The Ultimate Guide to Merchant Cash Advances in Canada
By Daniel Schoester | Published on 29 Jun 2023
Table of Contents
A merchant cash advance (MCA) is a type of debt financing becoming increasingly popular among small businesses. This loan rapidly approves you by analyzing the collected credit and debit card payments. Once you receive funding, payments will automatically be deducted from your payment processor to repay the loan. The percentage of card sales deducted is known as the holdback rate.
The factor rate determines your cost of borrowing. This generally ranges from 1.1-1.6x and calculates the total amount you must repay. With a factor rate of 1.6x, you’d need to repay $16,000 from your initial loan of $10,000. You’ll automatically repay this loan with the deducted holdback payments.
Despite the high cost, MCAs can be a lifeline for small businesses that need quick access to cash and cannot obtain traditional bank loans. Continue reading to learn about merchant cash advance loans in Canada, including the best providers and popular alternatives.
Advantages & Disadvantages of Merchant Cash Advances
| Advantages | Disadvantages |
|---|---|
| – Easy approval – Rapid funding – Automatic repayment – Flexible structure | – High-interest rates – Lack of long-term financing options – Potentially need to catch up on repayment schedule – Potentially higher payment processing fees |
Advantages
A merchant cash advance (MCA) offers quick and accessible funding for businesses, even if they have low credit scores or no collateral, making it an attractive option for those whom traditional lenders have denied. MCAs provide rapid funding, allowing businesses to secure necessary capital within a few days of application. This enables companies to respond promptly to market changes and seize growth opportunities.
The repayment process for MCAs is streamlined and automatic, with a predetermined percentage deducted from each credit and debit card sales transaction, eliminating the hassle of manual payments. Additionally, MCAs offer a flexible structure that accommodates businesses’ fluctuating cash flow needs, allowing them to address immediate operational requirements.
Disadvantages
While MCAs offer accessibility and quick funding, they have certain risks and considerations. One significant concern is the high-interest rates associated with MCAs, resulting in borrowers paying back significantly more than the initial amount borrowed. MCAs are not suitable for long-term financing needs, as the maximum borrowing period is typically limited to two years.
A slow sales season can cause you to fall behind on the repayment schedule. This can increase the risk of defaulting on the advance, highlighting the importance of carefully assessing cash flow projections. MCA providers often require businesses to switch their credit card processing, which may lead to higher payment processing fees, limiting the choice of a cost-effective solution. Companies must evaluate the overall costs associated with payment processing before committing to an MCA arrangement.
Merchant Cash Advance Explained
A merchant cash advance (MCA) is a financing option for small and medium-sized businesses. It’s great for companies that need quick access to cash but don’t have collateral or a perfect credit score often required by banks. You’ll qualify for the loan based on your sales history. After receiving the loan, you’ll automatically repay it with payments deducted from your point of sale (POS). This section will walk you through the standard terms associated with an MCA loan.
Holdback Rate
The holdback rate is the percentage of a business’s sales withheld and used to repay an MCA. A higher holdback rate implies that more of your daily or weekly sales are being withheld and used to repay the advance. This means you’ll pay the loan off faster but will receive less cash flow. In most cases, holdback rates range from 10% to 30%.
For example, assume you own a small retail store and must purchase new inventory. An MCA lender approves you for $10,000 – congratulations! You will receive the capital upfront, and the lender will take around 10%-30% of your future card sales until you repay the loan.
Next, suppose your store makes $10,000 in credit and debit card sales next month. The MCA provider will automatically deduct their percentage from this amount, leaving you with the remaining 70%-90%. This means the lender withholds $1,000-$3,000 to repay your loan, leaving you with $7,000-$9,000 deposited into your business bank account. The funds are deducted daily or weekly and will continue until you fully repay the loan.
It’s important to understand that the holdback rate is not the interest rate. Instead, it’s the percentage of your credit and debit card income for servicing your loan. A higher holdback rate favours your lender because you repay the loan faster. As a result, you should receive a lower factor rate.
