Merchant Cash Advances
Is a merchant cash advance (MCA) right for your business?
No.
That’s why we’re going to tell you about them so you can avoid at all costs.
To start, MCA’s are not loans. It is a cash advance in exchange for future sales.
MCAs are typically structured in one of two ways.
How are MCAs structured?
Percentage of debit and/or credit card sales
This is the traditional MCA structure. The lender provides an upfront sum of capital and the borrower repays a % of their credit and/or debit sales until the predetermined fee or factor rate is paid in full. This structure can be difficult for borrowers as there is no set repayment term and the daily or weekly interest cost fluctuates with your business’s sales.
Additionally, with this structure the payment is typically taken directly from your business’s merchant account meaning the MCA lender receives their cut before your sales even touch your bank account.
For example, let’s say you borrow $30,000 at a 1.1 factor rate and a 20% repayment rate on your weekly sales. You will have to pay 20% of your credit card/debit card sales until $33,000 is paid in full ($30,000 *1.1 factor rate).
In the below example, it would take you 8 weeks to fully pay back the loan. Even though the financing cost is only 10% of the borrowed capital, with such an aggressive payback period your APR ends up being ~116%.
And, that’s assuming no additional fees. There’s usually a fee.
The interesting phenomena in this structure is that the lower your credit card sales are, the longer it takes to pay back the loan, thus a lower APR as the total repayment is fixed.
Don’t believe me? You can try it yourself with an APR calculator (below).
https://venturize.org/access-capital/resources/merchant-cash-advance-apr-calculator
Fixed withdrawals
The other way a MCA is structured is through a fixed withdrawal from the borrower's bank account, essentially identical to a short term/working capital loan. A fixed payment, usually on a daily or weekly basis, is taken from your account independent of your business’s debit/credit card sales.
However, these are not “amortizing” loans in the sense that a portion of each payment goes towards principal and interest. In fact, you often can’t even pay these loans off in advance to save on interest/fees. Some lenders do offer some form of prepayment but you don’t typically receive the full benefit of interest savings.
What are the typical terms of an MCA?
Interest Rates
Let’s talk about interest rates real quick. As previously mentioned MCAs are not loans thus they are able to elude state usury and/or lending laws.
It’s basically legal loan sharking for small and medium sized businesses.
To obfuscate the sticker shock of astronomical APRs, MCAs and other short term loans typically advertise what is known as a factor rate. A factor rate represents the total cost of funding in decimal form.
For example, if you borrow $100k at 1.25 factor rate, your total payback will be $100k*1.25 = $125k. The APR will be then determined by how long it takes to pay back the funds and any additional fees.
The factor rate is determined by an ‘underwriting’ review similar to a traditional loan. While every MCA company is different, the underwriting factors taken into consideration are typically credits and debits in the provided bank statements, personal and business credit scores, and any additional information collected on the application.
Fees
A lot of MCAs not only charge astronomical APRs but charge a fee as well. The fee is typically taken out of the disbursed amount yet you still have to pay it back. If you’re borrowing $100k with a 1.25 factor rate and a 3% fee you will actually receive $97k but will have to pay back $125k.
Eligibility
One of the benefits of MCAs (I can’t believe I’m using benefit and MCA in the same sentence) is that they are typically available for a broader population of borrowers.
One of the bigger players in the MCA space, Credibly, requires only the following:
Often, MCAs are the only option available to young businesses and/or those whose owners have terrible credit scores.
Additionally, MCAs typically require only 3-6 months of bank statements and an application to determine eligibility. This makes for a quick and easy application process with businesses often receiving funding in 24-48 hrs, if not less.
But of course you’re trading all of that for usury.
Loan Amounts
Like any lender it’s going to depend on their internal limits and the quality of your business. However, most cap out around $500k.
Just keep in mind that borrowing $500k with a daily or weekly payment regardless of the factor rate is going to put a big strain on your company’s cash flow.
Security
Some MCAs require the business owner to sign a personal guarantee. So, if you default on the loan it is possible the lender comes for not only your business assets but personal assets as well.
It’s also common for MCAs, and any alternative lender, to file a UCC-1 filing. A UCC-1 filing is a legal notice filed by creditors to publicly declare their right to seize assets of debtors who default on a loan (source). The statement is typically filed with the secretary of state’s office in the debtor’s jurisdiction.
Is there ever a good time for an MCA?
Probably not.
If there are any other options on the table (see here) then we think it is highly advantageous for you to explore these other options.
You have two kidneys, maybe sell one of those?
If no other options exist, then maybe it is time to make a deal with the devil.
If you can afford it, you’re probably better off tapping personal funds/investments or going to a family member.
You could also just shut your business down. KIDDING.
How to get out!
“GET OUT! GET OUT! GET OUT! GET OUT! GET OUT!”
If a business can restructure its MCA debt as a term loan, then we think it smart to explore this option as soon as possible.
While you may just be robbing Peter to pay Paul, and Paul may charge 20-90% APR, at least Paul is willing to report your on-time payments to Experian or another credit reporting agency.
Since MCAs are not loans they are not reporting your payments to any business credit bureau preventing you from being able to build valuable business credit.
As with all high interest debt, the number one goal should be to GET OUT, and fast.
MCA Leads
BEWARE
In the lending industry it is believed that businesses requiring loans with usurious terms are not well run and will likely need additional funding in the near future. It’s kind of like the degenerate gambler that keeps crawling back to the loan shark to cover his bookie debt.
Robbing Peter to pay Paul.
It’s sad but often true.
And, as we previously discussed, most MCA lenders file a UCC-1 with the secretary of state’s office. Thus, there are public records of businesses that have recently borrowed money. Therefore, unscrupulous lenders have the ability to find these MCA borrowers and aggressively market to them.
In fact, there are entire companies that solely exist to provide leads sourced from UCC filings.
I’ve heard horror stories from borrowers who take out a loan and days after funding begin receiving dozens of calls on a daily basis from lenders trying to sell them more loans.
So, beware. If you’re borrowing from an MCA lender, or any lender for that matter, make sure you ask about their UCC-1 filings. Some lenders may even go as far to mask their name on the filing to protect your business from unwanted calls. However, this practice poses its own set of complications. You can read more about UCC masking and the pitfalls HERE.
Conclusion
This article was written with the intent to make you reconsider and highly scrutinize any contract put before you from an MCA lender. You should ALWAYS scrutinize legal contracts, and ALWAYS look at APR to compare apples to apples in the lending industry, even when the company is not offering an MCA.
If we’ve convinced you to not go the MCA route and you want to explore other SMB lending options, then check out our article on The Best Small Business Loan Options.
As always, this is not financial advice. For educational and entertainment purposes only.
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