How can my business get out of expensive merchant cash advance debt?

Business owners make use of merchant cash advances all the time. The process is quick and simple, making them a popular resource for owners avoiding traditional banks.

But while merchant cash advances are quick, they come at a steep cost that’s hard to see. Borrowers tend to focus on the affordability of the payment and on how manageable it is, even if they never go on to work out what it’s costing them over the year. The owner does not miss that extra at first, and that is what makes a cash advance attractive, it slips into the background without a fuss.

For a while the MCA works well. For some it works for a month, for some it might be a year, but sooner or later it squeezes the business hard. Most companies that use advances are trying to fix problems they can’t actually handle. If the company takes on a cash advance for a problem that’s impossible to fix, then the interest on that advance is the least of its problems.

And when the loan starts to squeeze a little too much, they take out a second to get them through. Most of them don’t actually recover the shortfall in their business over the long term.

Refinancing One MCA with Another Costs so Much

Problems can appear when the business owner takes out another advance to refinance the first. It is called refinancing and borrowers often see it as the answer to the costs of the first one. It can be the opposite of that. Businesses can also take on more than one cash advance at once, which is called stacking. That is never the cheapest option, and sometimes it ends badly for the company.

Theoretically a better approach is to consolidate with one new advance. Now you end up with one advance and likely a lower payment. That is a slightly better choice, but there is no more to it than that.

Here is the short version of why refinancing one MCA with another costs so much.

Interest rates on most conventional business loans are calculated using the amortization formula: with every single payment you pay off some interest and a fraction of the principal. The upshot is, pay back your loan early and you save money. And the earlier, the more you save.

In a merchant cash advance, the principal and the fee together are the total you owe. So if you paid early you would still owe the exact same. You save nothing on the costs of the cash advance if you pay it off early.

The troubling thing about refinancing is it may look good, but comes with 2 unseen costs. You end up paying the full cost again of a new advance, and you end up paying the MCA factor rate not only on the loan principal, but on your previous borrowing costs as well. After the first time you refinance, you pay interest on your interest. That might save you for a short time but it costs you big in the long run.

Reverse Consolidation MCA

And another form of financing used by some entrepreneurs is the reverse consolidation MCA. But these new reverse consolidation loans for MCA debts are something rather different.

It has been marketed to small business owners who carry two or more cash advances and want to consolidate their payments. It is a way to consolidate multiple stacked advances together into one new one large enough to cover them all.

The payments on reverse consolidation advances are low since the term is long. The new payments look so much less than the ones you pay now. To the borrower that looks perfect. On the surface they look just like a conventional cash advance.

So, let’s look under the surface. The key difference in these arrangements is that your existing advances are not paid off. Rather the payments to your lenders stay exactly the same, except now the consolidator makes them. You make one weekly payment to the consolidator.

The upside is there is just one payment, and a lot of the time the payment is lower than what the separate advances cost each week. The downside is the new loan usually costs more, lasts longer, and keeps going after the others are paid.

There are two possible problems you want to watch out for. So the first problem is the latest loan simply adds another layer to the stack and doesn’t end the other advances. The entrepreneur is digging the hole deeper.

You might ask, why would a consolidator even think of leaving the advances open? Why not just take out one loan and pay off the other advances with the money?

The answer is consolidators who leave existing loans open do so because it lets them return more money, and they also risk a lower loss if you decide to stop paying them.

One good way to look at it is to imagine something that never happens, but that can. Picture this: Your small business hits a rough patch and you miss your consolidator’s weekly payment.

You would probably face late fees and penalties. The first late fee will be less important than knowing what the consolidator will do with the old advances next.

If the consolidator stops payments on your accounts that you left open, the lenders could start adding on penalties and declaring you in default. All at once.

Before any loan, meet with a CPA and see if you can afford the loan. When you sit down with a consolidator, you should only consider signing if you have your numbers in black and white. You want to know if it really costs less overall. You also need to check what happens if you default, including with your other lenders.

Business Financing Options That Are Lower Cost

The first and last rule is, whenever possible, never to go back to cash advances or any other high cost financing. Instead, look for business financing options that are lower cost than what you pay now. Ultimately, when a cash advance is no longer working for a company, there are two options when it comes time to refinance. You can return to the banks and look into conventional business loans, or you can think about taking a look at asset-based loans. Each kind has pros and cons.

The most cost-effective way to go is a standard business loan, since the annual interest is much lower. Business loans can be tailored to the company and are ideal for refinancing debt.

The SBA will offer a guarantee on most small business loans, and that guarantee is important. That backing gives banks a reason to finance companies who might not qualify on their own.

SBA loans have a reputation for being paperwork-heavy. The truth is they are not difficult, they just feel that way. Their reputation comes down to perception, since they are not as different from a bank loan as they look. The requirements for the two are similar.

In the case of a bank loan or SBA loan, you will supply more documents than for an MCA. That is the price of getting a loan that charges less. The more the lender knows about you, the more it can trust you and charge you less.

Asset-based lending is a type of business financing that is tailored around your accounts receivable, inventory, and equipment, or real estate the business owns. Asset based loans are not as low in cost as conventional bank business loans, but are a relatively low cost alternative to cash advances, and there are times when that is the most important thing. For some business owners the right path is towards an asset based loan. That tends to be businesses that do not qualify for a conventional business loan.

In practice, asset based loans will be structured differently based on the asset. Loans using your receivables will typically be set up as a revolving line of credit. Loans using machinery or real estate will often have a fixed term and set payments.

Asset based loans and lines of credit can be put to good use paying off merchant cash advances. Set up properly, that is a sound way to lower costs.