Factor Rate
The factor rate calculates the total amount you’ll need to repay. Instead of an interest rate, lenders use this to determine your cost of borrowing. Factor rates are expressed as a single number, generally ranging from 1.1x to 1.6x.
Suppose you have a factor rate of 1.5x with a $10,000 advance. You must repay $15,000 ($10,000 x 1.5 = $15,000). The factor rate will remain the same regardless of how long it takes to repay the loan. Your holdback payments will contribute to paying off the total loan size.
It’s important to note that the factor and annual percentage rates (APR) differ. This is because the factor rate is not an annualized metric. To understand the annualized cost of borrowing, it’s best to estimate your monthly payment and use an interest rate calculator.
Less creditworthy businesses are generally required to pay higher factor rates. This is to compensate lenders for increased risk. However, you can negotiate a lower factor rate by decreasing your payback period or increasing your credit score.
Payback Period
The payback period is the time you have to repay your MCA. Failing to pay your total loan off by the due date may result in fees or damage to your business credit score. Payback periods for MCA loans generally range from six months to two years. More extended payback periods are riskier to lenders. As a result, you’ll likely have a higher factor or holdback rate. On the contrary, shorter payback periods can reward you with lower factor and holdback rates.
Merchant Cash Advance vs Traditional Bank Loans
Overall, merchant cash advance loans are more convenient but have less favourable lending conditions. The most significant advantage of an MCA is the speed of application and funding. Unlike traditional bank loans, which can take weeks or months to approve and fund, you can often obtain an MCA within 24 hours.
Furthermore, the application process for traditional bank loans can be much more time-consuming and complex than applying for an MCA. Businesses typically must provide detailed financial information and undergo a thorough credit check for a bank loan. This can be a barrier to some companies, especially those just starting out or with less-than-perfect credit.
However, it’s important to note that MCAs often have less favourable lending conditions than bank loans. This can materialize in the form of higher interest rates, lower loan amounts, and shorter payback periods. While MCAs are very convenient, traditional bank loans may be better for businesses needing more money or having longer-term financing needs.
The Finer Details of Merchant Cash Advances
| Key Points | Key Information |
|---|---|
| Interest Rate | – Factor rates (1.1x to 1.6x) used instead of APR |
| Fees | – Payment processing fees (1.5% to 3.5%) – Possible origination fees (1% to 5% of the loan amount) |
| Loan to Value | – Typically up to 1-2 times average monthly card transactions |
| Term Length | – Generally six months to two years |
| Repayment | – Automatic deductions from debit and credit card payments |
| Processing Speed | – Approval within 24 hours, funding in as little as 72 hours |
| Defaulting | – Lenders can seize future sales, impacting operations and debts |
Interest Rate
A standard APR is not used to calculate the cost of borrowing for MCAs. This is because of the many variables that make it difficult to predict. Instead, your cost of borrowing is determined using a factor rate. Your factor rate is not an annualized rate. Instead, you must repay the total amount across your term length. In general, factor rates range from 1.1x to 1.6x.
Fees
Aside from the factor rate, there are generally little to no fees associated with MCAs. However, since you are collecting payments through debit and credit cards, you will be subject to payment processing fees. Payment processing machines generally charge between 1.5% and 3.5%. Many MCA lenders will require you to use their payment processors exclusively. This can subject you to higher processing fees.
While credible MCA lenders are generally transparent, some may try to charge additional fees. A common one to be aware of is origination fees to cover the loan processing cost. This fee can range from 1% to 5% of the total loan amount.
Loan to Value
Loan to value (LTV) is commonly used with collateral loans. It represents the loan size ratio to the collateral’s value. Since an MCA is a quasi-collateral loan, this metric doesn’t directly apply. However, MCA loans generally lend you up to one to two times your average monthly card transactions.
For example, if you process $10,000 monthly card transactions, the lender may issue a loan of up to $10,000 – $20,000. However, a few additional factors determine your final loan size. This includes your business creditworthiness, repayment rate and holdback rate.
