Merchant Cash Advance Underwriting: the Fundamentals

Are you considering a merchant cash advance (MCA) to quickly finance your small business? Before you apply, it's important to understand the MCA underwriting process and how lenders make approval decisions. In this article, we'll provide an overview of MCA underwriting and share tips to help you improve your chances of success.

Key Points:

• The MCA underwriting process involves evaluating a business's creditworthiness to determine the merchant cash advance terms.
• Lenders review various factors, such as credit score, monthly revenue, and time in business, when evaluating MCA applications.
• MCA lenders use paper grades based on credit score, time in business, and revenue to assess risk and determine loan amounts, interest rates, and repayment terms.
• Software usage can simplify and enhance the MCA underwriting process.
• Effective merchant underwriting involves clear eligibility criteria, due diligence, proactive monitoring, customized procedures, collaboration, continuous improvement, and data-driven decision-making.

Understanding Merchant Cash Advance Underwriting

Small businesses have many financing options available, including merchant cash advances. However, understanding the merchant underwriting process is crucial to increase the chances of success and avoiding common pitfalls of MCAs. Here are some key points to keep in mind:

• The MCA Underwriting Process: Underwriting is the process where lenders evaluate the creditworthiness of a business and decide on the terms of the merchant cash advance.
• Less Strict than Traditional Financing: Merchant cash advance underwriting is generally more flexible than traditional financing underwriting.
• Factors Considered in MCA Applications: Lenders review various factors, such as credit score, monthly revenue, and time in business, when evaluating MCA applications.
• Reviewing Cash Flow and Revenue Consistency: Lenders may examine bank statements and credit card processing statements to evaluate cash flow and revenue consistency.
• Determining the Repayment Terms: The terms of the merchant cash advance, including the percentage of daily credit card sales taken as repayment, are established during the underwriting process.

What Is Underwriting?

Before lending money to individuals or businesses, lenders evaluate their creditworthiness through underwriting. Here are key points to consider when understanding the underwriting process for loans and financing:

• Assessing Risk: Underwriting is a way for lenders to determine the level of risk involved in lending money to borrowers.  
• Financial Information: The MCA underwriter will evaluate your financial status and creditworthiness by reviewing your income, assets, liabilities, and credit history.
• Types of Financing: Lenders use underwriting for different kinds of loans, such as mortgages, auto loans, and business loans.
• Varying Strictness: Depending on the lender and the type of financing, the underwriting process can be strict or flexible.
• Lender's Decision: The underwriting process results in the lender's decision to approve, deny, or offer different financing terms.

What Is the Merchant Cash Advance Underwriting Process?

MCA financing isn’t suitable for everyone. However, if you decide that it is, you should know and understand the following steps of the underwriting process:

• Application Submission: A business submits an application to a lender for a merchant cash advance.
• Financial Information Review: The lender reviews the business's financial information, including credit score, monthly revenue, and time in business.
• Cash Flow and Revenue Analysis: The lender may also review bank and credit card processing statements to assess the business's cash flow and revenue consistency.
• Underwriting Decision: Based on the financial information and analysis, the lender decides whether to approve, deny, or offer different terms for the merchant cash advance.
• Terms Determination: After approval, the lender sets terms for the advance.
• Funding: Once the terms are determined and the business agrees, funding is often available within a few days.

What Are Merchant Cash Advance Paper Grades?

Merchant cash advance underwriting guidelines use paper grades  to evaluate creditworthiness based on credit score, time in business, and revenue. These grades also determine loan amounts, interest rates, and repayment terms. Examples of businesses for each grade could include:

• A+ Grade: A well-established restaurant with impressive credit scores, consistent revenue streams, and a strong track record of successful operations.
• A Grade: A local boutique with good credit scores, consistent revenue streams, and a reliable history of success.
• B Grade: A new clothing company with fair credit scores, somewhat consistent revenue, and a moderate history of successful operations.
• C Grade: A small store facing financial difficulties with bad credit scores, unstable revenue streams, and limited successful operations history.
• D Grade: A new tech company that has yet to make consistent revenue, has poor credit scores, and has no proven history of successful operations.

How Are MCA Paper Grades Used?

MCA paper grades evaluate the risk of a potential borrower and offer a snapshot of a business's financial health and loan repayment capacity. The grades also determine the loan's terms and conditions. In detail, here are some ways MCA paper grades are used in the merchant underwriting process:

• Evaluating the Business's Creditworthiness: MCA paper grades are determined by analyzing factors such as credit score, time in business, revenue, and industry risk. This helps underwriters assess a business's suitability for a merchant cash advance.
• Loan Amount: A borrower's paper grade often determines the loan amount they are eligible for. Higher paper grades increase the chances of approval for larger loan amounts.
• Interest Rate: Lenders use MCA paper grades to determine the interest rate for borrowers. Borrowers with higher paper grades usually receive lower interest rates.
• Repayment Terms: MCA paper grades affect repayment terms. Low-paper-grade borrowers may have shorter repayment periods, while high-paper-grade borrowers may have more extended repayment periods.
• Managing Risk: Underwriters use MCA paper grades to manage risk by identifying delinquent borrowers. They may decline or offer less favorable terms to lower-grade borrowers to minimize the risk of default.

