Merchant Cash Advance – How Does It Work?

November 19, 2019

The Scenario: You need $50,000 to pay for inventory, another employee, payroll, etc. The Merchant Cash Advance company (MCA) sends you the full $50,000 amount to meet this need. In return, you send the MCA company your bank’s information. To collect their payments, the MCA company deducts an amount from your bank account either daily, weekly, or monthly. 

Is this the same as invoice factoring? No. We have encountered some business owners that are confused because MCA’s often refer to their interest rate as a “factoring rate.” They might even refer to their service as factoring but there are several key differences here, the biggest is the fees and interest. The second is that an MCA is a loan, whereas in invoice factoring you are selling an invoice as an asset to a company minus an agreed-upon fee.

What costs can I expect from an MCA?

It’s not uncommon for MCA companies to have an APR of 150-300%. These are staggering numbers and can hurt your business cash flow in the short and long-term. By comparison, a reputable invoice factoring company may have an APR of 24-36% range, a less predatory premium to solve your short term cash flow needs.

We recommend that founders, CEOs, and business owners look at the long-term costs when considering a Merchant Cash Advance. Is receiving the $50,000 right now worth paying $20,000 in interest and having payments deducted directly from your checking account? Dealing with the impacts of that APR a year, two years from now. It’s similar to a payday loan in that the high-interest rates create a difficult cycle to get out of. 

Especially if you’re looking at larger amounts, let’s say $150,000+ You have to be really careful to ensure your profits over the next three/six/nine months will cover the automatic deductions from your checking account. It’s stressful because you’re left hoping no surprises come up that would further limit the cash flow. 

What are the positives of an MCA loan?

After reading the previous section you might be asking yourself, “How do these MCA places even exist? Sounds like a bad deal all around.”

One positive is the speed, MCA’s can be a day or two faster than invoice factoring. Also, if you have a lower credit score, it won’t impact your chance of receiving a loan since the MCA company only considers your last 3-6 month revenue numbers and if you have money in the bank. If they think there will be money in the account when they take their automatic withdrawal, they are happy to offer you a deal.

The Bottom Line: It will always be fast and easy to get a Merchant Cash Advance. But that doesn’t mean small businesses should rush to do it. The automatic withdrawals stress your cash flow and can create long-term problems if your business isn’t growing at the same speed as you expected.

What is an MCA factoring rate? 

You’re on a Merchant Cash Advance website, or maybe you’ve just received a proposal from a sales rep. You’re looking at a table that has a “Factoring Rate” listed. Probably somewhere in the 1.0 – 1.6 range. 

Because of this format, you might instinctively look at the number and say, ok, this must be the monthly interest. Multiply that by 12 and you’ve got an APR of 18%. Not bad at all. That’s lower than a lot of credit cards.  

But the factoring rate isn’t a percentage like interest, it’s a multiplier.

This will get a little bit math-heavy, we don’t want to make you feel like you’re back in 9th-grade algebra, but let’s dive into a quick example. Let’s set the “factoring rate” at a 1.2 rate.

 

Amount: $100,000 

Term length: Payback in Three months

Equation: $100,000 (loan) x 1.2 (factoring rate) = $120,000 (what you owe)

 

The extra $20,000 in interest/fees, is 20% of the total. You’re paying $6,667 per month in interest and fees. 

By comparison, a 1.2% monthly interest loan would be just $1,200 a month, or $3,600 over the same three-month period. Keep this formula in mind if you’re considering a Merchant Cash Advance: Amount you receive x Factoring rate = Amount you’ll owe. This way you can plan ahead, look at your expected revenue for the next 3-6 months, and better decide how much money you need as well as determine if something like invoice factoring is the better, less expensive option.

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