Understanding Revenue Based Financing and Merchant Cash Advances: A Comprehensive Guide for Small Business Owners

What Is a Merchant Cash Advance (MCA)?

In today’s fast-paced business environment, small businesses often need quick access to capital to address pressing needs, seize growth opportunities, or simply manage cash flow. One financial product that has gained popularity for its fast approval process and flexibility is the Merchant Cash Advance (MCA). Unlike traditional loans, an MCA is not technically a loan; rather, it’s an advance against a business’s future sales, typically its credit card or debit card receipts. In other words, a merchant cash advance allows businesses to receive a lump sum of cash upfront in exchange for a portion of their future sales, making it an attractive option for businesses that may not qualify for conventional loans.

However, the simplicity and speed of an MCA come with potential drawbacks, including high costs and aggressive repayment structures. In this article, we’ll explore how merchant cash advances work, how they differ from traditional financing options, and whether they might be right for your small business.

How Merchant Cash Advances Work

The core principle of a merchant cash advance is simple: a lender provides an upfront cash infusion to a small business in exchange for a percentage of the business’s future revenue. Typically, this revenue comes from credit card and debit card transactions, but can also come from other forms of accounts receivable, including monthly contracts, construction draws, and other types of revenue. Repayment is made automatically by deducting a percentage (often called the "Specified Percentage") of the business’s daily or weekly sales (often called the “Daily/Weekly Amount”) from a designated business bank account specified at the time of funding. This means the repayment schedule fluctuates with the business’s revenue — when sales are high, the business pays more, and when sales are low, the business pays less.

There are several important and clear characteristics of an MCA. The first is the term of the MCA – there is no specified term or length of time in which the Amount Sold must be remitted. While there's no fixed term, repayment continues until the advance is fully repaid, which typically happens within 6 to 12 months.

Second, the filing of business bankruptcy does not render the business owner personally liable for the performance of the business’ obligations under the MCA. In other words, if the small business is forced to declare bankruptcy, the company’s obligation of performance is terminated.

Finally, and perhaps most importantly, true MCAs contain a provision that allows for reconciliation of the small business’ payments in accordance with the business’ financial realities. This feature can offer businesses some flexibility during periods of fluctuating revenue. If a business’s revenue drops significantly, the small business can request a temporary adjustment to the Specified Percentage, reducing the daily repayment amount in line with its lower sales. This process can help prevent financial strain by ensuring that payments remain proportional to actual revenue.

It is crucial for businesses to review their MCA contract carefully to understand reconciliation and how often it can be invoked. By leveraging the reconciliation process, businesses can better manage cash flow during slow periods, making MCAs a slightly more flexible option when compared to fixed loan payments. However, it’s essential to communicate proactively with the MCA provider and ensure that reconciliation is properly documented to avoid complications down the road.

How a Merchant Cash Advance is Different From a Business Loan or Line of Credit

It’s important to understand that an MCA is not the same as a business loan or a business line of credit. Unlike a fixed loan payment, an MCA adjusts to your daily sales. This means that if business is slow, you won’t face the same financial strain as with a traditional loan’s fixed payments. The reconciliation provision discussed above is a critical, yet often underutilized, feature designed to adjust the daily repayment amounts based on the actual revenue performance of the business. This feature is particularly valuable when a business experiences fluctuations in revenue, as it ensures that repayment remains proportional to sales, alleviating financial pressure during slower periods. In contrast to fixed repayment obligations in traditional loans, the reconciliation process helps maintain the flexibility of MCAs, allowing businesses to manage cash flow more effectively.

Additionally, business loans typically require strong credit histories and a track record of profitability, but MCAs are often more lenient and are underwritten based upon the business’ operating cash flows. This makes them accessible to businesses with poor credit or those that might not otherwise qualify for conventional financing.

With respect to the cost of funds, traditional loans charge interest over a fixed term, while MCAs use a factor rate. Although MCAs have fewer upfront requirements, the overall cost can be significantly higher due to the factor rate’s compounding nature.

Finally, MCAs carry only the obligation of performance where a business loan carries the obligation of performance and payment.

The Benefits and Pitfalls of Choosing a Merchant Cash Advance

MCAs offer many benefits in the correct circumstances. Small businesses may find that obtaining an MCA is preferrable to obtaining a traditional business loan. MCAs are approved and funded quickly — sometimes in just a few days. This is valuable for businesses in urgent need of cash. Repayments under an MCA also fluctuate based on your sales and do not come with an absolute obligation to repay. If you have a slow period, the payments adjust, which can be a relief for cash flow management. Lastly, MCAs focus more on revenue history than credit score, making them accessible to a wider range of businesses.

While beneficial in favorable situations, MCAs also carry risk and small businesses should consult with financial and legal counsel before accepting them. MCAs carry a high cost - the factor rate applied to an MCA can result in an effective annual percentage rate (APR) that far exceeds the cost of traditional loans. In some cases, APRs can soar into the triple digits. Moreover, while payments may adjust based on sales, the daily or weekly withdrawals can still become burdensome, particularly during slow periods. Finally, since MCAs are short-term solutions, businesses may find themselves in a cycle of relying on advances instead of building sustainable financial health.

How Can Wilkie Puchi LLP Assist in Your MCA Journey?

At Wilkie Puchi LLP, we understand the unique challenges that small businesses face when dealing with merchant cash advances. Whether you’re considering an MCA to boost your cash flow or you’re facing legal challenges related to a defaulted MCA, our experienced legal team is here to help.

Our services include:

• Contract Review: We’ll help you understand the terms and conditions of MCA agreements, ensuring you make informed decisions.

• Litigation Defense: If you’re facing a lawsuit from an MCA lender, we specialize in defending small businesses from aggressive MCA collections.

• Debt Restructuring and Negotiation: If your MCA repayments are becoming unmanageable, we can negotiate with lenders to restructure the terms and reduce your financial burden.

Merchant cash advances can be a powerful tool for some businesses, but they come with risks. Let the experienced team at Wilkie Puchi LLP guide you through the process and protect your business from costly missteps.

Contact us today for a consultation and take control of your business’s financial future.