Merchant Cash Advances: Everything You Need to Know (Including the Risks)

Merchant cash advances have become one of the fastest-growing forms of business financing in America. They're marketed as a quick, easy solution for businesses that can't get traditional loans. But behind the simple pitch lies a complex financial product that many business owners don't fully understand until they're locked into repayment.

This guide will explain exactly how MCAs work, break down the true costs in ways that are often obscured, and help you understand both the legitimate uses and the very real dangers of this financing option.

What Is a Merchant Cash Advance (And Why It's Technically Not a Loan)

A merchant cash advance is not technically a loan. This distinction matters more than you might think. When you accept an MCA, you're selling a portion of your future credit card or debit card sales to the funding company at a discount. The MCA provider purchases your future receivables in exchange for a lump sum payment today.

This legal distinction is important because it means MCAs are generally not subject to usury laws that cap interest rates on loans in many states. There are no federal requirements for MCA providers to disclose an APR the way lenders must under the Truth in Lending Act. This is why you'll typically see 'factor rates' quoted instead of interest rates.

How MCA Repayment Works

MCA repayment happens automatically through one of two methods, and understanding which one you're signing up for is important:

• Split withholding (credit card split): The MCA company takes a percentage of your daily credit/debit card sales directly from your payment processor. If you process $5,000 in card sales today and have a 15% holdback, they take $750.
• ACH withdrawals (fixed daily/weekly): The MCA company withdraws a fixed amount from your bank account daily or weekly, regardless of your actual sales. This is increasingly common.

The ACH model deserves special attention. While the original MCA concept was tied to actual sales (making payments lower when business was slow), ACH-based MCAs take the same fixed amount regardless of your revenue. If you have a slow week, you still owe the same daily payment. This creates cash flow risks.

Factor Rates vs. Interest Rates: Understanding the True Cost

MCA providers quote 'factor rates' instead of interest rates. A factor rate looks deceptively simple — typically between 1.1 and 1.5. But this number obscures the true annualized cost of the financing.

Here's how factor rates work: If you receive $50,000 with a factor rate of 1.3, you'll repay $65,000 total ($50,000 x 1.3). Simple enough. But the factor rate tells you nothing about the annual cost of that money.

A Real-World Example: Estimating True APR

Let's work through a specific example to understand the estimated cost:

On the surface, paying back $65,000 for $50,000 might seem like a 30% cost. But that's not how financing costs are typically calculated. You're paying back that money over 6 months, not using it for a full year. And you're paying it back gradually, so you don't have access to the full $50,000 for the entire period.

Using methods that account for the diminishing principal, this example works out to an estimated APR well over 100%. Some MCAs with shorter terms or higher factor rates can have equivalent APRs that are significantly higher. (Note: APR estimates can vary based on calculation methodology.)

Why MCAs Are Expensive

MCA providers often justify high costs by pointing to the risk they take — they fund businesses that banks often reject. But there are several factors driving the cost:

• Limited regulation: Without usury caps in many states, providers can charge what the market will bear.
• Broker commissions: Many MCAs are sold through brokers who receive commissions — a cost ultimately passed to you.
• Short terms: Quick repayment means capital can be recycled multiple times per year.
• Target market: Businesses seeking MCAs often have limited options, reducing price sensitivity.

The Debt Cycle: How One MCA Can Become Three

One of the most concerning aspects of MCAs is how easily they lead to debt stacking. Here's a common pattern:

A business takes a $50,000 MCA to cover a cash shortfall. Three months into repayment, the daily withdrawals are straining cash flow. Another MCA provider offers a 'renewal' or 'additional advance.' The business takes a second MCA, now owing two daily payments. Within months, they need a third MCA. Each new advance often has a higher factor rate due to the increased risk.

This stacking pattern is very difficult to escape and can lead to unsustainable debt loads.

What MCA Contracts Often Include

MCA agreements typically contain terms that heavily favor the funder. Watch for these provisions:

• Confessions of judgment: In some states, you pre-authorize the funder to obtain a judgment against you without a trial if they claim default. (Note: New York banned this practice in 2019 for transactions with out-of-state businesses.)
• Personal guarantees: Even though the MCA is to your business, you personally guarantee repayment.
• UCC liens: The funder files a lien on your business assets, which can affect your ability to get other financing.
• Reconciliation provisions: While some MCAs allow reduced payments during slow periods, the process may be difficult.
• Prepayment terms: Unlike many loans, MCAs often don't reduce the total owed if you pay early. Review the terms carefully.

When an MCA Might Be Appropriate

Despite the risks, there are limited circumstances where an MCA might make sense. These typically involve:

• A specific, high-return opportunity that will pay for itself quickly
• Very strong, consistent daily card sales
• Emergency funding when all other options are truly exhausted
• Clear understanding of the costs and a concrete repayment plan

We explore these scenarios in detail in our article 'The Only 3 Scenarios Where a Merchant Cash Advance Might Make Sense.' But for most businesses, there are better options available, even if they require more effort to obtain.

The Bottom Line

Merchant cash advances can provide fast funding when traditional options aren't available. But they come with costs that are often not fully transparent and risks that can threaten your business. Before signing any MCA agreement:

• Calculate or estimate the true APR, not just the factor rate
• Explore every alternative first (SBA microloans, online lenders, credit unions)
• Never stack multiple MCAs
• Consult with a financial advisor or attorney if possible
• Ensure your cash flow can handle the daily/weekly payments

If you're considering an MCA, use our calculator to understand the estimated cost, and read our guide to MCA alternatives before making a decision.