If you took a merchant cash advance, the funder almost certainly quoted you a factor rate, something like 1.25, rather than an interest rate. That sounds small, doesn’t it? 1.25 sounds tiny. But factor rates are not interest rates. For example, a 1.25 factor rate is a 25% one-time surcharge on the money you received, as opposed to a 25% annual interest rate. You can’t compare a factor rate with anything unless you convert it to an annual percentage rate. But you’ll have to do the math. The lender won’t do it for you.
There is a reason for that. A loan is regulated by both state and federal laws. But an MCA is actually a purchase of your future credit card receipts. As a result, it’s not technically considered a loan and has very little oversight. No one has to tell you what your APR is on your contract, and many don’t. It’s not structured as a loan, it’s structured as a purchase of future revenues.
Three Numbers
When you sign, three numbers get negotiated: the advance amount, the factor rate and the holdback percentage. The advance amount is the cash you receive. The factor rate tells you how much you’re paying for that cash. The holdback percentage is how the money gets repaid to the funder. It’s simply the percentage of your revenue that gets taken each day to pay down the advance. Payment is also tied to your credit card sales, so there’s no set term like you’d find with a bank loan. The more you sell, the faster you pay off your advance. Typically, the repayment period will be anywhere from three months to two years.
A factor rate can be as low as 1.09 or as high as 1.5, depending on your qualifications. In general, most funders consider a number of things, including your transaction volume, your length in business, your monthly or annual revenue, and your personal credit score. The requirements vary by funder, but one rule holds everywhere: the higher the factor rate, the more it will cost you to fund your small business cash flow needs.
The Conversion
Now the conversion. To convert a factor rate to an APR: Divide the total fee by the loan principal to get the percentage markup. Then multiply that percentage by 365 and divide by the loan term in days. Let’s walk through it with real numbers.
First, find out what the repayment amount (sometimes called the payback amount) is: the total you’ll pay in daily or weekly installments. It’s the advance amount times the factor rate. Say you were approved for $100,000 at 1.25. Take $100,000 and multiply it by 1.25. The payback amount is $125,000. Subtract what you actually received and you are left with a $25,000 fee (the “advance cost”) on top of the amount they advanced you. Divide that fee by the advance: $25,000 / $100,000 = 0.25. That is the percentage cost.
Then multiply 0.25 by 365 (days in a year), which equals 91.25. Now divide 91.25 by the number of days in your repayment period. If you repaid it in six months, there are 180 days and 91.25 divided by 180 is 0.5069. That means an APR of 50.69 percent.
1.25 is easy to read and understand. But 50.69% is a totally different thing. In other words, it’s really a fee of 25% on a 6-month loan, which is 50.69% APR. Wait a minute. That’s enormous.
Look at the length of the repayment period. This number is in the denominator, so the shorter the amount of time you have to repay, the higher the APR you’ll pay. Same factor rate, different APRs. Time is the killer. Before you compare one offer to another, you want to know exactly how many days this thing is designed to take.
The True Cost
Even then, the APR is not the whole cost. The APR gives you a way to see an overall picture of your yearly borrowing costs, but it does not tell you the whole story, because it does not include fees. Add the origination fee and processing fee and any other fees back in to get your true cost of the advance. Be sure to read the repayment section of the contract, as vague language can result in hidden fees that increase your cost of borrowing. If the language is confusing, or sloppy, take it as a sign of a larger problem. All details should be outlined in the contract, including the total price of the MCA.
That is also a reason to be careful about who you are dealing with, so do some due diligence on the merchant cash advance company before you accept any offer. Do they have an established website? Are there real people at the company? Are they legit? You’re looking for accountability. Lack of structure often means lack of honesty.
None of this means an MCA is always the wrong choice. It requires no collateral, approval is fast, and funders care more about your cash flow than your credit history, which is why owners use them to make payroll, pay rent on time or get through an emergency. If you had access to a cheaper source of financing, you’d go with that, right? But suppose you don’t. Then the math matters even more. You are trading cash now for an unknown and potentially expensive number of dollars in the future.
If you are already behind and the daily debits are eating the sales you were counting on, running the APR won’t make the payments smaller. What it will do is give you visibility into the true cost of borrowing. If you can pay off the advance right now, that’s ideal - but even then, it’s worth knowing how much that borrowing really cost you in interest, time, and cash flow impact. Because for small businesses, that’s where the damage is often done. Pull out every agreement, find the advance amount, the factor rate, the fees and the repayment period, and do the math on each one. That number is the starting point for any honest conversation about what you can afford and what comes next.
