Find out everything you need to know about how MCA loans work to see if they’re right for your business.
A farmer needs enough water to grow their crops—no matter how rich the soil is.
The same is true with running a business: a business needs capital to keep running—no matter how high overall profits are.
Sometimes businesses find themselves in need of quick capital, so they begin looking at their options and find MCA loans.
What are they? How do they work? And are they right for you?
Let’s find out.
What does MCA stand for?
Let’s start things off right: there actually is no such thing as an MCA “loan”. That’s because it’s not technically a loan, but rather an advance.
In fact, that’s what MCA stands for: Merchant Cash Advance. What’s the difference between a loan and a cash advance?
A loan is a source of long-term financing which is typically over a period longer than a year.
This contrasts with an advance, which is short-term financing often repaid in less than a year.
Why some businesses choose an MCA for funding has to do with how they work, which we’ll cover next.
How do MCAs work?
Businesses who traditionally opt for an MCA over a small-business loan often receive their revenue via credit or debit card sales, such as retail shops or restaurants.
That’s because they used to work by providing upfront cash in exchange for a cut of future credit card sales.
For example, a business would receive an MCA for $10,000. From that point on, each day a certain percentage or amount of the credit card transactions would be paid towards that advance (which is called a “holdback” amount).
However, this trend is changing since MCAs now function beyond credit cards. You can now repay an MCA by remitting daily or weekly debits (plus fees) from your merchant bank account. This is known as an Automated Clearing House withdrawal (ACH).
The remitted debits can now take place daily or weekly until the amount advanced to your business gets fully repaid.
There is an important “factor rate” that the MCA provider establishes based on how risky the advance is. The higher the risk, the higher the factor rate will be, and the higher your fees will be.
Back to our example of a $10,000 MCA: if there’s a factor rate of 1.2, then the total amount needed to be repaid will be $12,000. However, if the transaction is seen as high-risk, the factor rate will be higher—maybe 1.4. This would result in a total amount of $14,000 that the business needs to repay to the MCA provider.
What advantages do MCAs offer?
MCAs might be the best financing solution for a business, depending on their needs and circumstances. Let’s take a look at some reasons why they might opt for this lending option.
Since MCAs are repaid quicker than small-business loans, they are also issued more rapidly and with less documentation necessary.
An MCA provider is primarily interested in the amount of credit card transactions of a business, which will tell them if they can repay the advance—much simpler than all of the other paperwork and collateral involved with being approved for a business loan.
Thus, an MCA can be issued within a week and sometimes within 24 hours.
An MCA can also be flexible, depending on how well your business is doing. For example, if sales and credit card transactions are down, you’ll repay less of the MCA since it can be dependent on the number of transactions.
Why do some avoid MCAs?
It’s important to note that MCAs aren’t right for everyone.
High Borrowing Costs
An MCA is a cash advance that’s both issued and paid back quickly. That means the MCA provider won’t have years of interest on the advance rolling in.
So to make up for the lack of time, the annual percentage rate (APR) will normally be much higher than a loan—in the double or triple digits, from 40% to 350% including all borrowing costs and fees.
And if you repay the advance faster, the APR will go up in order for the provider to make sufficient profit.
No Federal Oversight
An MCA is considered a transaction, not a loan. Thus, there aren’t the same regulations or protections as a loan. Even though they are regulated by the Uniform Commercial Code, which varies from state to state, they don’t have the same level of governance as other lending options.
Depending on the finances of the business receiving the MCA, the high borrowing costs can lead to further debt problems. A business needs to first do the math of how much their projected borrowing costs will be before accepting an MCA from a provider
What are the best lending alternatives to MCAs?
Even though there are advantages to MCAs, they’re not for everyone.
Finding out what other lending options are available is always a wise decision instead of simply jumping at the first lending opportunity that is presented.
As was mentioned, traditional small-business loans can offer a much lower APR and more attractive repayment terms for some qualifying businesses.
If time is a major factor, then a short-term loan may be the answer to a business’ lending needs, allowing them to repay the amount in a matter of months.
Another option is invoice factoring, where a factoring company buys an unpaid invoice from a business at a discount, providing fast working capital. The factoring company then owns the debt and is legally allowed to pursue its repayment.
If the business has a strong credit profile, they may qualify for a business line of credit which can meet their needs for short-term cash flow.
Even though there are benefits to receiving fast capital with little paperwork or collateral necessary, there are also important risks to MCAs that need to be carefully weighed before choosing to receive one.
PPS wants to put you in the know. The more you understand about financing, the better you can run your business—and the more money you can save. Take a look at our blog to learn more about financing, discover new ways to save your business money, and to keep moving forward.