Merchant cash advances have become the financial darling of business owners seeking capital. The funding is simple and quick to get. The ease of access draws in companies that prefer not to deal with traditional lenders. The downside: the price of speed and ease is significant. Cash advances are expensive, and that’s something business owners don’t fully comprehend upfront. That’s because owners are looking at the wrong number. They’re fixated on the size of the weekly payment. A low recurring payment can trick you into thinking you have a good loan.
Eventually, the cost to the business may become too much, and the business may start to experience financial issues. And these issues are usually compounded by the fact that most businesses incorrectly use cash advances for scenarios in which a cash advance isn’t a good idea. And so, a bad situation becomes worse. So what do some owners do when their business is facing these high costs, and these growing financial problems? Well, they take a second cash advance, hoping that it will help bridge the gap in cash flow. More often than not, however, this is not the case.
Refinancing an MCA with Another MCA
If you decide to get the second advance, then, and even if you pay off the first advance with it, you would be refinancing an MCA with another MCA, and that is very expensive. Carrying two advances simultaneously is even more expensive and risky. Getting more than one advance at the same time is known as “stacking,” and stacking can lead to financial ruin. If you pay off all existing advances with the new advance, you end up with just one advance, and hopefully, with a lower payment. Using a second advance to pay off all existing advances is better, but not much. Paying off a conventional amortized loan early usually saves money, and the savings is proportional to how early you pay off the loan. Principal and interest are tracked separately, so by paying principal early, you do not pay “unearned interest.”
A merchant cash advance generally combines the principal with the fee into a single total payback amount. Therefore, if you pay off the advance early, you still owe the total amount, which means that there is no cost savings to pay off the advance early. Now, what does this mean when using a new advance to pay off an old one? This means you are effectively borrowing the money all over again at the full cost from the new funder and you are paying a fee on a new advance which is being used to pay off the fees of the old advance, also known as “interest on interest.”
Reverse Consolidation
What’s another product that has taken the industry by storm? Enter the “merchant cash advance reverse consolidation.” These products are for those businesses which have stacked multiple cash advances. They receive a new cash advance which is enough to cover all outstanding cash advances. The term of the new cash advance is long enough that the recurring payment will be “low,” so it won’t be so bad. At a glance, it looks like any other MCA refinancing product.
The difference is that the consolidation lender does not actually close out your outstanding cash advances. They are taking over the weekly payments: making the weekly payments on your behalf to the other lenders, and accepting the one weekly payment from you. That weekly payment to the consolidation lender is usually lower than the sum total of all the outstanding payments. However, the consolidation itself is usually more expensive and has a longer term. You will still be making that payment well after all the other advances are paid off.
This should bother you for several reasons. First, and most obviously: it is another cash advance added to your debt load, which complicates your stacking situation. Second: why does the consolidation lender agree to leave other advances open rather than close them? After all, they are paying the same amount of money either way. The answer is simple: they pay your weekly payments only because it improves their rate of return and lowers their risk. And remember: their risk is reduced if you default on the consolidation.
Say you just got a reverse consolidation. Now for whatever reason you are having problems, and you can’t pay the consolidation lender. Hopefully this never happens, but it can happen. At first you will probably have to pay some penalties, that happens. But if it continues, ask yourself, will the consolidation lender continue to pay the other funders? Take it one step further. If the consolidation lender were hypothetically to stop paying those funders, they would in all likelihood then also start charging you penalties, and if it continued they would declare a default. Before long you could have, for all intents and purposes, defaulted with all your funders.
Is a reverse consolidation actually debt relief? It can reduce your weekly payment but it’s a new, more expensive cash advance, layered on top of the ones you already have. If you are still going to get one, you should work with your CPA to evaluate the costs and benefits. Work together to build a business case that makes sense. Make sure the numbers add up. And make sure you understand what happens to your other funders if you default on the consolidation.
Traditional Small Business Loans or Asset-based Loans
You’re not out of options, yet. The best way to get out of insurmountable cash advance debt is to consolidate it using a product that is more affordable. Based on that assumption, for most business owners, there are two options: traditional small business loans or asset-based loans. Each has its pros and cons.
If you want to refinance a cash advance, the cheapest option is the traditional amortized business loan. Rates are competitive and significantly lower than rates offered on a cash advance. And the term length can be adjusted to your business. Business loans can be a great way to refinance or consolidate business debt. Most small business loans are backed by the SBA, which backs them in order to make them available to small business owners, even those in less than perfect situations. SBA loans are thought to be hard to come by because of all of the paperwork and the asset requirements. However, the requirements are very similar to traditional bank loans. They do require more paperwork than a cash advance. That is to be expected, however. Lenders need to know more about your business so that their risks are reduced and they can offer market rates.
ABL stands for asset-based loan and involves borrowing against things your company owns, such as receivables, inventory, machinery, and business-owned real estate. ABLs are more expensive than business loans, but they are easier to get and more flexible. That said, they are still reasonably priced. The financing used for each type of asset will differ. For example, receivables financing involves a revolving credit line, while machinery and business real estate financing involves an amortized term loan. An ABL can be used to leverage your company’s assets to pay off cash advances. If the ABL is structured correctly, it can help you get on a sustainable path.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
