What a Merchant Cash Advance Costs
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For small business owners in need of a quick cash infusion, few lending products beat a merchant cash advance, or MCA. MCAs have few qualification requirements, so underwriting is quick and you could receive the funds in a few days. Providers usually take their repayment automatically, saving you the headache of managing a monthly payment.
But this quick and easy lending product does have some significant drawbacks – chief amongst which is their cost. Merchant cash advances sometimes have APRs in the triple digits, and daily payments can put a dent in your cash flows. Here’s what you need to know about the costs of merchant cash advances.
What is a Merchant Cash Advance?
A merchant cash advance is an advance against future sales – typically credit card sales. The MCA provider analyzes your past few months credit card statements to project future cash flows. Then, they advance you a sum of money based on those projections.
In the past, a small business owner could only take out an MCA if they did business with credit cards. But now, if your business doesn’t do a large volume of credit card sales, providers offer advances based on sales and take repayment from a business checking account.
A MCA is not a loan, and therefore has easier underwriting requirements. This makes them a popular choice for small business owners who need cash in a hurry. Because they have lower underwriting requirements, and fund quickly, they represent more risk to a provider. Lenders charge higher fees to offset this risk.
How do Lenders Charge for Merchant Cash Advances?
Lenders charge a flat fee for a MCA. They use the factor rate – expressed at 1.2 or 1.5 – to calculate this fee. The factor rate is not a percentage, which can be confusing to borrowers.
The easiest way to calculate what you’ll pay for a MCA, however, is to convert the factor rate to a percentage and then multiply it by the advance amount . A factor rate of 1.5 would be 150%, if you applied for a MCA of $150,000 and the provider quoted you a factor rate of 1.5, you would pay a fee of $75,000 for the advance.
The math looks like this: $150,000 advance X 150% factor rate = $225,000 total cost – the advance $150,000 = $75,000 fee to the MCA provider.
A small business owner who took out this MCA with a repayment period of six months would pay $12,500 a month towards the fee. This is obviously a large sum of money, which is why it’s important for small business owners to understand the impact a MCA can have on their business. In exchange for quick cash, you must budget for the MCA’s monthly impact on your cash flow.
If you have previously used business credit cards or traditional bank loans to meet your small business’ capital needs, you’re familiar with the annual percentage rate, or APR. This rate is the simple interest rate plus any fees or other charges. The factor rate for a MCA is not comparable to an annual percentage rate because it doesn’t include any other fees you might incur.
All the Possible Fees You’ll Pay for a MCA
Each MCA provider could charge different fees. There is a wide variety within the industry, with most providers charging only two of these fees. However, some lenders could charge you every fee on this list.
Application fee – fee payable when you apply for the MCA.
Underwriting fee – this fee covers the costs of underwriting, which is when the lender verifies your qualifications for the MCA.
Administrative fee – charged to set up your account.
Bank fee – can be there as the processing fee for setting up the transaction.
Broker fee – a fee paid to any intermediary who brought your MCA application to the provider.
Risk fee – similar to the underwriting fee, this fee covers the time and effort the provider puts into evaluating your risk profile.
Loan fee or origination fee – this fee is a percentage of the total advance, and is charged to originate the loan.
Providers deduct these fees from the original advance. If you applied for an advance of $10,000 and the provider charges $2,000 in fees, you’ll only receive $8,000.
How is a MCA Repaid?
Since a MCA can be so expensive, you’re probably wondering how they’re repaid. Providers take their repayment in one of three ways:
Split withholding – your credit card processor splits credit card sales between your merchant account and the provider, sending their percentage directly to the provider.
ACH Withdrawal – the provider automatically deducts repayment from your business checking account.
Lockbox or Bank Withholding – your bank splits your credit card sales between your bank account and the MCA provider
Payments could be taken daily, most common with the first repayment method, or weekly. Because merchant cash advance providers charge a flat fee, there is no benefit to you for prepayment. Unlike paying off a traditional, amortizing loan early, you’ll realize no savings on interest.
The disadvantage to picking the ACH withdrawal repayment method is that you have to make sure the funds for the payment are in your business checking account, otherwise the payment could bounce. The lockbox method delays the release of credit card sales by a day, which could lead to further cash flow issues. Whatever repayment method your MCA provider chooses, put it in your budget and plan for it.
But to plan for a payment, you need to know how much money to set aside.
Calculating your Daily or Weekly MCA Payment
MCA providers take their repayment via a holdback percentage. This percentage is the percent of sales that will be “held back” and remitted to the provider. Don’t confuse it with the interest rate paid on a loan – it’s only the percent of sales taken for repayment.
MCA providers commonly charge holdbacks of 10% to 20%. If you have daily credit card sales of $10,000 and a holdback of 15%, the MCA provider would be entitled to $1,500 of those sales as repayment.
For some small business owners, this method of repayment is easier than writing a large, monthly check to a bank. With split withholding, you don’t have to worry about forgetting to mail a check or deposit funds into a checking account.
What if you chose ACH withholding for repayment? A similar concept applies – they’re entitled to the holdback percentage of daily sales. However, it’s your responsibility to ensure that the $1,500 is in your business checking account the day payment is due.
Repaying an MCA with a percentage of sales has the advantage of aligning sales with repayments. During a slow week, you pay less towards your merchant cash advance. The disadvantage is that if sales dip, it’ll take longer to pay off the advance.
Diving Deeper into a MCA’s Impact on Cash Flows
A MCA is a financial tool, and to use it successfully you should take the time to fully grasp how it will impact your cash flows.
Continuing with the same example above, you owe the MCA lender $225,000, repaid through withdrawals over an average of 22 working days a month. Sales average $30,000 a week and your holdback is 18%.
Weekly, you’ll pay the provider $5,400 weekly, monthly $21,600. At this pace, it will take just over ten months to pay off the advance. But that’s assuming your business doesn’t have seasonal dips and sales remain stable.
What’s more, if working capital expenses are $22,000 a week and you’re paying a MCA provider $5,400, your free cash flow is only $2,600. If you’re not careful, money could get very tight. A 15% rent increase, a citywide mandate to raise the minimum wage, and you’re operating in the red.
Before taking out a MCA, crunch these numbers and run a few different scenarios to prepare estimated budgets. Try creating a budget based on a 5-10% dip or a 5-10% growth in sales, or one that factors in how an increase in supplies would impact costs, whatever applies best to your business. Before you sign the MCA’s paperwork, take the time to gain a full understanding of its potential impact on your business.