SBA Loans as an MCA Exit Strategy

Merchant cash advances (MCAs) are becoming an increasingly common tool for business owners to obtain financing. They are quick and easy to acquire, and this flexibility appeals to those businesses who do not want to deal with the rigors of a traditional loan application. Unfortunately, the convenience comes at a high price. Business owners often don’t realize the true cost of the advance upon acquisition, because they do not pay attention to the right number: the weekly repayment amount. A low weekly repayment amount is conducive to giving the impression of an affordable loan.

Eventually the costs add up to the company and the company’s finances can suffer. The suffering is normally compounded by the fact that most companies end up using cash advances when a cash advance is not meant to be used. Making a bad situation worse. When there are high costs, suffering and additional trouble in finances, some owners will take a second cash advance to cover for the cash flow hole. Unfortunately, that is usually not what happens. The second advance is a tough decision to make, even to pay off the first cash advance.

Taking Two Advances at a Time

Taking two advances at a time, called “stacking,” can put you on the path to financial ruin. Although using the second to repay the first is a slightly better plan, it’s still not great. Paying early with a conventional amortized loan will often save you money because your principal and interest are tracked separately so you get to skip the unearned interest. A cash advance is all lumped together into one payment, the entire total of which you owe even if you pay early, so paying early won’t save you anything.

Since you’re taking out another cash advance to pay off the first one, you’re paying a lot of money - for two reasons. First, you have to pay for the cost of borrowing the money again from the new lender. Second, you have to pay interest on the new loan in order to pay off the interest from the old loan. Essentially, you are paying interest on interest.

Merchant Cash Advance Reverse Consolidation

The other type of refinance on the market is the merchant cash advance reverse consolidation. This type of product has been receiving a lot of publicity lately. Reverse consolidations are intended for those businesses who have stacked a number of cash advances together. It is a brand new advance large enough to replace all the others and at a long enough term to make the weekly payback seem affordable. So far it sounds like a refinance. The difference is that a reverse consolidation company does not pay off the open advances which would then close them. Instead they take over the payments: they pay each lender their weekly payment and you only pay them one weekly payment.

The total weekly amount you would pay the consolidation lender would typically be less than your total outstanding payments. But since the consolidation loan would usually be more expensive and longer, you would be paying this off for much longer than the other cash advances. And that’s concerning for a couple of reasons. The first and most obvious reason is that you would have an additional cash advance added to your debt, which does not help your stacking issue.

Second, why does the consolidation lender leave your other loans open rather than paying them off, since it has to pay the total amount in either case? The reason is that it only pays your other loans week by week, because that way it increases its rate of return and its security, and its security is increased if you default on the consolidation loan.

Let’s talk hypothetically here. Let’s suppose after getting a reverse consolidation things go south and you can’t make the payments to the consolidation lender. You don’t want this to happen, but it could. At first you’ll probably just get hit with some late payment penalties. That’s normal. But what would happen if you continued? Will the consolidation lender continue to pay your lenders? If they didn’t you know they would start to tack on penalties, and if they continued to not pay you would be in default. It won’t take long before your business would have essentially defaulted on all of your lenders.

If you plan on taking a reverse consolidation, maybe talk to a CPA first. Run through all the numbers and create a business case, verify that it will work, and clarify what happens to the other lenders if you default on the consolidation loan.

Small Business Loans or Asset-based Loans

You do have choices as a business owner, even in a situation like this one. The way out of unmanageable cash advance debt is to refinance it into something that is manageable. That’s it. So with that in mind, most business owners have two choices: small business loans or asset-based loans. Here are the pros and cons of each.

The cheapest way to refinance cash advances is with a regular amortized business loan. Regular business loans feature market rates, well below the rates offered by merchant cash advances, and flexible terms that can be tailored to suit your business. Business loans can be an ideal solution for refinancing or consolidating business debt. Small business loans are often backed by the Small Business Administration, or SBA. The SBA backs these loans in order to make them more accessible for small business owners, and it helps those who have less than perfect circumstances.

Are SBA loans really that hard to obtain? The perception is that SBA loans are more difficult to qualify for because of their documentation and collateral requirements. In fact, their requirements are fairly similar to traditional bank loans. They will involve more paperwork than a cash advance, however. That is to be expected. The lender has to gather more information to gain a clear picture of your business. It has to know who it’s dealing with to keep risk low. That is how it can offer market rates.

Another choice is an asset based loan (ABL). With an ABL you can monetize the following assets: receivables, inventory, equipment and business owned real estate. An ABL is more expensive than a business loan but it is easier to get, more flexible and it’s reasonably priced. The structure of the financing differs depending on the asset that it’s financing. Receivables are financed with a revolving line of credit and equipment and business owned real estate are financed with an amortized term loan. With an ABL you are able to leverage your assets and use the proceeds to pay off the expensive cash advances. When designed properly it can provide you with a sustainable solution.