Cash flow is a constantly changing aspect of business, even in prosperous economic times. However, with the current state of the economy, including rising interest rates, market volatility, and general business slowdowns, many companies are struggling with cash flow. This is especially difficult for small and medium-sized businesses that find it challenging to secure bank loans during economic downturns and when cash flow is disrupted. Unfortunately, many businesses are resorting to Merchant Cash Advances (MCAs), which are easy to obtain but come at a high cost and can cause disruptions.
MCAs are typically presented as a one-time funding option that functions like a loan but is disguised as a receivables purchase. The MCA provider provides a cash advance and then withdraws periodic payments directly from the business owner’s bank account using a control agreement. These payments can occur daily, weekly, or at other agreed intervals. While the specifics of each MCA agreement may vary, there are key terms to be aware of.
The advance amount is the lump sum received when the MCA is funded, while the payback amount is the total amount the business owner must repay. This amount is calculated based on the funded amount and includes various fees, including a charge known as a “factor.” The holdback is an agreed-upon percentage of the daily receipts that is withheld to repay the MCA.
However, there are several reasons why MCAs can be detrimental to a business:
1. High Costs: MCAs involve various fees, including a fixed percentage (factor rate) of the daily or weekly receipts. Repayment terms are shorter than traditional loans, ranging from 90 days to a year. These charges result in high costs that are difficult to calculate. For example, an MCA with a 1.2-factor rate and a six-month repayment term would result in a 40% APR (before additional fees).
2. Payback Cycle: The automatic deductions associated with MCAs depend on cash flow, which can make it difficult to keep up with the charges. If cash flow lags, businesses may struggle to repay the advance, leading to compounding funding costs. This can create a problematic cycle, often resulting in businesses taking on additional MCAs.
3. Scaring Away Other Lenders: Due to the high costs and difficult repayment cycle, most traditional lenders are unwilling to finance businesses already utilizing MCAs. The commitment of sales revenue to repaying the MCA can also impact credit evaluation and may require the existing MCA to be paid off before additional funds are advanced.
4. Lack of Regulatory Oversight: MCAs are not subject to the laws governing traditional loans, resulting in no regulation on how much MCA companies can charge. Terms and conditions vary among providers, making it challenging to compare MCA financing costs to typical loans. Additionally, terms and conditions are often not fully disclosed during the application process, leaving businesses unaware of the extent of the charges.
An alternative to MCAs is equipment refinancing to obtain working capital. This option is more cost-effective and simpler compared to MCAs. Equipment refinancing offers predictable payments, clearly defined loan terms, and the ability to leverage existing equipment equity. Choosing a reputable lender who takes an interest in your business and has knowledge and experience in your industry is crucial.
In conclusion, before considering an MCA, it is recommended to seek additional financial input and explore alternative options.