What Factors Determine MCA Paper Grades?

The paper grades used to evaluate a business's creditworthiness for a merchant cash advance depend on various factors ranging from credit score to business size. In further detail, here are the main factors:

• Credit Score: Borrowers with higher credit scores are more likely to be assigned higher paper grades.
• Credit History: A history of timely payments and responsible credit use can lead to a higher paper grade.
• Industry Type: Some industries are considered higher risk than others, and borrowers in these industries may be assigned lower paper grades.
• Size of Business: Smaller businesses may be considered higher risk than larger businesses and may be assigned lower paper grades.
• Monthly Revenue: Higher monthly revenues can lead to a higher paper grade.
• Time in Business: More established businesses may be considered lower risk and assigned higher paper grades.
• Outstanding Debt: Borrowers with high levels of outstanding debt may be considered higher risk and may be assigned lower paper grades.

What Are the Qualifications for the Different Paper Grades?

Businesses get assigned MCA paper grades depending on their creditworthiness and business performance. Here are the qualifications for each grade:

• A Paper Grade Merchants: High credit score, long credit history, profitable business, and low outstanding debts.
• B Paper Grade Merchants: Average credit score, moderate credit history, decent revenue, and manageable debt.
• C Paper Grade Merchants: Below-average credit score, short credit history, inconsistent revenue, and higher debt levels.
• D Paper Grade Merchants: Poor credit score, limited or no credit history, struggling business, and high debt-to-income ratio.

How Can a Company Estimate Its Paper Grade?

Companies can consider factors that influence their creditworthiness and business performance to estimate their MCA paper grade. Some actionable tips for this purpose include:

• Check Credit Score and History: Obtain a credit report and make sure it is accurate, without errors or negative information that could lower the score.
• Review Business Financials: Analyze revenue, expenses, profit margins, and outstanding debts to determine the financial health of the company.
• Research Industry Type: Investigate the industry's risk level and the company's position in the market to assess its competitive advantage and potential for funding.
• Evaluate Business Size: Assess the company's size, growth potential, and scalability to determine its eligibility for funding.
• Consider Operating History: A longer operating history demonstrates stability and reliability, which can positively impact a company's creditworthiness.
• Payment Processing Method: Choose payment processing methods or software integrations preferred by MCA providers to improve funding eligibility.
• Plan Use of Funds: A clear plan for fund usage and objectives can impact approval decisions.
• Check Personal Credit: Ensure personal credit is in good standing, as it can impact the company's MCA paper grade.
• Review Bank Statements: Check bank statements for errors, inconsistencies, and suspicious activity that could affect the application.

What Does a Merchant Cash Advance Underwriter Do?

An MCA underwriter plays a crucial role in evaluating risks and approving loans for trustworthy borrowers. Key duties, skills, and responsibilities of a successful underwriter include:

Job duties:

• Loan Application Review: Review loan applications to assess business financials, credit scores, and payment history.
• Market Trend Analysis: Analyze industry and market trends to make informed lending decisions.
• Loan Negotiation: Negotiate loan terms and conditions with clients and sales representatives.
• Loan Proposal Presentation: Prepare and present loan proposals to senior management for final approval.
• Regulatory Compliance:  Ensure compliance with regulations and company policies.

Skills:

• Financial Analysis: Strong analytical and financial skills to evaluate loan applications and make lending decisions.
• Industry Knowledge: Knowledge of the MCA industry and lending practices.
• Communication: Excellent communication skills to interact with clients and sales representatives.
• Time Management: Ability to work under pressure and meet tight deadlines.
• Attention to Detail: Detail-oriented and organized to ensure accuracy in loan application evaluations and documentation.

Responsibilities:

• Credit Evaluation: Evaluate the creditworthiness of loan applications and determine appropriate funding amounts and interest rates.
• Loan Portfolio Management: Manage and monitor loan portfolios to minimize risk and ensure timely payments.
• Record Keeping: Maintain accurate records of loan applications, approvals, and denials.
• Cross-Departmental Collaboration: Collaborate with other departments such as sales, marketing, and customer service to ensure smooth loan application processes and client satisfaction.
• Industry Knowledge: Stay up-to-date with industry trends and regulations to ensure compliance and best practices

How Is Software Used in the Merchant Cash Advance Underwriting Process? 

Merchant cash advance underwriting software has become increasingly prevalent over the last few decades to simplify and enhance the underwriting process. The following 7 ways demonstrate how it can be utilized:

• Credit Analysis: Merchant cash advance underwriting software can evaluate a business's creditworthiness by analyzing credit reports, scores, payment history, and debt-to-income ratio.
• Cash Flow Analysis: By analyzing a company's bank statements and financial transactions, the underwriting software can quickly perform a comprehensive cash flow analysis.
• Risk Assessment: Merchant cash advance underwriting software can help assess risk by analyzing a business's past performance, financial data, market trends, and industry benchmarks.
• Automated Underwriting: Automated underwriting software quickly approves loans, streamlines tasks, and consolidates data from multiple sources.
• Predictive Analytics: Underwriters use predictive analytics software to forecast a business's future performance, improving lending decision accuracy based on historical and relevant data.
• Fraud Detection: Software can help detect fraudulent activity by analyzing transaction patterns, identifying inconsistencies, and flagging suspicious behavior.
• Compliance Monitoring: Software can monitor compliance with regulations and policies, such as anti-money laundering (AML) and know-your-customer (KYC) requirements. 

