Decoding a Loan Offer from an MCA Provider

Decoding a Loan Offer from an MCA Provider

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We got a copy of an MCA loan offer from Merchant Capital Source from an anonymous borrower. The following detailed how we helped him understand the offer and figure out the approximate APR with our Merchant Cash Advance APR Calculator

If you don’t know what a Merchant Cash Advance (MCA) is, read this first.

Here is the offer sheet:

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Let’s look at the numbers first. There are 4 important numbers in the offer sheet

  1. $85,000 paid to the merchant
  2. $112,625 of the future card receivables will be paid to the purchaser (the MCA provider)
  3. 12% of the debit/credit card payments will be paid through ACH to the purchaser (until $112,625 is fully paid)
  4. $250 administrative cost paid by the merchant.

Because of the $250 administrative cost, the actual amount deposited to his bank account is ($85,000 – $250) = $84,750. The cost of the advance is therefore ($112,625 – $84,750) = $27,875 or 32.89% of the advance amount. This is higher than a typical OnDeck Loan, which has similar application requirements and funding timeline.

The APR for MCAs can only be approximated because the repayment period is not fixed — it’s based on the merchant’s card sales. In this case, it’s 12% of the credit/debit card sales. The total payment is fixed but the APR is based on the cost and time it takes to pay back the advance. Historically, the business averaged $150,000 monthly in card sales, which we’ll use for our estimate.

Using the MCA APR calculator below, enter $84,750 for the advance amount, $112,625 for the payback amount, 12% of the future card sales, and $150,000 for the projected monthly card sales.

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The APR turns out to be 115.84% and the payback period is 188 days. Note that, since the APR is estimated using the projected monthly card sales, if the actual card sales are higher, the APR will be higher. If the actual card sales are lower, the APR will be lower. Basically, the interest expense is 32.89% of the advanced amount and he has to pay it back in about 6 months. This is a very typical MCA offer and it’s extremely expensive. NOTE: Since APR is the annualized interest rate, if you pay it back sooner it actually makes for a higher, or more costly, APR.

The anonymous borrower told us he felt squeezed when he started paying back the advance. He has a 30% gross margin business that is 100% through card sales, 12% out of that 30% is a lot. He took the advance in response to the rapid growth of his business. Looking back, he realizes he should have planned his growth strategy better. Fortunately, he got a few equity investors in the end so he survived taking out the advance; however, he said his business might have gone under if he hadn’t gotten the new investors. In the end, the advance did help him extend the runway for his business, albeit at a high cost.
Beside the numbers, the MCA provider had him agree not to do the following during the repayment period:

Change payment processors: MCA providers typically link their accounting and ACH debit system to the merchants’ payment processors, so they don’t want you to change it during the repayment period.

Add a payment processor: This is to prevent merchants from registering card sales in a way that the MCA provider can’t recognize (and thus would not be able to take their cut).

Sell the business: This is to prevent merchants from taking an advance, selling the business, and then running away, leaving the new owner and the MCA provider in the dust.

Sell any Future Receivables to another person or entity: They don’t want merchants taking on additional debt during the repayment period. It increases a merchant’s chance of default, as an even higher percentage of sales goes into debt servicing.

In addition to the terms and numbers listed on the offer sheet, this MCA provider also asked the business owner to personally guarantee the advance. This means that if the business goes under for whatever reason, the business owner will be personally responsible for the amount owed. If the business owner doesn’t pay back, this will affect his personal credit scores and collectors will start calling.

Finally, as shown below, this particular MCA provider actually provided some prepayment credits in case the business owner wanted to pay back the balance early or had exploding sales that the full amount was paid back earlier than expected. This is a good feature and helps alleviate the high refinancing cost we observed from other MCA providers. This helps cap the APR. If the business owner pays back the balance 2 times faster, the APR wouldn’t double. While it’s a good feature, it’s actually pretty rare — most MCA providers don’t offer prepayment credits.

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Overall, this is a very typical MCA offer. As you can see, the cost is quite high. It’s probably not a good option for expansion capital since, to make sense, the expansion would have to have a very high ROI. But if you are in a situation where you are in need of emergency cash, it can be a potential last resort. If you find yourself in that situation, we recommend you first try using a credit card cash advance or a loan from OnDeck or Kabbage to lower your borrowing cost.

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About the Author — Yun-Fang is a small business advisor who has lived in the SF bay area for 15 years. She is a software engineer and has worked at Yahoo!, Facebook and Soldsie prior to becoming an advisor for Nav. She is passionate about using technology to connect people and to make the world a level playing field.

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