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How a merchant cash advance works

The contract you sign for an advance is a sale agreement, the payments come out of your bank account every business day, and the factor rate on the offer leaves out the one number you need. Each piece is below.

What you signed

On paper, you sold receivables

A merchant cash advance agreement is written as a purchase. The funder buys a fixed dollar amount of your future card or bank receipts, say $70,000, and pays you a discounted price for them today, say $50,000. That is why the paperwork is titled “purchase and sale of future receivables” and the price is quoted as a factor rate.

The label has consequences. A purchase of receivables generally falls outside the interest rate caps that apply to business loans in most states, New York included, which is how a product that can cost 95% a year is sold legally.

The buyers are mostly businesses a bank is slow to serve. A nail salon in Sunset Park or a contractor working out of Long Island City might wait months for a community bank to underwrite a loan, and can often have an advance funded in a day or two. Speed is what they are paying for.

The mechanics

Five steps, in order

The advance and factor rate are quoted. You receive, for example, $50,000 at a 1.40 factor rate. Multiply the two: you owe $70,000 total, before any fees.

A holdback percentage is set. This is the share of your daily card or bank receipts the funder collects, commonly 10 to 20 percent. A higher holdback repays faster but strains daily cash flow harder.

A fixed daily or weekly remittance is calculated. Many agreements convert the holdback into a fixed dollar amount based on your trailing average receipts, debited automatically. This is where a slow month becomes a cash flow problem: the fixed payment does not fall with your revenue unless your agreement includes reconciliation.

Reconciliation, if it exists, lets you request an adjustment. Some agreements let you request the remittance be recalculated against actual receipts, monthly. Not all agreements include this, so look for the clause before you sign.

Remittance continues until the full $70,000 is collected. The contract sets no end date the way a loan term does. Payoff moves with your receipts, so the exact annual cost can’t be known on the day you sign.

The math

Why 1.40 does not mean 40 percent

Most people read a 1.40 factor rate as a 40 percent cost. It is 40 percent of the advance, with no time attached. APR is cost per year, so the payback period decides everything. On $50,000 at 1.40, paid by debits every business day, twelve months works out to about 71% APR, nine months to 95%, six months to 142% and four months to 212%.

Put your own advance amount and payback period into the calculator linked below before you trust any factor rate. Funders everywhere quote the same way, so the math holds whether the offer comes from Manhattan or from a company you have never heard of. To see what the same amount costs as an SBA-backed loan, start with the U.S. Small Business Administration’s loan overview.

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