Merchant Cash Advances Explained: The Good, Bad, and Ugly
Type “small business loan” into Google and you get about 172 million results. That number alone tells you something changed. There’s an entire marketplace of funders out there competing for the attention of business owners who need money. And almost none of them require a lunch meeting.
Chapter 7 of Charles H. Green’s The Banker’s Guide to New Small Business Finance dives into the world of online capital providers. The first and most controversial of the bunch is the merchant cash advance. It’s been around since the late 1990s. It’s completely unregulated. And it costs a fortune.
The New Funding Marketplace
The innovative funding world has a few things in common no matter which product you’re looking at.
Everything is virtual. Applications happen online. Approvals happen online. Money moves electronically. There’s no banker across a desk asking about your golf game.
Products are standardized. You don’t get a custom deal. You get the deal that matches your profile. The funder plugs your numbers into their model and spits out an offer. Take it or leave it.
Pricing is expensive. We’re talking 24% APR at a minimum. Often much higher. These funders serve borrowers that banks won’t touch, and they price that risk accordingly.
Repayment happens daily. Most of these products use daily ACH transfers to pull money from the borrower’s bank account. Not monthly payments. Daily. That’s a big deal for cash flow management.
What Is a Merchant Cash Advance?
MCAs are the oldest players in the innovative funding space. They started in the late 1990s, long before “fintech” was a buzzword.
Here’s how they work. An MCA company buys a portion of your future credit card revenue. You get a lump sum today. They take a percentage of your daily card sales until they’ve collected the agreed-upon amount.
The key legal distinction is that this is not a loan. It’s structured as a “Future Receivables Purchase and Sale Agreement.” The MCA company isn’t lending you money. They’re buying something from you. Your future revenue.
Why does that matter? Because loans are regulated. Purchases are not. Usury laws set caps on interest rates that lenders can charge. But if you’re not a lender, usury laws don’t apply to you. That’s the whole game.
The Math That Matters
Green walks through a detailed example that makes the cost crystal clear.
A business gets an advance of $93,851. The specified repayment amount is $127,637. The MCA company captures 16% of daily credit card revenues.
The business does about $100,000 per month in card volume. At that rate, the MCA collects roughly $533 per day. Repayment takes about 240 business days. Work out the annualized return on investment for the MCA company and you get roughly 54%.
But here’s where it gets worse. Say business picks up and card volume rises to $140,000 per month. Now the MCA collects more per day because they take a fixed percentage. Repayment happens in about 172 business days instead of 240. The annualized ROI jumps to roughly 76%.
Read that again. The better your business does, the more expensive the advance becomes. The MCA company’s return goes up when you succeed. That’s baked into the structure.
The Legal Gray Zone
When something looks like a loan, walks like a loan, and quacks like a loan, is it still “not a loan” just because the paperwork says so?
Green raises this question because MCA agreements often include features that look suspiciously loan-like. Personal guarantees from the business owner. Collateral requirements. UCC-1 filings. The right to inspect business records. Foreclosure rights. Power of attorney clauses. Confidentiality agreements that prevent the borrower from discussing terms.
A California court thought it looked like a loan too. In 2011, a court awarded a $23.4 million judgment against AdvanceMe (AMI), one of the original MCA companies. The legal question of whether MCAs are really loans or really purchases has never been definitively settled.
That ambiguity works in the MCA industry’s favor. As long as the structure holds up legally, they operate outside the regulatory framework that governs banks and traditional lenders.
The Biggest Player: AdvanceMe (AMI)
AMI was the oldest MCA company, founded in 1998. By 2008, they had advanced over $1 billion to small businesses. Their goal was to hit $1 billion per year by 2013.
To put that in perspective, if AMI were classified as a bank by FDIC standards, it would have ranked as the 43rd largest small business lender in the country. That’s a single MCA company competing with major financial institutions.
AMI approved over 70% of applications. Compare that to banks, which turned down far more borrowers than they funded. AMI tracked 390 different NAICS industry codes to evaluate risk. Their renewal rate was 75%, meaning three out of four businesses came back for another advance.
Those numbers tell a complicated story. On one hand, these are borrowers who need money and can’t get it from banks. On the other hand, a 75% renewal rate means most businesses end up right back in the MCA cycle. Whether that’s a lifeline or a trap depends on who you ask.
The Problems Nobody Wanted to Talk About
When the mortgage industry collapsed in 2008, a lot of mortgage brokers suddenly needed new jobs. Many of them flooded into the MCA brokering business. They knew how to sell financial products. They didn’t necessarily care about the borrower’s best interest.
Rogue lenders made things worse. Some MCA companies started using “confession of judgment” documents. These are legal instruments where the borrower essentially agrees in advance that if there’s a dispute, the MCA company wins automatically. No trial. No defense. The borrower signs away their right to fight.
The industry eventually tried to self-regulate. Seventeen MCA companies formed the North American Merchant Advance Association (NAMAA) to establish standards and practices. Whether that’s enough to clean up an unregulated industry is an open question.
What Banks Should Learn From This
Green’s point isn’t that MCAs are evil. His point is that MCAs exist because banks left a massive gap in the market. Business owners who need $50,000 or $100,000 in working capital can’t get it from their bank. So they turn to the MCA company that approves 70% of applications and funds them in days.
The cost is brutal. The terms are aggressive. The legal structure is designed to avoid regulation. But the money shows up when the business needs it. For a lot of small business owners, that’s the only thing that matters.
This post is part of a series on Charles H. Green’s The Banker’s Guide to New Small Business Finance, published by Wiley in 2014.
Previous: How Data and New Rules Changed the Lending Marketplace