Avoid This Mistake
- Only Borrow What You Need: Carefully calculate the exact amount you need to meet your short-term goals.
- Consider the Repayment Schedule: Look at the daily or weekly repayment amounts and ensure they align with your cash flow.
- Project Your Future Sales: If you expect a seasonal dip in sales, factor that into your repayment schedule.
Example
You borrow $50,000 but only need $30,000. Your daily payment is $350, but if sales drop during the slow season, you may struggle to keep up. Borrowing only $30,000 would have reduced your daily repayment and eased the strain on your cash flow.
3. Ignoring the Impact on Daily Cash Flow
A merchant cash advance is repaid daily or weekly as a percentage of your credit card sales. While this structure seems manageable during high-sales periods, it can become a serious burden during slow months. Unlike traditional loans with fixed monthly payments, MCAs take a percentage of every transaction.
Why It Matters
Daily payments can drain your business’s cash flow, leaving little room for other expenses like payroll, rent, or inventory. If sales decrease, payments will still be deducted, which can create a cash crunch.
How to Avoid This Mistake
- Understand the Repayment Structure: Calculate the percentage of daily sales that will be deducted and assess if your cash flow can handle it.
- Keep a Cash Flow Buffer: Have a reserve of cash to cover slow sales periods.
- Ask for Flexible Repayment Terms: Some lenders offer flexibility, such as lower payments during slow seasons.
Example
If your daily revenue is $1,000 and your MCA repayment takes 15% of daily sales, you’ll owe $150 each day. If sales drop to $600 per day, your payment still takes $90, leaving less money for rent, payroll, and other expenses.
4. Not Reading the Fine Print on Fees and Penalties
Hidden fees and penalties can make a merchant cash advance more expensive than you expect. Some lenders charge fees for late payments, early repayment, origination, and administrative costs. Without understanding these fees, you may be hit with unexpected costs.
Why It Matters
Some lenders charge prepayment penalties, which means if you pay off the loan early, you still owe the full amount of the fees. This makes it impossible to save money by paying off the debt early.
How to Avoid This Mistake
- Ask About Prepayment Penalties: Make sure you understand if you’ll be charged fees for early repayment.
- Review the Contract: Carefully review the lender’s terms, including origination fees, administrative fees, and any “surprise” charges.
- Look for Lenders with Transparent Terms: Work with reputable lenders that provide clear fee disclosures.
Example
You plan to pay off your MCA early to save on fees, but your contract has a “non-refundable fee” clause. This means even if you pay it off early, you still owe the full cost of the advance.
5. Using a Merchant Cash Advance as a Long-Term Solution
MCAs are designed for short-term cash flow needs, but some business owners end up relying on them repeatedly. This can lead to a debt cycle, where you use one MCA to pay off another, resulting in higher fees and constant payments.
Why It Matters
If you consistently rely on MCAs to fund your operations, you’ll face high costs, limited cash flow, and ongoing debt. Without a long-term strategy, you may struggle to break free from the debt cycle.
How to Avoid This Mistake
- Use MCAs for One-Time Needs Only: Merchant cash advances should be used for short-term, one-off expenses like purchasing inventory or handling emergency repairs.
- Explore Other Financing Options: For longer-term cash needs, look for business loans, lines of credit, or equipment financing.
- Create a Debt Repayment Plan: Ensure you have a plan to repay the MCA in full, without taking on more debt.
Example
A business owner takes out a $25,000 MCA to cover inventory, but instead of repaying it, they take out another MCA to cover operating expenses. This cycle continues, and the owner ends up with multiple MCAs with overlapping payments.
When Should You Use a Merchant Cash Advance?
A merchant cash advance may be a good option if you:
- Have urgent cash flow needs and can’t qualify for a traditional loan.
- Need funds to purchase inventory before a peak season.
- Want to take advantage of a limited-time business opportunity.
However, if you need long-term financing, consider alternatives like business loans, lines of credit, or equipment financing.
Frequently Asked Questions
How much does a merchant cash advance cost?
MCAs use factor rates (1.1 to 1.5) instead of APRs. A $30,000 MCA with a 1.3 factor rate would cost $9,000 in fees, for a total repayment of $39,000.
What’s the biggest mistake businesses make with merchant cash advances?
The biggest mistake is overborrowing. Borrowing more than you need increases daily payments and limits your cash flow.
Can I pay off a merchant cash advance early?
Some contracts allow early repayment, but others have non-refundable fees, so you’ll still owe the full amount.
How do I avoid MCA debt cycles?
Use MCAs only for one-time needs, like emergency repairs or inventory purchases. If you need ongoing financing, consider a business line of credit.
What’s the alternative to a merchant cash advance?
Alternative financing options include business lines of credit, SBA loans, invoice factoring, and equipment loans.