Pros of MCA Underwriting Software

Incorporating merchant cash advance underwriting software offers several benefits to the lending process. Here are some key advantages:

• Improved Efficiency: Software can automate many underwriting tasks, reduce the time and resources needed to evaluate a loan application, and make the process more efficient.
• Consistency: Merchant cash advance underwriting software can ensure consistent and objective underwriting decisions, reducing the risk of bias or errors caused by human judgment.
• Enhanced Accuracy: Software can accurately analyze large data sets to provide a comprehensive view of a business's creditworthiness and financial position.
• Better Risk Management: Merchant cash advance underwriting software can identify potential risks and help make more informed lending decisions by analyzing a business's financial history and market trends.
• Scalability and Flexibility: Underwriting software is flexible, customizable, and scalable, enabling lenders to manage their operations efficiently as loan volumes and business needs grow.
• Faster Loan Approvals: Automated underwriting software swiftly processes and approves loan applications, providing borrowers with faster funding and a streamlined customer experience.
• Cost Savings: Software can increase lenders' profitability by reducing underwriting time and resources, resulting in cost savings.

Cons of MCA Underwriting Software

Although MCA underwriting can benefit from software in many ways, it is also important to consider potential drawbacks like the following:

• Lack of Human Judgment: Automated underwriting software uses algorithms and data analysis to make lending decisions. However, it may overlook important contextual factors that only humans can identify.
• Over Reliance on Data: Software uses data analysis to assess a business's financial situation. Nevertheless, missing or incorrect information can lead to misinformed lending decisions.
• Technical Issues: Software can sometimes experience technical problems, causing delays or errors in the merchant underwriting process.
• Cybersecurity Risks: Using software systems to store sensitive borrower information can pose cybersecurity risks such as hacking, data breaches, and other cyberattacks.
• Bias: Software can perpetuate biases if the algorithms are trained on biased data or critical contextual factors are not considered.
• Implementation Costs: Implementing software in underwriting can involve high upfront costs, such as licensing fees, training, and hardware upgrades.

The Benefits of Automated Underwriting in Merchant Cash Advance Investing

Automated underwriting is increasingly popular for merchant cash advance investing due to its various benefits, including:

• Increased Efficiency: Automated underwriting can expedite informed decision-making for investors by quickly analyzing large amounts of data.
• Consistency and Accuracy: Automated underwriting minimizes human error and ensures that all applications are evaluated using the same criteria.
• Improved Risk Assessment: Automated underwriting accurately evaluates risk factors, helping investors make informed decisions and reduce losses.
• Scalability: Automated underwriting systems can efficiently manage large numbers of applications, enabling investors to seamlessly expand their MCA investment portfolios.
• Reduced Costs: Automated underwriting streamlines the merchant underwriting process and reduces the need for manual labor, resulting in reduced labor costs.
• Faster Turnaround Time: Automated underwriting systems process applications quickly, reducing the time for investors to receive funding and borrowers to get the cash they need.
• Better Portfolio Management: Automated underwriting systems provide MCA investors with tools such as real-time insights and analytics to effectively manage their portfolios.

Best Practices for Effective Merchant Cash Advance Underwriting

Effective best practices should be followed when underwriting merchant cash advances to avoid negative consequences for both borrowers and lenders. These practices include:

• Clear Eligibility Criteria: Clear eligibility criteria reduce default and loss risks by approving only qualified borrowers for funding.
• Comprehensive Due Diligence: Conducting a thorough due diligence process is critical to assess potential borrowers' creditworthiness and identify any potential repayment risks.
• Proactive Monitoring: Regular monitoring of borrowers' financial performance and creditworthiness can help identify potential issues early and prevent defaults.
• Personalized Underwriting: Customizing underwriting procedures based on individual borrower characteristics and risk profiles can help investors make better-informed decisions.
• Collaboration With Sales Teams: By working together to carefully vet borrowers before approving funding, the collaboration between underwriters and sales teams can reduce defaults and losses.
• Continuous Improvement: To reduce the risk of losses over time, investors can continually review and improve their underwriting processes.
• Data-Driven Decision-Making: By using data analytics and technology solutions, investors can improve their decision-making process and make unbiased decisions.

What are the Best Merchant Cash Advance Companies?

To find the best merchant cash advance company, businesses need to consider their needs and creditworthiness, and conduct thorough due diligence. Here are some recommendations to consider:

• Backd - Best for Large Loan Amounts
• Lendzi - Best for Excellent Customer Reviews
• GoKapital - Best for Same-Day Funding
• Uncapped - Best for E-commerce Business Loans
• Torro - Best for New Businesses
• Fundera - Best for Lender Marketplaces
• Fora Financial - Best for Poor Credit