Merchant cash advances can be a simple solution when you need money fast. But if you’re not careful, it could quickly become a financial burden.
Businesses sometimes take cash advances because they’re easy to get. But the ease of access comes at a price - repayment terms that can sink you. In the end, the cash advance can hurt a business more than it helps.
If you’re reading this, you already know how expensive MCAs can be. It still pays to be on guard against any financing that could make the deal even less favorable. That’s especially important when it comes time to refinance the debt.
Why an MCA can be disastrous for your business
“Refinancing” an MCA is Expensive
MCA reverse consolidations: Costs and risks
How to refinance an MCA
Your CPA: An ally in refinancing an MCA
A Cash Advance Is a Double-edged Sword
A cash advance is a double-edged sword for any business. A high factor rate plus daily or weekly repayment can put a tremendous strain on a company’s budget. Repaying the debt can get messy.
Many MCA customers ignore the funding cost when deciding what to pay. They focus instead on how much the daily/weekly payment will be and whether they can afford it. It’s a huge mistake. When the business owner is concentrating on payment affordability, they’re not considering the final cost.
Let’s say a mid-sized company receives a merchant cash advance with these terms:
Amount advanced: $250,000
Factor rate: 1.35
Term: 36 weeks
$250,000 times a factor rate of 1.35 comes out to $337,500. Take the advance amount, multiply it by the factor rate, and divide it by the term to get the weekly payment: 250,000 x 1.35 / 36 = $9,375.00 per week.
It’s easy for the owner to convince themselves they can afford the $9,375 payment every week, so the owner doesn’t think twice.
Can you make a $9,375 weekly payment for 36 weeks? The owner of the business we’re discussing was too optimistic about the future, just like many owners of small businesses.
But what happens if business drops off for a while?
What if the large financial injection the business owner was counting on doesn’t arrive?
What happens if a big customer doesn’t renew their contract?
Will that payment still work if receivables dry up temporarily?
Every industry experiences ups and downs, including unexpected slow periods. If your business is going through a rough patch, it can become difficult to make the payment, much less do it consistently. If the business can’t meet the weekly payment obligation, the company can find itself in hot water.
The simple truth is that a business will often use a cash advance for something that’s just not a good fit. If there’s a serious, long-term problem causing the issues, the cash advance is no more than a stopgap, not a solution.
My point is this: if you’re struggling with cash flow problems, or with profitability issues, or with slow collections, or with bad management, those problems remain regardless of the advance. And no cash advance will solve those underlying problems.
One approach some businesses take when they can’t meet MCA payments is taking on additional advances.
It is not uncommon for a business to take out multiple advances to try to keep the operation going. This is referred to as “stacking” cash advances. The result of stacking is a heavier daily repayment obligation that can bury a business.
A merchant cash advance is never cheap in the long run. An advance that’s cheaper on a per-week basis might buy some time, but the underlying issues are still there.
Using one advance to pay back another can increase total costs. It’s another situation where the payment looks affordable. But looks are deceiving.
With a typical amortizing bank loan, if you pay extra principal early, you generally pay less interest, and the loan ends sooner. The reason you can skip the interest on a bank loan is that the loan is amortized. The principal and the interest are accounted for separately. That’s not the case with a cash advance. A cash advance is not amortized.
With an advance, you’re generally paying the full factor rate regardless of when you pay it back, unless the contract offers an early-payoff discount. With a cash advance, the factor rate determines the total amount you owe, and paying early generally will not change that total. $250,000 with a 1.35 factor rate means you owe $337,500, whether you pay it back in a year or a day, unless the contract provides an early-payoff discount.
In week 12 the balance is still $225,000 ($337,500 less the $112,500 paid so far). It makes no difference how the $225,000 is paid: all at once, or over the remaining 24 weeks at $9,375 per week. Paying early generally will not save you money. So a new advance that pays off the original advance generally saves nothing.
