Merchant Cash Advance with Bad Credit

Lauren Ward

Updated November 2, 2020

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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.

Using a merchant cash advance gives businesses with bad credit the opportunity to access needed financing. Bad credit is generally defined as a FICO® Score of less than 580, between 580 and 679 is considered fair. In exchange for receiving a lump sum of cash to use at your discretion, the lender siphons off a portion of your company’s credit card sales until the balance is paid in full. Collateral isn’t always required and there are also typically less stringent credit requirements compared to a small business loan.However, merchant cash advances are structured much differently than traditional financing options. Be sure to understand the details in full and seriously weigh the pros and cons before making a decision.

Merchant Cash Advances Explained

A merchant cash advance is a type of small business financing that provides you with a lump sum of cash from a merchant cash advance provider at the beginning of the borrowing term. Instead of making fixed payments like you would with a loan, however, you consistently repay the funds with a portion of your sales until the balance (and additional fees) is gone. Instead of accruing interest like a traditional loan, lenders apply factor rates. Factor rates will be explained in detail in the next section, but in general, the higher the factor rate, the more expensive the merchant cash advance will be. With a business cash advance, borrowers with less than stellar credit may be more likely to qualify for funding than with a traditional small business loan. This is because merchant cash advances are repaid based on a businesses future sales, so credit scores aren’t as much of a deciding factor. Plus, the application process is generally fast and you typically get access to the funds quickly if you qualify. However, you’ll need enough sales volume to cover the repayment process, since funds to repay the cash advance are automatically deducted every time you make a sale. Because merchant cash advances don’t usually require borrowers to have good credit, their combined fees and interest rates can be quite high. This type of financing is typically used by companies that need cash fast and have limited options elsewhere. While merchant cash advances don’t generally require borrowers to have strong credit scores, providers may still run a credit check during the application process.

How Merchant Cash Advances Work

A merchant cash advance works differently than a traditional business loan, so it’s important to understand all of the components of the transaction. Once you receive the lump sum, you’ll have a set period of time to repay the total owed amount—which includes the principal as well as fees and interest. Depending on your borrowed amount and your sales volume, the repayment term could last anywhere between three months and three years.Rather than being charged a fixed interest rate like with a loan, a merchant cash advance assesses a fee as a factor rate. A factor rate is a multiple of the amount you’re being funded. For example, if your factor rate is 1.2 and you borrow $50,000, you would multiply the two together to determine the total balance to be repaid.1.2 * $50,000 = $60,000As you can see in this hypothetical scenario, it would cost $10,000 to borrow $50,000 with a factor rate of 1.2.The next concept to understand when considering a merchant cash advance with bad credit is the holdback amount. This refers to the percentage of your credit card or debit card sales that will be diverted to repaying the cash advance. In general, you can typically expect a holdback amount to range between 10% and 20% of your sales (or sometimes up to 30%). It is important to seriously weigh this along with your factor rate to avoid any cash flow issues-—and potentially default—during the repayment period.Defaulting on a merchant cash advance comes with a series of problems. For starters, you could be charged late fees or have your holdback amount increased, both of which can substantially increase your balance. Your company’s credit score could also drop if the lender reports your delinquent account to the credit reporting bureaus. That could make it more difficult to get financing approval in the future.

Qualifications and Application Process

Qualifying for a merchant cash advance typically relies more on your company’s financial transactions rather than credit history, which is why businesses with bad credit may opt for this type of financing. Merchant cash advance companies may also have a minimum threshold for monthly credit card sales.While the application process may not be as intensive as a traditional small business loan application, still expect to pull some of your company’s financials together. Here are some common documents that may be requested:

Several months of bank statements
Tax returns
Accounts receivable summary report
Profit and loss statement

While there will likely be a credit check during the application process, your company’s daily sales are generally weighed more heavily than its credit score. In many cases, you don’t need to provide a personal guarantee and instead keep the advance completely in the business’s name. If you are requesting a large sum, however, you may need to provide that personal guarantee or some other type of collateral.

Pros and Cons of a Merchant Cash Advance for Bad Credit

A merchant cash advance may be a financing solution to consider in some scenarios, but it’s worth fully weighing the pros and cons of this type of financing.One of the biggest benefits of using a business cash advance is that you can get lump sum financing even if you or your company has bad credit. You can also typically expect a quick funding time if you qualify, often within a day or two of applying. These conveniences come with a hefty price, however. Merchant cash advances usually involve extremely high fees and factor rates. Typically interest rate limits don’t apply since they’re technically not loans. Another drawback is that there aren’t any savings if you pay off your balance early, as there might be when you make prepayments on a traditional business loan. And you may experience a cash flow crunch because of the daily holdback amount.Another con is that merchant cash advances are only available to businesses with credit or debit sales, such as retailers or restaurants. Finally, your payments on a cash advance are not reported as positive payments on your credit report, so it doesn’t help to build your business credit.

Alternatives for Bad Credit Business Financing

Businesses with bad credit may consider other alternatives before deciding on a merchant cash advance. Some lenders specialize in bad credit business loans, including those designed specifically for startups and women business owners. It may be challenging for applicants with less-than-stellar credit scores to qualify for a business loan. And keep in mind that terms and rates may vary based on personal qualifications and lender policies.Another option is a business line of credit. It may be difficult to qualify with traditional banks, but you may find some alternative online lenders who offer lines of credit for businesses with less-than-stellar credit.Finally, invoice factoring could be another viable choice if your business needs better cash flow while waiting for companies to pay their invoices. The factoring company fronts you the majority of the amount of your unpaid invoices, but first subtracts a percentage as its fee. Once the invoices are collected, you’ll receive the remaining balance. The price of invoice factoring can be very high, however, plus you may have to rely on the factoring company to manage your client relationships when collecting invoices.

Comparing Financing Options for Your Small Business

A merchant cash advance offers quick and easy financing for small businesses with bad credit, but there is substantial risk involved. Before accepting a merchant cash advance, review all of your options and evaluate your company’s cash flow to make sure it’s strong enough to support the ongoing holdback amount. Looking for more small business financing opportunities? Compare your small business financing options with Lantern Credit.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit (https://www.consumer.ftc.gov/topics/credit-and-loans) The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC20038

Frequently Asked Questions

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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