A guide to merchant cash advance underwriting

The Merchant Cash Advance (MCA) product has been around since the early 2000s through a company called AdvanceMe (now known as CAN Capital after going through a variety of name changes). An MCA is essentially the purchase of future credit card receivables using cost factor. A typical transaction would work to where a purchaser (the MCA company) would note that the business has been doing $45,000 a month in merchant processing over the previous 12 months, then offer to buy $58,500 of said processing receivables in exchange for advancing $45,000 to the business tomorrow.

To collect on the purchase, the MCA company might keep 15 percent of the daily processing volumes of the business until the full purchase is complete. Here’s an example of what this deal might look like on the purchase agreement:

• Advance Amount: $45,000
• Factor rate: 1.30
• Total Purchase Amount: $58,500
• Holdback: 15 percent
• Note: The full purchase amount should be satisfied in about 8.6 months

The “sister product” to the MCA is that of the alternative business loan, which is a real business loan with origination fees, fixed terms, and approval equating to around 10% of the annual gross sales of a business. For example, a lender might approve a business doing $1 million in sales for $100,000 on a 12 month term. Here’s an example of what this deal might look like on a loan agreement:

• Loan amount: $100,000
• Origination fee: $1,500 (based on 1.5 percent of the loan amount)
• Disbursement amount: $98,500
• Total cost expense (including interest): $30,000
• Total repayment amount: $130,000
• Daily Payment: $515.88 (252 business day payments over the next 12 months)

Understanding Merchant Cash Advance Underwriting

If you are going to apply for an MCA or alternative business loan, it’s important to understand how underwriting works, along with what your expected cost of funding should be, to equip yourself with shopping ability.

What Are MCA Paper Grades?

The industry has about 4 major paper grades, which are grades assigned to your business based on risk profile, which is determined by various factors like your credit card sales or credit scores. They are used to determine how much to approve a business, what type of terms or payback cycles should be used, and what type of cost factors to use when pricing an offer. An “A” paper grade is known as the best quality, or lowest risk borrower, while a D paper is known as the worse quality.

How Are Paper Grades Determined?

The merchant’s current standing within the categories below will determine how their profile is considered in the eyes of the lender:

• The type of industry in which the merchant operates;
• If the merchant is a home-based business;
• The personal credit score of the owner and the business’s credit score;
• The number of non-sufficient funds (NSFs), overdrafts, and negative daily or monthly bank balances;
• Presence (and status) of tax liens, judgement liens, and bankruptcy filings;
• Presence (and status) of current merchant cash advances and/or alternative business loans;
• Status of business landlord or business mortgage payments.

A Paper Grade Merchants

These are merchants that usually have a good FICO score (generally 650 or higher), a good business credit profile, clean bank statements, no liens, no landlord or mortgage issues, a separate business location, and, if they have a current cash advance or alternative business loan, it is in good standing and can be paid off at closing.

If you are in this category, you will qualify for the best pricing and terms in the industry, which have the following range:

• 6 to 9 month term or payback cycle: Cost factors range from 10% – 15% of the total loan amount.
• 10 to 15 month term or payback cycle: Cost factors range from 19% – 28% of the total loan amount.
• 18 to 24 month term or payback cycle: Cost factors range from 30% – 35% of the total loan amount.

Note, if you are in this category, there may be a number of other business financing options available to you—you should carefully consider your available options and which is best for you.

B Paper Grade Merchants

These are merchants with a 600 – 640 FICO, or may have higher credit scores with markings that knock them out of the A paper grade category. These markings could be a couple NSFs or overdrafts, a tax lien on a payment plan, or a discharged bankruptcy. If they have a current cash advance or alternative business loan, it can be paid off at closing. If you are in this category, your cost factor may be about 10% higher than that of an A grade merchant.

C Paper Grade Merchants

These are merchants usually have personal credit scores below 600. They might other markings as well, like over 5 NSFs per month over the last three months, or a variety of similar issues listed under the B paper grade, but they may have more of said issues or the issues are more complicated.

In addition, they could have outstanding cash advance or alternative business loan balances that can’t be paid off at closing, they could have outstanding bills to pay to a landlord, they could have a tax lien with no pre-arranged payment plan, etc.

D Paper Grade Merchants

These are merchants that are considered the poorest quality grade, but with the highest level of risk. They will have poor personal credit scores, along with similar profile complications as those of the C paper grade merchants, with just higher levels of complication.

Estimating Your Paper Grade

Just like getting a grade on a school paper, we all want to be in the “A” grade range. While it might be difficult on your own to figure out you are B, C, or D grade, there is in fact a way to rule out being A grade:

• Check your personal and business credit scores. If your personal credit score is lower than 650, do not expect A paper grade pricing.
• If you’ve had more than 5 NSFs per month over the last 3 months, do not expect to qualify for the best rates.
• If you know you have an outstanding tax lien, do not expect A paper grade pricing.
• If you know you have multiple MCA or business loan balances outstanding that are stacked on top of one another, do not expect A pricing.

Merchant Cash Advances aren’t the only financing option available to business owners. While they offer convenience and speed, they often come at a high cost, even if your business has the best grade. Make sure you know about other available business financing options and what best fits your business needs before you sign on the dotted line.