Small business financing will likely become more difficult in the post Paycheck Protection Program (PPP) world. Many lenders have pulled back what they’re offering to cash-strapped small businesses coming out of the lockdown—with many lenders backing off entirely and others re-evaluating their credit criteria and only offering credit to the most creditworthy borrowers. This is particularly true for business lines of credit, but is also true for business credit cards (a traditionally good source of borrowed capital for those businesses that might have a less-than-perfect credit profile) as well as term loans. With that in mind, there are some things you should know about a Merchant Cash Advance post-PPP to make sure you can leverage this source of capital to help you business.
What Is a Merchant Cash Advance (MCA)?
If you’ve never heard the term before (it’s also sometimes referred to as a business cash advance) or are unsure about exactly what an MCA is, it’s important to be up to speed before you sign on the dotted line. An MCA isn’t really a loan, but is an advance based upon the volume and value of credit card transactions that flow through your credit card merchant account every month. This can make it difficult to compare costs to other lending options like term loans or even business credit cards in an apples to apples way like interest rate or APR.
NOTE: A Merchant Cash Advance is only available to those businesses that process credit cards for payment. If your business doesn’t take credit cards, an MCA will not be available to you.
MCA providers generally have no standard fee structure or interest rate. Meaning you’ll need to make sure you understand the MCA before you commit to the funds.
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Costs for an MCA can be high when translated into interest rates or APRs. Your periodic payment will likely be a daily direct debit from your business bank account, though recently some weekly debit options have become available. If you do a lot of credit card transactions, qualifying for an MCA is much easier than a traditional loan or some lines of credit and can have fewer hoops to jump through in the application process, but it comes at costs you’ll want to fully evaluate before you jump in with both feet.
What Makes an MCA Different from a Small Business Loan?
Because an MCA is not a loan and is really an advance based upon your credit card volume, the way you repay the advance and the fees might feel unfamiliar with what you are accustomed to. Most MCA providers debit money from your daily credit card transactions to repay the MCA (though some options allow for weekly debits instead). If your MCA requires daily debits, there is generally no grace period. You should expect to start making daily payments the day following disbursement of funds.
Additionally, there may be a new term or two you should become familiar with. In addition to terms like periodic payment, daily debit, and payback period, there is something called a holdback. Holdback refers to the percentage of your daily credit card transactions that are debited from your account every day. The holdback percentage is usually between 10% and 20% of your daily receipts and remains fixed until the advance is paid in full.
Borrowers often confuse the holdback with the rate you will pay for the advance. If you want to understand the cost of an MCA, the factor rate is key to evaluating it. Most MCAs, when they express the interest rate, will use a factor rate. Think of it as more of a calculation rather than an interest rate percentage.
NOTE: Holdback, interest rate, and factor rate are not the same thing
For example, if you are quoted a factor rate of 1.5, that means that for every dollar you borrow you will pay back $1.50. In other words, if you borrow $10,000 at a factor rate of 1.5, you will pay $5,000 back to the MCA provider as your cost of the borrowed capital. $10,000 x 1.5 =$15,000.
In this example, if the holdback percentage was 15% and $5,000 was deposited into your merchant account for today, the holdback would be $750. 15% of $5,000 is $750. If you received $8,000 in your account tomorrow, the holdback amount would be $1,200. 15% of $8,000 is $1,200.
Your holdback amount will vary depending on the credit card receipts in your merchant account. In other words, when you have a big day with a lot of credit card receipts, your periodic payment (based on the holdback) will be larger than slower days with fewer credit card sales.
Because your periodic payments will likely be daily, you’ll want to confirm whether or not those daily payments will be debited only on business days—or will they also include weekends? And, as mentioned earlier, know whether you’ll have weekly or daily debits so you can control cash flow effectively. Daily debits can be frustrating for a business owner not expecting the first payment to be due so quickly.
Is an MCA a Good Financing Option for My Business?
There are many small businesses that successfully use MCAs every year, but you should be clear on the costs and understand the repayment terms. That’s especially true in these uncertain economic times.
Not all MCAs or MCA providers are created equal—costs, fees, repayment terms, even customer service can vary wildly. Working with a lending expert can help you get a better understanding of those terms.
If the financing options available right now aren’t the right fit for your business, that means it’s a great time to work on your personal & business credit issues to get lender-ready so you can graduate to other options at lower costs down the road. (A free Nav account can help you monitor and manage the data that matters to lenders and alert you to your best financing matches as you work on your lender profile.)
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How Can I Make the Most of a Merchant Cash Advance?
Although MCAs can be used for a variety of reasons, the best use case is to take advantage of an opportunity to capture additional ROI on a project.
For example, if there were an opportunity to purchase quick turnaround inventory at a discount and the above 1.5 factor rate example could help turn a profit, a Merchant Cash Advance can fund fast and help you capitalize on the opportunity. It’s best practice to include the $.50 on every dollar in the cost of goods sold to make sure you could purchase the inventory, repay the advance, and still make a profit. (For context, the Electronic Transactions Association reported in 2017 that small businesses using online financing options were anticipating a 4x return on every dollar they borrowed online.)
Because of the current lending environment, taking advantage of a merchant cash advance also means working on the obstacles that could be holding you back from other financing options. Accessing capital at lower rates and terms can save your business thousands over the course of a year, and as lower-cost financing options become available to small businesses, lenders will be looking for borrowers with excellent personal credit, solid cash flow and a history of on-time payments with any existing debt obligations. You can get lender-ready with Nav and get matched to financing options based on your real data as lenders begin opening up to new borrowers in the coming months.
Why You Shouldn’t Take Multiple MCAs
Although some brokers or lenders will offer multiple MCAs, it’s not a good practice and can put your business in tremendous financial jeopardy. Two or three of these very high-interest products have forced bankruptcy and closed the doors of more than one small business over the 20 or so years since MCAs were introduced.
What to Do If You Want an MCA
If you are considering an MCA, make sure you understand this type of financing.
- Make sure the ROI is clear. How will it help your business make money? Is the opportunity sufficient to outweigh the expense?
- Compare the cost. Nav’s free small business calculators can help you translate the cost of an MCA into an APR so you can see how that compares to other forms of financing.
- Read the fine print. Make sure you understand the payment schedule. Avoid MCAs that require you to sign a “confession of judgment,” which could result in assets being seized by the creditor.
MCAs require a savvy small business owner who is very aware of his or her financial situation to successfully leverage this financial tool to build a healthy and thriving business. If that describes you, and you do a healthy volume of credit card transactions within your business, a Merchant Cash Advance could be an option to consider.