Because the underlying debt amount hasn’t gone down, the new advance will also be based on that larger amount. And that means a higher advance fee, which means you are not just paying interest on interest, you are paying advance fees on advance fees.
Reverse Consolidation Loan
Essentially, a reverse consolidation uses a new advance to pay off the previous advances. Just like “refinancing,” the name is a misnomer.
A new lender advances money and takes over the payments on your existing advances. The new lender’s weekly payment takes over for all the weekly payments you were paying to your existing lenders. Now you make one payment to the new lender, which pays all the others.
The new lender does not immediately pay off your advances. Instead, the new lender takes over the remaining payments on each advance you have.
It appears to give you the “breathing room” you need to get out of a bad situation. The weekly payment on the new advance will usually be lower than all the combined weekly payments you were making to the various lenders. It just looks like you’re saving money.
The new advance will be for a longer period of time than the remaining term of the original advances. A lower payment over a longer term can still mean a higher total cost.
Why would a lender take on several payments instead of just one, especially if there is no additional cost to pay them off now? Any short-term cash flow benefit needs to be weighed against the total cost and risks.
The reason: making the weekly payments raises the lender’s return and greatly reduces the lender’s risk if you default. If the lender keeps the weekly payments, the lender is at risk for far less money.
Suppose a business with three MCAs in danger of missing a payment signs on for a reverse consolidation loan, hoping it will bring the ship into safer waters.
Then a big client cuts them loose, the business starts missing payments, late fees pile up, and the lender calls in the loan.
When the payments stop, will the consolidation lender keep making the weekly payments on the other three MCAs? If payments to the new lender are missed, it generally has little incentive to keep paying on the earlier MCAs.
If the new lender isn’t making the weekly payments, the three original lenders will stop receiving payments as well. Then each advance is in default.
The business is now on the hook for four MCAs, all in default. Its financial picture is worse than ever. One MCA can get you into trouble; several put you in danger of losing your business.
Refinance the MCA
Conventional business financing may be an option, depending on eligibility and terms. A qualified financial professional can help compare refinancing costs and terms. Even if you decide to refinance into a conventional loan, and somehow find one, the cost of the advance will still be there.
To get rid of the burden of a cash advance, refinancing is one option to discuss with a qualified financial professional.
An SBA-backed loan may be an option for businesses that qualify. The SBA backing makes the bank comfortable with the loan. The bank sets the rate and terms, which may or may not fit the business’s needs. That backing encourages lenders to make loans to companies with thin margins or credit issues.
Shopping for an SBA loan takes time, and qualifying does not mean the terms fit your business. It also takes time to find a lender willing to work with a business that’s had trouble in the past.
Asset-based lending involves using collateral to secure a loan. Eligibility depends partly on available collateral, which may be at risk if payments are missed. The collateral might be real estate or business equipment. With an asset-based loan, lenders may offer an amortizing loan, with costs that vary by lender and borrower.
It’s typically somewhat higher than an SBA loan would be. But asset-based loans generally have less red tape than an SBA loan.
Factoring is another way to get the funds to pay off the cash advance. It can work for businesses with invoices that have a combined balance that’s higher than their total debt.
A factor will take over your open receivables and give you immediate cash in exchange for your invoices. Factoring is generally not as affordable as an SBA or asset-based loan, but it’s usually the easiest one of the three to obtain.
When you have already piled on advances to make ends meet, you might get desperate. Take the time to find the right option. A qualified financial professional can help compare the costs and risks.
A CPA can assess your situation, see what conventional products you qualify for, and guide you toward the best solution. Seeking help from your CPA may not seem worth the trouble or expense, but it could save you a great deal of money in the long run.
About Delancey Street
Delancey Street is a business debt settlement company that helps business owners nationwide. Our goal is simple: negotiate proposed settlement terms with your funders, subject to their agreement. We are based in New York. We tell you how it is; because your business and future is on the line.
