What is a merchant cash advance, in plain terms

A merchant cash advance is a lump sum paid to a business today in exchange for a fixed dollar amount of its future receivables, remitted in daily or weekly pieces until the whole amount is delivered. The price is a factor rate, not an interest rate. It is a purchase, not a loan, and that changes what happens when sales fall.

How the cost works: the factor rate

There is no interest rate and nothing accrues. The price is a multiplier, fixed on the day you sign. A $40,000 advance at a factor of 1.30 means you remit $52,000 in total. The cost of the money is $12,000, and it is $12,000 whether you remit it in four months or twelve.

Illustrations, not quotes. Real terms come from a funding partner and depend on your file.

Fees can sit on top of the factor, and the way they sit matters. Some contracts deduct an origination or underwriting fee from the advance while applying the factor to the full amount. As an illustration: a $1,200 fee on that $40,000 advance means $38,800 lands in your account and $52,000 goes back, so the money cost $13,200, not $12,000. Before you sign, ask two questions in the same breath: what is the total I remit with every fee included, and what actually lands in the account.

Same factor rate, three different terms

The factor rate is the whole price, but the term decides how hard the price hits. Take the same $40,000 at 1.30, so $52,000 remitted, and spread it over three different terms at 21 working days a month.

Illustration, not a quote. The daily debit is $52,000 divided by the working days; the annualised figure is the 30% cost scaled to a year. It is not an APR. An APR assumes a balance that falls as you pay it down, and this total never falls.

Read the table twice. The cost column does not move. The daily column doubles between eight months and four, and the money is three times as expensive a year in the four-month row as in the twelve. That is why "what is the factor rate" is only half the question you ask whoever quotes you. The other half is "over what term", and the third half, if you like, is "so what comes out every day".

What happens when sales drop?

Start with how the daily debit gets set, because that is where the trouble is built in. In my read of how these files are underwritten, a funder looks at several months of your bank statements and fixes a daily or weekly amount off the average of what it saw. So a week below your average pays the same debit as an average one. By construction, your thin weeks are over-bitten.

Put numbers on it, as an illustration. A business depositing about $50,000 a month brings in roughly $11,500 a week. A $310 daily debit is about $1,550 a week: 13% of an average week. In a $7,000 week, the same $1,550 is 22%. Nothing about the contract changed. The week did. That is the test to run before you sign: not against your average week, against your thinnest one, and against the month you know is coming.

Now the part the word "purchase" is supposed to cover. If the funder bought a share of your future receivables rather than lending you money, then when your receivables fall, what it is owed should fall with them. Many contracts say so, in a reconciliation clause: you ask, you send the statements for the period, and the fixed debit is reset to the agreed percentage of what you actually brought in. It is not automatic. You have to ask, in writing, inside whatever window the contract sets, with the statements attached, and you have to know the clause is there. So read for it before you sign. A contract that calls itself a purchase and offers no way to reconcile is one to read twice and to ask about out loud. This is what the words commonly mean in these contracts; it is not legal advice, and whether a clause does what it says is a question for whoever reads your contract with you.

Does paying it off early save money?

Usually not, and this is the one that surprises people. The total you remit is fixed on day one. Paying $52,000 back in four months instead of eight costs the same $12,000. It just costs it faster, which is the four-month row in the table above.

The exception is a written early-completion discount. Some funders offer one; some sell it hard, because it is a thing to sell. If it matters to you, ask before you sign, get the size of it in the contract, and read the conditions on it. Then compare it with a business line of credit, where the opposite is true by default: interest is charged on the drawn balance, so it stops the day the balance does.

How the payments come out

Two mechanics, and both go to market under the same name. A fixed daily or weekly debit from the business bank account is the common one, and it is the one every example on this page uses. The other is a share of each day's card sales, sometimes called a holdback, which flexes with your takings. The difference is how the money comes back out, and it matters most in a slow month. Merchant cash advance vs. revenue-based financing walks through it.

Four questions to ask before you sign

1. Is there a reconciliation right, and how exactly do I exercise it? Which clause, what window, what you send, who decides.
2. Is early completion discounted, in writing, and by how much? If the answer is a verbal "we usually do", the answer is no.
3. What is the total I remit with every fee included, and what lands in my account? Two numbers. Do the arithmetic on the page above with the real ones.
4. Which guarantee am I signing? A performance guarantee commonly means you promise not to block the remittances, switch processors or close the account. A full personal guarantee means the balance is yours personally if the business cannot deliver it. They are different things to put your name to. Ask which, and read the words.

When it is the wrong tool

• To cover a hole rather than fund something that produces revenue. An advance turns this month's shortfall into a daily payment on top of next month's.
• When the remittance would not clear in your slowest week. Test it against that week, not your best one.
• When you are already remitting on one. A second on top is stacking, many contracts forbid it, and two daily debits out of one account is a well-worn route to a business that cannot cover either.
• When a line of credit might be open to you after a few months of cleaner statements. The same money costs several times less.

When it can make sense

• The money buys something that earns quickly: parts for a job already sold, the repair to the truck that is stopping work, stock for a season that is booked rather than hoped for.
• The daily debit clears in your thin week with room to spare, and you have run that number.
• You have asked the four questions and liked the answers enough to sign.

Before you sign

Take the four questions back to whoever quoted you. A funder that will not answer them plainly has told you something. If nobody has quoted you yet and you want to see what a partner would read, the form takes about two minutes, asks for a band rather than a figure, and I do not run credit on it. Either way, run the thin-week arithmetic first. It is the only number on this page that is yours.