Merchant Cash Advances for Start-ups: All You Need to Know

By running a startup you may have come across the term merchant cash advance before, but not known how it differs from a more traditional business bank loan.

This article will break down all the differences, including terms, repayments, how rates are calculated and the reasons for taking advantage of a merchant cash advance that might work for your business needs.



In simplest terms, a merchant cash advance is a loan paid as a lump sum to a business, which is repaid as an agreed percentage of your future card transactions. Technically speaking you are agreeing to sell a percentage of your future credit card sales to a lender, and you receive the money as an ‘advance’.

How does an advance differ from a traditional loan?

Advances tend to be more flexible than a traditional business loan applied for through a bank. They are not secured with any collateral from your business and repayments are taken as a percentage of your card transactions. This means that repayments are typically proportional to your earnings as a business. So, if you have a slow month with not many card transactions, you will repay less of the loan amount. Conversely if your card payments are seeing a lot of growth and are up, you will pay back more of your loan in that period. One thing to note is that with a merchant cash advance, businesses will have to pay back the pre-agreed cost of funding even if they complete repayments ahead of schedule.

How does a merchant cash advance work?

Applying for a merchant cash advance is a lot simpler than applying for a bank loan. Usually you only have to answer a few questions about your startup and its sales, after which you’ll be quoted a factor rate and payment term. Both of these are dependent on the cash amount requested, and your past business performance. Some lenders will take credit history into account, and if you have a lower credit score you may see this reflected in a higher factor rate.

Factor rate determines how much you will be paying back (including all fees) and the amount of time it will take to pay off completely. A factor rate will tell you the total amount of the loan cost as a multiplier, for example 1.1 or 1.5. To work out the total amount owed, simply multiply the loan amount by the factor rate.

Example

• Advance amount requested by startup: £3,000

• Factor rate quoted by lender: 1.3

• Total amount due: £3,900
  

The payment term and the factor rate can have a massive impact on how suitable a particular lender is for your needs. A relatively high factor rate may work out cheaper over a longer payment term compared to the same loan and payment term based on cumulative interest.

Advantages of a merchant cash advance for startups:

• Quick: The entire process from application to funds in your account could take as little as 2 days.
  
  
• Hassle free: The application process is quick and easy with no long paperwork to fill out.
  
  
• No collateral: As cash advances are unsecured, you don’t have to worry about putting up any assets to secure the loan.
  
  

Drawbacks of a merchant cash advance for startups:

• Cost: Compared to a long-term bank loan, you may end up paying more to borrow using a merchant cash advance, making it a more expensive way to get funding.
  
  
• Short term: Merchant cash advances are quick to apply for and quick to be approved but they tend to be useful over the short term. The longest payment terms typically are around a year but many start at three months. If you are looking for a longer-term solution then you may need to look at other funding.
  
  

Why would a startup need a cash advance?

An advance can be a strategic cash injection to your business and can help to capitalise on timely growth opportunities. Some small businesses will use an advance to promote or hire new members of their team, refurbish and refresh their premises, or buy up inventory on offer at a great price from a competitor closing down.

Is a merchant cash advance for startups a good idea?

Taking advantage of a merchant cash advance can be a great way to propel the growth of your startup if you come across a time-sensitive business opportunity. The advantages of a quick unsecured loan are plenty, as long as you are not relying on an advance to stem longer term persistent cash flow issues. It is important to make sure to weigh up all of the finance options available to startups to find the right one for your startup.