Is MCA Right For Your business?

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Is MCA Right For Your business?

You’re a small-business owner in need of capital now, and a merchant cash advance looks like a good deal. Before you act, consider this: That quick cash could really cost you.

MCAs have been known to carry annual percentage rates — the total cost of a loan, including all fees — in the triple digits. These costs, as well as the daily repayment schedule, can cause serious cash-flow problems. In some cases, MCAs lead to a debt trap, where it’s virtually impossible to repay and you must refinance into another — and yet another — MCA or file for bankruptcy.

That’s why many consumer advocates and nonprofit lenders consider MCAs a financing option of last resort. Below, we lay out the pros and cons of merchant cash advances to help you make a wise financing choice.

How merchant cash advances work

A merchant cash advance has historically been for businesses whose revenue comes primarily from credit and debit card sales, such as restaurants or retail shops. Now, merchant cash advances are available to other businesses that don’t rely heavily on credit card or debit card sales. Merchant cash advance providers say their financing product is not technically a loan. A merchant cash advance provider gives you an upfront sum of cash in exchange for a slice of your future sales.

Merchant cash advance repayments can be structured in two ways.

You can get an upfront sum of cash in exchange for a slice of your future credit and debit card sales, or you can get upfront cash that is repaid by remitting fixed daily or weekly debits from your bank account, known as ACH, for Automated Clearing House, withdrawals.

This option has become the most common type of merchant cash advance, according to Sean Murray, a former merchant cash advance broker and founder of trade magazine deBanked. They’re referred to as ACH merchant cash advances and allow providers to market to businesses that aren’t primarily tied to credit and debit card sales.

Instead of making one fixed payment every month from a bank account over a set repayment period, with a merchant cash advance you make daily or weekly payments, plus fees, until the advance is paid in full.

How much you’ll pay in fees is determined by your ability to repay the merchant cash advance. The merchant cash advance provider determines a factor rate — typically ranging from 1.2 to 1.5 — based on its risk assessment. The higher the factor rate, the higher the fees you pay. You multiply the cash advance by the factor rate to get your total repayment amount. For example, an advance of $50,000 that carries a factor rate of 1.4 represents a total repayment of $70,000, which includes fees of $20,000.

Total advance Factoring rate Total fees Total repayment
$50,000 1.4 $20,000 $70,000

 

Here is a more detailed breakdown of how merchant cash advance repayments can be structured:

Percent of credit card sales: The merchant cash advance provider automatically deducts a percentage of your credit or debit card sales until the agreed-upon amount has been repaid in full. Let’s say you need $50,000 to purchase a new oven for your restaurant. You apply and get approved for a merchant cash advance of $50,000. The provider has assigned a factor rate of 1.4 on the contract, so you owe $70,000.

The repayment period typically ranges from three to 12 months; the higher your credit card sales, the faster you’ll repay the merchant cash advance.

In this case, let’s say your merchant cash advance provider deducts 10% of your monthly credit card sales until you’ve repaid the $70,000, and your busy restaurant averages $100,000 in credit card revenue per month. You’d repay $10,000 monthly, with daily payments of $333 in a 30-day month. At this pace, you’d pay off the advance by the seventh month. But if your revenue dropped to $70,000 per month, you wouldn’t repay the merchant cash advance in full until the 10th month, paying $233 daily.

As we explain below, the speed with which you repay your loan is a factor in determining your APR and can help drive it into the triple digits.

The predetermined percentage of sales is an estimate based on your projected monthly revenue. Since your sales can fluctuate, the speed with which the loan is repaid could be longer or shorter than expected, says David Goldin, CEO of Capify, a merchant cash advance provider, and president of the Small Business Finance Association, a trade association that represents merchant cash advance companies. “Eighty percent of the time, it takes longer than the purchaser thought it would take.”

Fixed daily withdrawals: This kind of agreement lists a daily or weekly payment to be withdrawn, based on an estimate of your monthly revenue. For example, a business with $100,000 in monthly revenue would owe $333 per day or $2,331 per week based on a percentage of sales of 10%.

Unlike the repayment structure tied to credit card or debit sales, your payment does not fluctuate with your sales. That means you’ll pay the same amount regardless of whether sales are down or up.

By: Steve Nicastro

Is a Merchant Cash Advance Right For Your Business?