Merchant Cash Advance (MCA): The Quick Cash
Running a business is expensive, and sometimes you need a little financial help. Whether you need money for new equipment or to bulk up your inventory; the old saying “you have to spend money to make money” can be applied. For businesses looking for capital, there are many options, ranging from traditional small business loans to increasingly popular merchant cash advances.
What is a Merchant Cash Advance and when to use it?
A Merchant Cash Advance (MCA), also known as a “marketplace loan” or “online loan” is a short-term loan made to a small business based on the lender’s estimation of the borrower’s daily, weekly, or monthly ability to repay. Repayment of an MCA loan takes the form of a daily, weekly, or monthly debit to the borrower’s bank account by the lender. Due to stricter bank underwriting practices and the red tape often involved with obtaining loans from banks, the Merchant Cash Advance industry has become popular among small businesses, as a faster alternative to bank loans. However, this solution is not for every business and every funding need. In this article, we explain MCA loans, including their drawbacks and things you need to consider before signing on the dotted line.
An advantage of an MCA is the quick, usually on-line application process. It’s quick, generally very easy, and funding decisions are made quickly with a high degree of automation. Another advantage of MCA loans is the liberal underwriting. Businesses may obtain advances even if the owner has a low credit score.
When to Avoid a Merchant Cash Advance?
While many business owners are seduced by the quick approval and funding, and that is a very compelling feature of marketplace loans, there is a dark side. Salespersons and brokers can be very aggressive and pushy. Since this product is sold through a network of highly compensated unregulated brokers, there is little uniformity in the quality or accuracy of the information they will provide you in order to get you to sign on the bottom line.
Often, marketers and MCA lenders try to confuse borrowers by disguising and mischaracterizing the nature of the transaction, by calling it something other than what it is. Many will use terminology such as a “factoring agreement” instead of “loan agreement”, to confuse borrowers and to avoid running afoul of regulators that may limit the amount MCA lenders can charge in fees and interest. Make no mistake MCA loans have few if any similarities to factoring—a much less costly and far more flexible financing alternative which has been used for hundreds of years by small business owners.
How a merchant cash advance works and should your business get one?
Cash advances are products primarily targeted at business owners with poor credit because they have trouble qualifying for other traditional types of loans. Business owners aren’t always interested in the absolute lowest cost of financing. Sometimes important factors like speed and ease of application are important. However, business owners should understand the financing alternatives that may be available to them as follows:
- A business owner receives a set dollar amount in their bank account.
- In exchange, the business owner agrees to pay the issuer a fixed percentage of future credit card sales until the advance, plus a borrowing fee (interest), is paid off.
- Merchant cash advances are fixed-price loans. That means that a business owner will pay a fixed amount of interest for the upfront cash no matter how quickly they pay off the loan.
- Payments on cash advances are made daily, and fluctuate as sales volume fluctuates. On days where the business owner has lower revenue, the business makes a lower payment, and on days when they have higher revenue, they have a higher payment.
- Whether sales are up or down, the issuer is almost guaranteed to get their cut of the daily sales. “The daily repayments are actually tied in with the credit card processing systems,” explained Brown. “It is a lower risk form of financing [for the lender] because the ‘lender’ gets the money before it even goes to the businesses.”
How to Decide Whether to Take a Merchant Cash Advance
To decide whether or not to take a Merchant Cash Advance, ask yourself these questions:
- Is an MCA loan the best financing option for me?
- Have I explored less costly alternatives such as factoring?
- Is a Merchant Cash Advance the least costly financing option?
- Do I really understand the costs of an MCA loan?
- Can my business withstand the cash flow disruption that occurs when the MCA lender debits my bank – account every week or every month?
- Can I afford to pay penalties if I have inadequate funds in my account on the date the MCA lender attempts to take their periodic payment?
- Can I afford renewal fees if I have to renew my loan?
- Will I be able to pay my bills when due if an MCA lender is taking a percentage or fixed amount off the top of my sales?
- How complex are the Key terms used for MCA, its repayment, and costs?
How complex are the Key terms used for MCA, its repayment, and costs?
Literally, cash advance issuers use words that sound like interest rate but mean something completely different. For example, terms like factor rate, cents on or interest fee can be confused for an annual percentage rate (APR) which is the annual rate charged for borrowing or earned through an investment and is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan. Business owners who try to calculate the APR based on these specialized terms often miss the mark, and dramatically underestimate the cost. The lack of standard information means that lenders can use different language to explain the cash advance product. In fact below, we give two examples that could be used to explain the exact same product.
Let’s uncork the slang here to help business owners understand the industry terminology:
Upfront funds: This refers to the money you will receive immediately as soon as a merchant’s advance is cleared; it is the amount of money you borrow in a merchant cash advance.
Price (also fixed fee, total cost): In the following examples, the merchant will pay $11,500 to borrow $10,000. That means the merchant must pay back the initial $10,000 plus the $1,500 loan fee. Whether it takes you three months or six months to pay off the loan, the cost will remain $11,500.
Factor (buy rate, cash on): What does it mean to factor in math?
