Merchant cash advance: how it works, what it costs and when a loan is cheaper
A merchant cash advance is repaid from your card takings plus a fixed fee. How the factor rate works, and when a term loan or overdraft costs less.
Reading time5 min read
CategoryBusiness guides
Written byThe bizbritain team
A merchant cash advance gives your business a lump sum now. You repay it from a share of your card takings, plus a fixed fee. Repayments rise in a busy week and fall in a quiet one. It can be quick to arrange, but it often costs more than a loan or an overdraft.
This guide explains how it works, what it really costs and when a loan is the cheaper choice.
Section 01
How does a merchant cash advance work?
A provider pays you an upfront sum. It then takes a share of every card payment your customers make until the advance and the fee are repaid.
According to the British Business Bank, a typical deduction is around 10% of each card sale. It says repayment usually takes three to 18 months.
There are no fixed monthly repayments. The more card sales you take, the faster the advance is cleared. It is only open to businesses that take a steady flow of card payments, such as shops, cafes and restaurants.
You do not usually need to offer property or stock as security. The application needs less paperwork than most loans, and the money can arrive quickly.
Section 02
What does a merchant cash advance really cost?
The cost is set by a factor rate, not an interest rate. A factor rate is a number such as 1.2. You multiply the advance by it to find the total you repay.
Here is an illustration, not a quote. Say you take £10,000 at a factor rate of 1.2. You repay £12,000 in total. That is the £10,000 plus a fixed fee of £2,000.
So what is the catch?
The fee does not shrink if you repay quickly. If a strong Christmas clears the advance in four months, you still pay the full £2,000. Over a shorter time, the same fee is a much higher yearly cost.
The British Business Bank makes the same point. It says fees are fixed, early repayment is restricted, and there is nothing to gain from paying early. It also warns that the high fees can make an advance more costly than other funding.
Section 03
When a term loan or overdraft costs less
A term loan has fixed repayments over a set period, and it quotes an interest rate. That makes it easier to compare offers side by side.
According to the British Business Bank, a business loan usually has lower interest than a merchant cash advance and a longer time to repay.
An overdraft works differently again. You pay interest only on the amount you use, for as long as you use it. For a short gap between paying suppliers and being paid, that can cost far less than a fixed fee.
Many businesses use both. A term loan covers a planned purchase, and an overdraft covers the dips. Our guide to funding seasonal stock shows how that split works.
Section 04
Is it regulated? The questions to ask first
Do not assume either way. According to the FCA, it regulates business lending only where the borrower is a sole trader or small partnership borrowing £25,000 or less. Lending to limited companies is outside its remit.
The British Business Bank describes a merchant cash advance as an alternative to a traditional business loan. So ask the provider directly, and get the answers in writing.
What will I repay in total?
Ask for the factor rate and the full amount repayable, in pounds.
How much of each sale is taken?
Ask what share of each card payment goes to the provider, and how often it is collected.
Does repaying early save anything?
Ask whether any of the fee is refunded if you clear the advance early. Usually it is not.
Can I still take cash?
The British Business Bank warns that steering customers towards cash can breach the terms. Ask what the contract says.
Is this agreement regulated?
Ask whether it is covered by the FCA, and who handles a complaint if something goes wrong.
Section 05
Who a merchant cash advance suits
It can suit a business with strong card takings and a short, clear need. That might be stock for a busy season, or an urgent repair to get trading again.
It suits a business less well when the need is large or long term. The British Business Bank says advances should only be used by businesses that can repay quickly.
If you are weighing up a bigger step, such as new equipment or a second site, compare the options first. A broker can look at the deal across a wider range of lenders. Find out more about business growth finance with us.
This guide is general information, not financial advice. Applications are subject to status, affordability and lender criteria.
Got a question the guide didn’t answer? Talk to an advisor.
We’ve arranged growth finance for thousands of British businesses. If you’ve read the guide and you want to see what £25k to £10m from 100+ lenders could do for yours, our advisors are on the phone now.