How Does a Merchant Cash Advance Work? A Complete Guide

Understanding Merchant Cash Advances: How They Work

A merchant cash advance (MCA) is a unique form of business funding that has become increasingly popular among Dallas small businesses. Unlike traditional loans, an MCA provides a lump sum of capital in exchange for a percentage of your future sales.

But how exactly does this work? In this comprehensive guide, we explain everything you need to know about merchant cash advances, from the basics to advanced considerations.

What Is a Merchant Cash Advance?

You might be surprised to learn that a merchant cash advance is technically not a loan. It is structured as a commercial transaction known as a “purchase of future receivables” at a discount. An MCA provider gives you a lump sum today in exchange for a portion of your future credit card sales or daily bank deposits.

This legal distinction is critical because it means MCAs are generally not subject to state usury laws that cap interest rates on traditional loans.

Key Terminology

Advance amount: The lump sum you receive upfront.

Factor rate: A multiplier (typically 1.1 to 1.5) that determines your total repayment amount.

Holdback percentage: The percentage of daily sales remitted to the MCA provider.

Retrieval rate: Another term for holdback percentage.

Purchased amount: The total amount you will repay (advance amount multiplied by factor rate).

Reconciliation Clause: This is a vital contract provision often overlooked by borrowers. It gives you the right to request a refund or adjustment if the provider withdraws more than the specified percentage of your actual sales.

How the Process Works

Step 1: Application

You apply with basic business information. Most modern providers now use financial technology tools like Plaid or Finicity to securely connect to your bank account for instant verification, speeding up the underwriting process.

Required documents typically include:

• Business bank statements (typically 3-6 months)
• Credit card processing statements (if applicable)
• Business information (name, address, ownership)
• Personal identification

Step 2: Approval and Offer

If approved, you receive an offer detailing:

• Advance amount
• Factor rate
• Holdback percentage
• Estimated repayment term

Step 3: Funding

After accepting the offer and signing the agreement, funds are typically deposited within 24-48 hours. Some “same-day” funders can even wire capital within hours of approval if the bank connection is active.

Step 4: Repayment

Repayment occurs automatically through one of two methods:

Credit card split: A percentage of your credit card sales is automatically directed to the MCA provider before the remaining funds settle in your account. This is often handled directly by payment processors like Worldpay or First Data.

ACH withdrawal: A fixed or variable amount is withdrawn directly from your bank account daily or weekly.

Understanding Factor Rates

Factor rates are the primary cost component of an MCA. Unlike interest rates, factor rates do not compound over time, but the math can still be confusing for first-time borrowers.

How Factor Rates Work

The factor rate is multiplied by your advance amount to determine total repayment.

Formula: Advance Amount x Factor Rate = Total Repayment

Example:

• Advance amount: $50,000
• Factor rate: 1.30
• Total repayment: $50,000 x 1.30 = $65,000
• Cost of capital: $15,000

Insider Tip: The Buy Rate vs. The Sell Rate

One detail most brokers won’t tell you is that there are often two rates involved: the “Buy Rate” and the “Sell Rate.” The Buy Rate is what the funder charges, while the Sell Rate includes the broker’s commission. If a broker adds 10 points to the rate, your 1.25 factor rate could become 1.35. We always recommend asking if the rate presented is the “direct” rate or if it includes a broker markup.

Typical Factor Rate Ranges

Factor Rate vs. APR

Factor rates do not directly translate to APR because repayment time varies. However, because MCAs are repaid quickly, the effective APR can be quite high—often ranging from 35% to over 350% in extreme cases.

Example APR Calculation:

• Advance: $50,000
• Factor rate: 1.30
• Cost: $15,000
• Repayment period: 6 months
• Effective APR: Approximately 60%

This high effective rate is why MCAs should be used strategically for short-term needs where the return on investment (ROI) exceeds the cost.

Understanding Holdback Percentages

The holdback percentage determines how much of your daily sales goes toward repayment.

Typical Holdback Rates

Most MCAs use holdback rates between 10% and 20% of daily sales.

Example:

• Daily credit card sales: $5,000
• Holdback percentage: 15%
• Daily remittance: $750

How Holdback Affects Repayment Time

Higher sales mean faster repayment. Lower sales mean slower repayment.