To understand more factor in math term; is simple; factorization or factoring consists of writing a number as a product of several factors by breaking it up into numbers that can be multiplied together to get the original number.
EXAMPLES: 6 = 3 x 2 so, the factors of 6 are 3 and 2, the factor of 9 = 3 x 3 so, factors of 9 are 3 and 3.
The factor in our example expresses is the Total Cost of the Loan as a factor of the borrowed amount. In the second point where we talk about Price, we assume the factor rate was 1.15. This means that the merchant will pay $11,500 to borrow $10,000.
Factoring: Price factorized = (Initial Funds x factor rate)
so, Price factorized = $ 10,000 x 1.15 = $ 11,500
Remittance rate (also daily card sales, percentage payback): The remittance rate is not your interest rate, even though some borrowers think it is. Business owners pay back their cash advances through a series of variable payments. The exact payment the owner makes each day is based on a percentage of credit card sales for the day. If so the merchant agrees to commit 15% of sales per credit card per day to redeem the loan. On a day when the merchant receives $ 4,000 through credit cards, he will pay $ 600 for the payment. The day she gets $ 8,000 in sales, he pays $ 1,200.
Origination fee: Most of the time, origination fees are calculated into the total price of the loan (explained above). However, an MCA lender could charge an origination fee on top of their factor fee. This drives up the total cost of the loan.
Compare Merchant Cash Advance vs Business Loan
Understanding how an MCA and a term loan works are important, but knowing which one between both is the right for your business at the exact moment is the most important before you apply, a merchant cash advance (MCA) might be costlier than a business loan. But an MCA also typically has more flexibility on repayment terms, causing less of a financial burden
This type of financing (MCA) does not build business credit because merchant cash advance providers do not report to business credit reporting agencies.
When to Consider a Merchant Cash Advance
A merchant cash advance is a good idea for seasonal businesses or businesses that have a high volume of credit card sales. Specifically, a merchant cash advance might be appropriate if you meet the following:
You don’t want a loan on your credit report – If you’re trying to rebuild your credit or are planning for a big purchase, such as buying a home, you may not want a business loan showing up on your credit report. An MCA doesn’t generally show up on your credit report.
You run a seasonal business – Due to the repayment terms, a merchant cash advance is a good option for seasonal businesses. This is because the amount repaid is less when a business is making less revenue and the repayment amount increases when the business makes more revenue. This is in contrast to business loans that have fixed monthly payments regardless of business performance.
You’re an online merchant – Online merchants and other businesses that conduct a majority of their sales online are prime candidates for a merchant cash advance. This is because they’ll able to receive a high advance amount in return for just a portion of their daily credit card receipts. If you earn revenue via check or cash, merchant cash advance probably isn’t right for you.
Pros and cons of Merchant Cash Advance
Do Your Homework
If you answered “yes” to all the questions above after understanding how works the repayment, then an MCA loan is one possible alternative for your business. Check the MCA lender’s online ratings, reviews, policies and fine print. Before signing on the dotted line, research MCA lenders and talk to other entrepreneurs who have borrowed from them. Look for hidden costs and avoid providers who are overly pushy.
Do Merchant Cash Advance Seems Too Risky or Costly for You?
If you think there is even a chance that you may not be able to repay your MCA loan on time every week, there are better alternatives like an account receivable loan.
This funding solution works by providing a cash advance based on the value of invoices you submit to your customers for work you’ve already performed or for goods you’ve already delivered. Factoring is generally for a business that sells goods or services to other businesses—like trucking companies, staffing companies, manufacturers, IT companies, freight brokers, and wholesale distributors. The factoring company gives you a certain percentage of the invoice value upfront, up to 98%. Then, you receive the remaining amount once your client pays the factoring company.
In other words, invoice factoring (account receivable) pays you immediately for receivables you may not otherwise be able to collect on for weeks or months. You’ll eliminate the hassle of collecting on customer accounts and, with the uninterrupted cash flow, you’ll be able to pay for current needs, and fund your company without borrowing or taking on debt. Unlike MCA loans, factoring also comes with a variety of other features such vetting your customers’ credit to help you avoid extending credit to customers who cannot pay you on time, and collection services.
A merchant cash advance or marketplace loan should be your last borrowing alternative. You have to generate the sales required to keep your business afloat while repaying your cash advance debt. It’s also important to remember that, with an MCA loan, the provider gets paid first. Then, you can start paying your own bills. On the other hand, with account receivable (invoice factory), you get paid first, and YOU decide when your bills, employees, suppliers, and lenders get paid.
If MCA makes sense for your business, In this case, it looks like the pros definitely outweigh the cons? Never forget that an MCA is a financial obligation and are not a good idea in most cases if a business is struggling to make ends meet and hoping that a cash injection will help. Unfortunately, some businesses in that situation get denied for a loan, but are eligible for a cash advance, and end up in a worse situation than before. So if you’re thinking about it, reviews this list above to see where the pros and cons fall for your business otherwise contact Peach Capital and let our experts assist you!
P.S. As always, please take a minute to leave a comment on my blog. I want it to be a conversation rather than a rant from my soapbox.
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