A merchant cash advance (MCA) is a form of financing where a business receives an upfront lump sum of cash in exchange for a portion of its future revenue (usually credit card or debit card sales). Instead of fixed repayments like a loan, the MCA provider takes a percentage of the business’s daily or monthly revenue until the advance (plus fees) is repaid. Think of it like selling tomorrow’s sales to get money today.

MCA-style funding has been adapted to the SaaS business model—substituting recurring revenue for the “merchant” sales you’d find in a restaurant or retail business. Unfortunately, many SaaS founders don’t fully understand how MCAs work and that can cause a miscalculation of borrowing costs, or worse, cash flow problems.

A merchant cash advance may sound like a loan, or it might be sold as revenue-based financing, but it’s different. 

Here’s how MCAs work:

1. The MCA provider gives the business an upfront cash advance.

2. The business agrees to give up a set percentage of daily or weekly revenue, which is called a holdback percentage.

3. MCAs use a factor rate, instead of an interest rate, to calculate the total repayment amount, which is repaid daily or weekly, depending on the terms, until the balance is $0.

Example:

• Advance amount (principal): $100,000

• Factor rate: 1.3

• Total repayment: $100,000 × 1.3 = $130,000

• Cost of capital: $130,000 – $100,000 = $30,000

The effective annual rate (EAR) accounts for both the cost of capital and the repayment timeline. That’s where MCAs catch people by surprise, because they’re usually repaid quickly with more frequent compounding. The effective cost should be measured against the average outstanding balance rather than the full $100,000, since the merchant doesn’t have the full principal outstanding the whole time.

Let’s assume:

• Repayment period: 6 months (common for MCAs)

• Average outstanding balance: Since the balance shrinks daily/weekly, we estimate the average borrowed balance is about half the principal ($50,000).

We can use the following to calculate a simple periodic rate and then annualize it:

• Finance charge = $30,000

• Average balance = $50,000

• Period = 6 months

Simple periodic rate = $30,000 ÷ $50,000 = 0.60 (60%) over 6 months.

Nominal Annualized Rate (APR) ≈ 60% ÷ 0.5 years = 120% 

Effective Annual Rate (EAR) ≈ (1 + 0.60)^2 - 1 = 156% 

Takeaway:

In the example, the MCA “headline” cost looks like 30% ($30k on $100k). But when annualized, the true cost of capital can easily exceed 100%, making it one of the most expensive financing tools out there.