Many companies have budget gaps. These can be even worse for newer businesses. Companies that don't have many clients might offer better terms to attract more business. Just like a starter  vendor, a startup might offer Net 30 terms.

Offering these terms is a great strategy for developing business relationships, but a lot of time lapses between providing goods or services and getting paid. And in the meantime, your company's bills must be paid.

What are merchant cash advances?

Technically, an MCA isn't a loan. Rather, it is an advance of funds, based on credit card sales of a business. A business can apply for an MCA and quickly get funds deposited into its account. The company can offer Net 30 terms, not having to wait a month for payment.

Businesses that merchant cash advances are good for

A merchant financing program is ideal for businesses accepting credit cards which need fast and easy business financing. An MCA program is designed to help them get funding, based strictly on cash flow as verifiable per business banks statements. As a result, lenders generally will not ask for any burdensome document requests.

This is unlike what most conventional lenders demand. Their document demands can include financials, business plans, and résumés. With MCA, there's no need for collateral. A business's credit card receipts and business bank statements do all the talking.

How MCAs really work

Merchant cash advance providers weigh risk and credit criteria differently from the way bankers do. An MCA provider looks at a company's daily credit card receipts in order to see whether a business can pay back the funds in a timely manner. In essence, a business "sells" a part of future credit card sales in exchange for immediate payment.

With a holdback, an agreed-upon percentage of daily credit card receipts are withheld to repay the MCA every day. This continues until the advance is paid in full.

The entrepreneur and MCA provider agree on advance and payback amounts, holdback, and the advance's term. Once an agreement is made, the advance is transferred to the business's bank account. This is in exchange for a future portion of credit card receipts.

A business using a merchant cash advance typically pays back 20 to 40 percent or more of the amount borrowed (the factor rate). The holdback amount a small business pays every day (a percentage of sales receipts) is different from the repayment amount for the entire advance.

Holdback percentage is based on the amount of funds a business gets, how long it will take to pay back the money, and how big the monthly credit card sales are.

Access to a business owner's merchant account eliminates a collateral requirement. Since repayment is based on a percentage of the daily balance in the merchant account, the more credit card transactions a business does, the faster they can repay the advance.

Caveats regarding MCAs

Rates on a merchant cash advance can be a lot higher than other financing choices. In fact, they can end up being prohibitively high. As a result, it's crucial to understand all terms on offer.