Term Length
The term length is how long you have to repay your MCA loan. This generally ranges between six months and two years. Depending on your loan size, business credit profile, and other factors, you may be eligible for an extended term. However, note that extended term lengths are riskier to lenders. As a result, you’ll likely have a higher factor and holdback rate.
Repayment
Your MCA repayment is handled automatically from your debit and credit card payments. You don’t have to worry about late or missed payments because lenders deduct a percentage of your daily or weekly sales until you repay the loan. However, a slow season could put you drastically behind your payback schedule since your monthly payment is variable. If your term length is creeping up, you could default on your loan if you cannot make the required payments. Otherwise, you may need to pay significant fees to extend your term.
Processing Speed
The processing speed for an MCA loan is much faster than a traditional loan. Often, you can receive approval within 24 hours and funding in as little as 72 hours. As such, waiting weeks or months before receiving your funds is unnecessary.
Defaulting
Defaulting on an MCA can be disastrous for a business’s finances. Since your MCA loan is directly linked to your credit and debit card machine, your lender has collateral over your accounts receivable. If a business defaults on an MCA, the provider can seize future sales, making operating and repaying other debts challenging. Before agreeing with a provider, companies should understand the default clauses, including any early repayment penalties or additional fees.
The Best Merchant Cash Advance Companies in Canada
When choosing a merchant cash advance company, comparing rates, terms, and fees is essential. Ensuring the company has a good reputation and is committed to helping businesses succeed is also necessary. Consider these comparison factors when assessing the best merchant cash advance companies in Canada.
Merchant Growth
Merchant Growth offers financing from $5,000 to $500,000 with fast approval in 24 hours. Their accessible and flexible MCA products do not require collateral and can be used for short-term expenses or business opportunities. Repayment is based on a percentage of future sales, with term lengths ranging from 6 to 18 months. They also offer a fixed solution where businesses repay a specified amount daily or weekly.
2M7 Financial Solutions
2M7 Financial Solutions offers funding up to 125% of average monthly sales, with simple repayment through automatic deductions from daily sales. The application process is fast, funds are deposited within 24-48 hours, and it doesn’t impact credit scores. Businesses can use the funds for various purposes like cash flow, equipment, inventory, renovations, staffing, marketing, and debt consolidation. 2M7 Financial Solutions has a high approval rate and supports the growth of their clients.
Greenbox Capital
Greenbox Capital provides funding options ranging from $3,000 to $500,000, with repayment based on sales and flexible schedules. The application process is fast, and funds can be deposited within 24 hours. The funds can be used for various purposes, such as growth strategies, marketing, inventory, equipment upgrades, hiring, and training. Greenbox Capital focuses on the business’s overall health and considers factors like revenue, cash flow, vendor payment history, and years in business for approval.
Shopify Capital
Shopify Capital provides a lump sum of money in exchange for a fixed fee. The repayment is based on a percentage of your daily sales until the total amount is paid off. The holdback rate depends on your risk profile. There is no set deadline for repayment, and the holdback amount is automatically deducted from your business bank account based on your store’s daily sales. Shopify Capital notifies eligible stores via email and the Shopify admin dashboard, and eligibility can also be checked on the Capital page of the admin panel.
Clearco
Clearco positions itself differently from MCA lenders but has the same underlying principles. They target e-commerce businesses using Amazon, Stripe, Shopify, and Paypal. They will analyze six months of sales to qualify you for a loan. However, uniquely Clearco will cap your monthly payment when your sales exceed a certain threshold. This will provide more cash flow to your business as your holdback rate decreases. However, it will also take longer to repay the loan.
