By now you may know of the Merchant Cash Advance (MCA) along with its sister product the alternative business loan.
An MCA is a type of financing in which the lender purchases future credit card sales from the business in exchange for an upfront amount of money. The cost of this type of financing is usually expressed as a factor rate, or a percentage of the total lending amount. There are no interest rates nor fixed payment terms.
An alternative short term loan is the sister product of the MCA and is offered by many of the same lenders that offer MCAs. The short term loan is a true business loan that includes interest rates, origination fees, APRs, and a fixed payment term. Short term loan lenders have a more relaxed underwriting criteria, which produces more accessibility compared to traditional business loans that have a more conservative underwriting criteria.
High Costs, High Risks
MCAs and short term loans come at a very high cost. An MCA might have a cost factor of 1.20 over a 6-month cycle (a premium deal by MCA standards but is still a very expensive one). The short term loan might have a cost expense of 20% with a 6 month fixed term plus origination fees, which again is considered a premium deal, but is obviously very costly.
There’s an even more costly product on the market today, known as the secured advance loan. It’s where you are likely to have a much higher cost of financing compared to traditional loans, but you will also have to secure the loan with collateral (your house, car, jewelry, or other valuable).
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How a Secured Advance Loan Works
Usually after a merchant is declined for an MCA or alternative short term loan, their broker or funding advisor might recommend the secured advance by asking the merchant if he has any pre-owned assets of value that can be used as collateral. Here’s the process for the application:
- The merchant applies online, through the telephone, or through a broker. There are usually no credit checks, bank statements, cash flow statements, financial statements, or tax returns required.
- The merchant would indicate the type of asset they have, if it’s owned, the estimated appraisal value of the asset, pictures of the asset, and more. Depending on the type of asset, additional information is likely to be requested.
- After due diligence, interviews, and other information is examined, if there’s a likely approval to be completed, the firm will arrange the shipping of the asset to their warehouses for further appraisal, approval, and to finalize other aspects of underwriting. Real estate receives special attention in the inspection process.
- Insurance is included with the shipping, which can range from $50,000 – $500,000 depending on the asset and situation. In terms of who pays for the shipping, that is usually determined on an individualized basis.
- After the asset is received, final underwriting is completed and an offer that equals to 50% – 70% of the LTV of the asset is presented to the merchant, along with term options. The term options usually will not go over 8 months and expect high cost factors in the 1.25 – 1.45 range. This is what makes this product controversial— despite collateral being included with the transaction, the costs are still high with unfavorable repayment terms.
- After the merchant accepts the offer, the firm will keep the asset guarded in their warehouse until the merchant pays back the program in full. Once paid in full, the merchant can either “renew” immediately or have the asset shipped back if they no longer need further financing.
The Pros And Cons
Although a secured advance loan is easy to qualify for, it comes at a high cost.
Merchant cash advances and short term alternative loans come at a higher cost because the lender is financing a merchant based on future sales activity, without any collateral on the table. Because of the high failure rate of small businesses, the high cost had to be aligned with said high risk.
With the secured advance loan, the merchant is now putting up valuable assets to secure the financing. Common sense would dictate that this should bring down the costs. However, instead of the costs going down, the costs end up going up.
In addition, the merchant now has the added stress that if they go out of business, they could lose something of value to them.
Depending on the status of your personal and business credit scores, the financial health of your business, and what you’re looking to finance, there are alternative options.
If you have collateral to put up and your personal credit is sound, you may think about a longer term alternative loan. They will generally want you to meet minimum income and credit requirements, and secure the loan with collateral (although generally you can hold onto the asset you’re using as collateral as long as you’re up to date on loan payments).
If you’re financing the purchase of equipment, equipment financing could also be an option. These loans are secured by the equipment purchased, and usually have less strict requirements because the equipment collateral can be easily liquidated.
Before you take on financing, make sure you understand the cost and what you might have to give up should you not be able to pay back the loan.