Cash advance loans (also known as merchant cash advances, or MCAs) are often used by businesses in need of a quick cash injection. They can help your business overcome a cash flow lull, increase working capital, or solve your short-term financing needs. This blog breaks down how they work, and the costs associated with them, so you can choose the best form of funding for your business needs.
What Are Merchant Cash Advances?
Many people think of merchant cash advances as a type of loan, but oftentimes the companies which offer them avoid the word “loan” altogether. The latter is not entirely accurate from a consumer viewpoint, but companies that offer these advances can legally market it this way because they consider their financing to be a commercial transaction or a product, not a loan.
A merchant cash advance involves borrowing against your businesses’ future revenue. In other words, if you run a business and your customers pay using extended payment terms (such as net 30 days or next 60 days), the cash advance company will project what they expect you to earn based on prior transactions, and offer you cash based on what they think you’ll be able to pay off. MCAs give you payment typically within few days (usually 2 to 5 days).
How MCAs Work
MCA providers say they’re not charging interest, but rather an “advance fee.” The MCA company would usually publish an advance fee between 20 – 40%, but the actual interest when calculated can reach up to 100%. If you get a cash advance of $10,000 with an advance rate of 20%, you’ll pay back $12,000.
Why MCAs Get Expensive
APRs can climb into the triple digits with MCAs. An annual percentage rate (APR) represents the total yearly cost to borrow over the term of the loan. It includes all fees and interest. If you were to do a bank loan, chances are you’d pay an APR of less than 10 percent. If you start looking into credit cards, your APR will probably sit somewhere between 12 and 30 percent. With an MCA, your APR could range from 40 to 350 percent.
Shorter terms/ higher sales do not reduce your fees with MCAs. Under normal circumstances, if you pay off a balance early, you pay less in fees. It doesn’t work that way with an MCA because your fees are mapped out ahead of time. There’s no benefit to paying off the balance quicker. In fact, you may even get hit with an early-payment penalty, depending on the terms of your agreement.
MCAs don’t have the same federal oversight that loans do. They’re considered commercial transactions. That’s how they get away with having APRs over 300 percent and why they don’t have to tell you your APR like other lenders do. That’s also why, if you look at a contract with an MCA provider, it’s usually going to be a whole lot more confusing than any other form of funding or financing will be.
You may be making interest-only payments for an extended period of time. MCA lenders typically require borrowers to provide their bank account information and automatically withdraw money on a daily or weekly basis or they may skim a percentage off the top of credit card earnings that would normally be deposited into the business bank account. However, because of the way MCA fees and interest are structured, payments are interest-only and the actual loan amount is not drafted until all interest and fees are paid.
It’s easy to get stuck in a debt cycle. Consider how payday loans became a major issue a few years back. People who couldn’t pay off the full balance with their next paycheck could extend their terms by paying another fee. Some would continue paying the fee seemingly forever and never pay down the principle of the loan. If your business is constantly losing 10 percent of its daily revenue to pay off a balance, it’s easy to come up short-handed. Remember, it doesn’t help you to pay off the balance of an MCA quicker because you’re paying the same fees regardless. So, even if you find a way to generate more transactions, sell more, or work harder, you’re still losing a huge percentage of your sales. You haven’t really solved your cash flow problem. You’ve merely deferred it.
Why Do People Get MCAs if They’re So Expensive?
- Bad Credit: Bank loans and revolving credit options typically require good or excellent credit. MCA providers target new businesses with no credit history or low credit score.
- No Collateral: When you start moving into traditional bank loans, collateral is typically required. For some small-business owners, that means they put their house on the line. That’s a scary proposition.
- Misleading Terms: Again, because MCA providers aren’t legally providing loans, the terms they lay out are often confusing. It’s easy to think an advance fee is an interest rate if the service doesn’t explain it well.
- Lack of Familiarity with Options: When you’re in a bind and your business needs cash yesterday, it’s easy to go with the option that’s right in front of you. However, there are many far less expensive ways to get a cash injection for your business.
Invoice Factoring May Be a Better Solution
If your business sends out invoices for services performed or goods delivered, invoice factoring can get you the cash you need without spending a fortune or getting caught in a debt cycle. Instead of borrowing money, you get funding for your invoices by a factoring company, and that company collects from your customers. Invoice factoring works well for all businesses, whether they are well established or new and have minimal credit history.
Get a Free Invoice Factoring Rate Quote from Interstate Capital
Interstate Capital is North America’s leading invoice factoring company. We help businesses just like yours get the cash they need every day. Plus, we offer value-added services such as 24/7 account access, a dedicated account manager to answer all your questions, and money-saving tools. If your business has unpaid invoices, leverage them to get the cash you need today, and don’t spend more than you need to. Find out how affordable factoring is with a free rate quote from Interstate Capital.