Merchant Cash Advance Alternatives
| Alternative | General Borrowing Cost | Payback Period | Collateral |
|---|---|---|---|
| Business Credit Card | 15-25% APR, Annual fee | N/A | No |
| Business Loan | 5-15% APR, Originitaion fees | 1-10 years | Potentially |
| Invoice Factoring | 1-6% of the invoice amount | N/A | No |
| Equipment Financing | 5-15% APR, Origination fees | 1-5 years | Yes |
Business Credit Card
A business credit card is an excellent alternative to an MCA. They operate as unsecured revolving loans with an interest-free period of one month. This means you won’t incur interest on purchases until your statement payment is due. In addition, many business credit cards have rewards or cashback programs. Other cards have no foreign exchange fees.
The primary downsides are that your borrowing limit will likely be lower than secured lending alternatives. In addition, business credit cards generally have high fees, such as a 15%-25% APR and annual fee.
Business Loan
Business loans come in many variations. Generally, they are more challenging to qualify for than an MCA and provide more favourable lending conditions. For example, business loans typically have longer term lengths, higher lending limits, and lower interest rates. Small business loans may be easier to qualify but will likely have higher interest rates and smaller lending limits.
Business loans can either be secured or unsecured. Secured loans require you to provide collateral, such as your inventory. Failing to make payments will result in asset seizure to pay off your loan. Meanwhile, unsecured loans require no collateral but are riskier to lenders. As a result, secured loans generally have lower interest rates.
The cash flow structure of your business loan can also change. For example, a line of credit operates like a credit card. You’re issued a maximum borrowing limit and can draw from it as needed. It is the most flexible option because you’ll only pay interest on the drawn money. Conversely, a term loan provides more stability. You’ll receive a lump sum and repay it over a fixed period with a fixed monthly payment.
Invoice Factoring
B2B businesses with extended account receivable cycles commonly use invoice factoring. This option lets you sell unpaid invoices at a discount to receive immediate cash. Discounts generally range between 1% and 6%, depending on your client’s creditworthiness.
For example, if you sent a $2,000 invoice due in three months, you could collect 94%-99% of that immediately. You won’t have to wait months to collect invoices from your customer. You’ll receive money now, and the invoice factoring company will collect the funds from your customer in three months.
Equipment Financing
Equipment financing is a type of secured loan that collateralizes machinery and equipment. You can use this loan to purchase new equipment or borrow against machinery you already own. Equipment financing typically has lower interest rates than MCAs. However, the lender can seize your collateral if you fail to make payments.
FAQ About Merchant Cash Advances in Canada
A merchant cash advance provides immediate capital repaid with a portion of future debit and credit card sales. They generally have higher interest rates than alternatives put provide rapid access to funds.
Once approved, the lender will deposit a lump sum into your business bank account. The repayment is typically a fixed percentage of future debit and credit card sales automatically debited from your merchant account. You will automatically make payments until the total loan is repaid.
You must become a registered merchant service provider to sell merchant cash advances. This requires obtaining the proper licenses from your province or territory and financial regulator. You will also need to obtain contracts with lenders that offer MCA products.
You can start a merchant cash advance business by becoming an MCA provider. This requires registering with your provincial or territorial regulator, obtaining merchant service provider contracts, and finding customers. You must consult a lawyer for legal advice to ensure compliance with all applicable laws.
Merchant cash advances can be a good option for businesses needing fast access to capital. However, they typically have higher interest rates than secured loans and don’t have long-term financing options.
Yes, merchant cash advances are legal in Canada. However, the laws and regulations vary by province or territory. You must consult a lawyer for legal advice to ensure compliance with all applicable laws.
You can record a merchant cash advance in QuickBooks by entering the loan details, such as the lender, interest rate, and repayment terms. Once approved, you must enter an invoice for each payment due. The amount will be automatically taken from your checking account and recorded in QuickBooks.
If you default on a merchant cash advance, the lender can take legal action to collect the debt. Depending on the terms of your agreement, they may also withhold future income from your payment processors to repay the loan.
A merchant cash advance loan is a type of financing that uses your business’s future credit and debit card sales to repay the loan. The lender will deposit a lump sum into your business bank account, and you will make automatic payments from your merchant account until the entire loan is repaid.
