If you’re in need of business funding, you may have considered a merchant cash advance (MCA). But before you commit to one, it’s important to understand how merchant cash advance fees work.
MCAs help small business owners access working capital quickly, but they’re also quite expensive compared to other financing options. So read on to learn about the various fees and potential challenges that come with MCAs and how they can impact your business.
How do Merchant Cash Advances Work?
A merchant cash advance is a type of short-term alternative business financing. However, it is not the same thing as a traditional bank loan. An MCA is an advance on your business’s future sales (typically, debit and credit card transactions). The MCA provider gives you cash upfront based on your projected sales, then collects that money, plus fees, by withdrawing a portion of your daily revenue until it’s fully repaid.
Since MCAs are not loans, they’re not subject to the same rules and regulations. They also have more lenient eligibility requirements, since most MCA companies base risk on the expected performance of your business and not so much your personal or business credit score.
Merchant cash advances are an increasingly popular form of small business financing for this reason. But they can be dangerous due to the high fees and short repayment period. In fact, when expressed as an annual percentage rate, the cost of an MCA can easily reach 300% APR or more.
Overview of Merchant Cash Advance Fees
Understanding the fees involved in merchant cash advance can help you determine if it’s worth it for your business. The true cost of an MCA can be difficult to determine, and it’s often much higher than expected.
Here’s a look at common merchant cash advance fees:
- Factor rate: As we mentioned, an MCA isn’t a loan. That means it doesn’t accrue interest the same way a bank loan does. Instead of charging a traditional interest rate, the MCA provider will charge a factor rate. This is a percentage, usually expressed as a decimal, that shows how much extra you will owe on the advance. MCA factor rates typically range from 1.1 to 1.5. Additionally, factor rates don’t amortize, meaning you won’t save money by paying off the advance ahead of schedule.
- Origination fees: Some MCA funders also charge a fee for underwriting the advance. These fees can be as much as $2,000 to $3,000 and are deducted from the advance amount you receive.
- Funding fees: You may also be responsible for paying additional fees that help cover the cost of securing funding through third-party vendors.
- Commissions: If you get an MCA through a broker, they may receive a commission of up to 11% of the advance amount. This is not paid out of your pocket, but some MCA companies may charge you a higher factor rate so that your broker can receive a larger commission.
- Miscellaneous fees: Keep in mind that merchant cash advance providers are different and may charge any variety of fees. Other fees you may come across include application fees, bank processing fees, risk fees, etc.
Understanding Your Factor Rate
Since merchant cash advance companies use a factor rate instead of a traditional loan interest rate, it’s important to understand how this works and how it will impact your total merchant cash advance fees paid.
First, to see how much you’ll pay in total for an MCA, you can multiply the factor rate by the full advance amount.
For example, say you took out an advance of $50,000 with a factor rate of 1.4. Multiply your advance of $50,000 by 1.4, and your total cost payback amount would be $70,000.
Here’s the math: $50,000 advance x 1.4 factor rate = $70,000 total cost – the $50,000 advance = $20,000 fee to the MCA provider.
Calculating Your Daily MCA Payment
It’s also important to understand how your MCA will be repaid and how that will impact daily cash flow.
The amount of daily sales that go toward repaying your MCA is known as the holdback percentage. This is the percent of sales that are held back and directed to the MCA provider. Usually, this amount ranges between 5% and 20%.
For example, if your holdback percentage was 10% and you earned $12,000 in credit card sales for the day, $1,200 would be held back as payment. If you earned $15,000 the next day, $1,500 would be held back as payment.
As you can see, MCA payments can take a big bite out of your daily receivables. The more you bring in, the higher the payment amount for that day. The plus side is that the higher your payments, the faster you’ll pay back the advance.
The True Cost of a Merchant Cash Advance
A merchant cash advance might seem like a convenient way to get fast cash without having to go through a lengthy application process or rely on having good credit. However, due to the high fees and nature of MCAs, they can pose a financial threat to your business and even your personal assets.
MCA payments can take up a large portion of your daily revenue. And seasonal dips or unforeseen business expenses (like a rent increase or a slow paying client) could cause you to operate on very tight margins. Plus, the lower your daily revenue, the longer it will take to repay the advance. You may be tempted to “stack” MCAs in order to maintain adequate cash flow, resulting in a cycle of debt that’s tough to break free from.
Before taking out an MCA, it’s crucial to crunch the numbers and consider a few different scenarios that could affect your budget. In some cases, it may be better to pursue less costly MCA alternatives such as small business loans or a line of credit.
If you already have an MCA and are concerned about how it’s impacting your business, you may benefit from legal help. Tayne Law Group is experienced in helping clients navigate MCA challenges, including assistance with renegotiating the terms of an MCA through settlements, repayments on the balances, representation in MCA lawsuits, consulting, and more.
If you’re having challenges with your MCA payments, defaulted on an MCA, or have been sued by a creditor, we recommend you speak with an experienced MCA attorney right away. Our decades of experience can guide you to find a solution that allows your business to keep operating and stay afloat. So don’t wait and contact our team today toll-free at 866-890-7337 or fill out our short contact form. Your information is never shared or sold and all conversations are confidential. All work is done by the Tayne Law Group and is never outsourced to non-attorney third parties.