Guide to Merchant Cash Advances: Regulations & Brokers

Kelly Boyer SagertUpdated August 16, 2022

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

Some small business owners may wonder: “Are merchant cash advances legal?” The short answer is yes. A merchant cash advance (MCA) is a legal option for small businesses to consider when seeking funding. As with all financial decisions, choosing whether to use one should involve considering both pros and cons.

How Do Merchant Cash Advances Work?

At a high level, here’s how merchant cash advances work. An MCA is a type of financing for small businesses (also known as “merchants”) that accept credit card/debit card payments from their customers. When a small business applies for and is approved for this type of financing arrangement, it can get funds advanced from merchant cash advance companies. The small business then usually repay the advance in one of two ways. First, the cash advance company could take an agreed-upon percent of the small business’s debit or credit card deposits each day. Alternatively, it could directly withdraw funds from the merchant’s bank account on an agreed-upon schedule. Rather than charging an interest rate, this type of funding has a factor rate—often ranging from 1.1 to 1.5. Unlike interest rates, which are given as percentages, a factor rate is expressed as a decimal figure. The factor rate is then used to calculate the cost of financing for the small business borrowing the funds.The rate a company is charged can depend upon how much of a risk it poses to the lender. Factors considered when setting a rate can include the industry the company’s in, the company's financial history, its credit and debit card sales, and its years in business. To calculate the amount owed, you multiply the advance by the rate. For example, consider a $10,000 advance at a 1.4 factor rate. That’s $10,000 x 1.4 = $14,000. This would not include any fees charged.Next, let’s consider the regulations that affect MCAs.

Merchant Cash Advance Regulation Overview

The answer to the original question about whether MCAs are legal may be surprising simply because there aren’t any regulations of significance directly associated with MCAs. That lack stems from the fact that these advances aren’t considered loans. And that, in turn, means that companies providing this kind of funding don’t need to follow state usury laws (the laws that limit how much interest can be charged in order to protect consumers). It’s possible that some states will add merchant cash advance regulations to their books at some point in the future, but only time will tell which laws will pass.Additionally, because an MCA isn’t a type of loan, there isn’t federal merchant cash advance regulation, either. It’s worth noting, however, that the United States government does consider violent attempts to collect debts to be a federal offense.Having said that, there are a couple of non-interest-related ways that this type of funding is regulated, as well as at least one type of industry self regulation.

Non-Interest Rate Regulations

Companies offering this type of cash advance are regulated by the Uniform Commercial Code (UCC). However, the UCC regulation doesn't have an impact on interest rates.The UCC isn’t a federal law. Rather, it’s a law that all states have uniformly adopted so that “businesses can enter into contracts with confidence that the terms will be enforced in the same way by the courts of every American jurisdiction,” according to the Uniform Law Commission. The UCC, then, could come into play if merchant cash advance legal issues arise. For example, a lender may take out a UCC lien against some or all of the assets owned by your business to secure the MCA. If you default, the lender may take action to possess the assets or it may contact your clients and demand that they pay the lender directly, rather than you. Alternatively, if you pay off your MCA and the lender does not remove the loan, you have the right to get it removed under UCC regulations. Beyond the UCC, there are two federal entities that may affect MCAs. The Dodd-Frank Act can require the collection of borrower demographic information while the Federal Trade Commission (FTC) can provide oversight if deceptive practices take place.

Self Regulation

Some cash advance companies may agree to abide by the Small Business Borrowers’ Bill of Rights. This bill of rights was created by the Responsible Business Lending Coalition, and elements of it include:

The right to transparent pricing and terms
The right to non-abusive products
The right to responsible underwriting
The right to fair treatment from brokers
The right to inclusive credit access
The right to fair collection practices

If you decide to obtain funding through an MCA, it may make sense to find out if the MCA company you’re considering will honor these rights.

What Are Merchant Cash Advance Brokers?

The fourth bullet in the bill of rights just described focuses on brokers. A merchant cash advance broker is someone who connects companies that need financing with funding companies that can provide them with the money they need. These brokers typically get paid on a commission basis. Merchant cash advance broker commissions and the ways in which these brokers treat customers can vary, as implied by the bullet point in the bill of rights. If you decide to use a broker, you may want to choose one recommended by a trusted friend or colleague.

Using Merchant Cash Advance Companies

There are a number of reasons why a small business might want to use an MCA. Small businesses may decide to use an MCA to fill in gaps in cash flow and to cover unexpected expenses. Some might use one to tide over seasonal fluctuations and/or to buy inventory. This type of funding may also be appealing to startups, small businesses that don’t have much credit established yet, have poor credit, or don’t have collateral to put up, and companies that aren’t able to get more traditional forms of funding. This last group can include small businesses that need to get a merchant cash advance with bad credit. In general, merchant cash advance requirements are not complicated. But it’s important to talk to the specific funder you’re considering to find out what’s needed for your small business to begin to receive advances. And of course not all merchant cash advance companies are alike. Some offer higher limits than others; some are more open to companies with bad credit than others; and so forth. Since the field is so unregulated, it’s important to choose a reputable company that you can trust. It’s typically a good idea to check out an MCA company you’re considering with your local Better Business Bureau to see how it rates and whether there are any complaints against it.

Pros and Cons of Merchant Cash Advances

As with just about any kind of small business funding, there are pros and cons to this option. Here are some of the most significant.

Pros of MCAs

Advantages of this kind of funding may include:

Speedy process from approval to the receipt of funds
Uncomplicated paperwork (perhaps just a basic application and a record of recent credit card/debit card transactions)
No collateral is needed
Payment amounts may drop if the amount of sales transactions dips
Lack of credit history isn’t typically an obstacle
Freedom to use the funds as desired

Cons of MCAs

Disadvantages of this type of funding can include:

High cost, with factor rates ending up translating into 20% to 50% of the cash advance amount
Fees, which can be significant
No early repayment benefits
Lack of regulatory oversight
Don’t help in building credit
Could create debt cycles that can be difficult to escape
Automatic payments can complicate cash flow

The Takeaway

Merchant cash advances aren’t the right solution (or even possible) for every business in every given situation. When your small business needs funding, It may help to prepare by knowing how to apply for a small business loan. It can also make sense to compare cash advance types to choose what makes the most sense for your company. And to see your full range of options, you may want to look at what other small business funding is available to you. Lantern lets you fill out one simple form to compare a range of offers from lenders in our network. Knowing your options is the first step towards making a choice that’s right for you.

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About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.

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