Scenario A: Strong sales

• Total repayment: $65,000
• Daily remittance (average): $900
• Approximate repayment time: 72 business days (about 3.5 months)

Scenario B: Slower sales

• Total repayment: $65,000
• Daily remittance (average): $500
• Approximate repayment time: 130 business days (about 6.5 months)

This flexibility is both a benefit and a consideration. Your repayment adjusts with your cash flow, but you pay the same total amount regardless of how long repayment takes.

Eligibility Requirements

MCAs have more flexible requirements than traditional loans:

Minimum Requirements

What MCAs Do Not Typically Require

• Collateral (usually unsecured)
• Perfect credit
• Years of business history
• Extensive documentation
• Personal guarantees (varies by provider, though “bad boy” guarantees for fraud are common)

Advantages of Merchant Cash Advances

1. Speed of Funding

MCAs are among the fastest business funding options available. Approval can happen within hours, and funding within 24-48 hours.

2. Flexible Repayment

Because repayment is based on a percentage of sales, payments automatically adjust to your cash flow.

3. High Approval Rates

MCAs have higher approval rates than traditional loans, making them accessible to businesses that might not qualify elsewhere.

4. No Fixed Monthly Payment

Unlike loans with fixed payments, MCA repayment flexes with your revenue.

5. Minimal Documentation

The application process requires less paperwork than traditional financing.

6. Credit Score Flexibility

Businesses with lower credit scores can still qualify.

Disadvantages to Consider

1. Higher Costs

The effective cost of an MCA is typically higher than traditional financing options.

2. Daily Payment Impact

Daily withdrawals can strain cash flow, particularly during slow periods.

3. No Early Payoff Benefit

Unlike loans where early repayment saves interest, MCAs typically require the full purchase amount regardless of timing.

4. The “Double Dipping” Trap

Some businesses take multiple MCAs or renew an existing one before it is paid off. In a practice called “double dipping,” the provider may use the new funds to pay off the old balance without waiving the fees on that old balance. You essentially pay fees on money you never see.

5. Less Regulation

MCAs are not technically loans and face less regulatory oversight in many states. However, states like New York (Commercial Financing Disclosure Law) and California (SB 1235) have recently enacted laws requiring providers to disclose APRs to increase transparency.

When a Merchant Cash Advance Makes Sense

MCAs are best suited for specific situations:

Ideal Use Cases

Inventory purchase for a large order: When you have a confirmed order but need capital to fulfill it.

Seasonal preparation: Building inventory before your busy season.

Emergency repairs: When equipment failure threatens your business operations.

Short-term opportunity: When a time-sensitive opportunity requires immediate capital.

Bridge financing: When you need funds while waiting for a larger loan approval.

When to Consider Alternatives

• Long-term capital needs
• Large equipment purchases
• Real estate acquisition
• Situations where you can wait for slower, cheaper financing

Calculating the True Cost

Before accepting an MCA, calculate the true cost.

Cost Comparison Example

MCA Option:

• Advance: $100,000
• Factor rate: 1.25
• Total repayment: $125,000
• Estimated term: 8 months
• Cost: $25,000

Traditional Loan Option:

• Loan amount: $100,000
• Interest rate: 12% APR
• Term: 2 years
• Total repayment: ~$114,000
• Cost: ~$14,000

The MCA costs more, but funds immediately. The loan costs less but may take weeks to obtain.

Questions to Ask MCA Providers

Before signing, ask these questions:

1. What is the total repayment amount?
2. Is this the “Buy Rate” or does it include a broker fee?
3. What is the holdback percentage?
4. How are payments collected (split vs. ACH)?
5. What happens if my sales decline significantly? (Ask specifically about the Reconciliation Clause).
6. Are there any additional fees (origination, underwriting, admin)?
7. Is there a prepayment discount?
8. What are the default terms?

Red Flags to Watch For

Be cautious of MCA providers who:

• Pressure you to decide immediately
• Are not transparent about total costs or APR (especially in NY or CA where it is required)
• Encourage stacking multiple advances
• Have unclear contract terms regarding reconciliation
• Require significant collateral
• Have excessive additional fees

Making the Right Decision

A merchant cash advance can be a valuable tool when used appropriately. The key is understanding the costs, having a clear plan for the funds, and ensuring the return on your investment exceeds the cost of capital.

At Equipment Financing Dallas Pros, we help Dallas businesses evaluate all their financing options, including MCAs. We can help you understand whether an MCA makes sense for your situation and connect you with reputable providers if it does.

Considering a merchant cash advance? Contact us to discuss your options and get quotes from multiple providers.