Merchant-Cash-Advance_bnr Editor's choice

All you want to know about Merchant Cash Advances


In the past few years, Equity crowdfunding and Peer-to-Peer loans have emerged as key sources of finance for the small businesses. A yet another expensive yet easily available funding option for small businesses is Merchant Cash Advances (MCA). According to the Green Sheet, the MCA market is estimated at $500-$700 million, with the potential to reach $3-5 billion over next few years. This article answers some questions on the Merchant Cash Advances.

 

1. Who are the customers of Merchant Cash Advances?

Small businesses, like retail, restaurant, and service companies, which cannot apply for a bank loan or fail to secure a bank loan, but have a daily cash flow are the buyers of Merchant Cash Advances (MCA). Unlike a bank loan, that requires a good credit score and a collateral security, an MCA firm necessitates consistent sales from its borrowers

 

2. How do they differ from Bank loans?

A bank loan accumulates interest over time and the borrower is required to pay the total amount (i.e. Principal+ interest) at the end of the agreed time period. A company offering an MCA charges a premium instead of an interest. It deducts a fixed percentage of the daily Credit/Debit card sales until it recovers the advance plus premium amount. In other words, Merchant advances do not have a fixed payment or no due date, but they’re usually issued within 48 hours of applying. In fact Cash advance providers insist that advances are not loans and the agreement is a “purchase and sale of future income.”

 

3. Which is more expensive – a Bank loan or Merchant Cash Advances?

Merchant Cash Advances are considerably expensive than a Bank loan.

The below table compares the cost of a bank loan and a Merchant Cash Advance in a hypothetical situation. Here, we assume that a firm pays off its loan and advances within 4 periods. The premium on an advance of $30 is 33% whereas the bank charges an interest of 15% on its loan to be payable at the end of period 4. The MCA Company charges 12% on the borrower’s gross sales to recover its advance and the premium amount. Finally, our firm pays off the advance by period 3 and the loan amount by period 4 as promised to the bank.

 

Period

Gross Sales

Amount charged by the MCA company

Amount due

1

100.35

12.04

27.96

2

111.00

13.32

14.64

3

122.00

14.64

0.00

4

100.00

-

-

 

 

 

 

 

 

Comparing a bank loan against a merchant advance, we see that the latter is a costly deal.

Bank Loan

Merchant Advance

Effective Interest rate

15%

33%

Time periods taken to repay

4

3

Cost per period (in USD terms)

8.63

13.33

According to Leonard C. Wright, a columnist for the American Institute of CPAs, the effective rates for these advances can range from 60% to 200% APR.

 

4. Is the industry regulated by the US Government or its associated body?

The industry is not regulated by government. Consequently, some of the MCA companies are claimed to act in an irresponsible manner by flouting usury laws. To that extent, an AdvanceMe whitepaper advocates the idea of self-regulation; or else the govt could set up regulatory body to monitor the industry. Definitely, there are questions over responsible business practices.

 

5. What sort of due diligence should the borrowers perform before opting for MCAs?

The borrowers should scrutinize the MCA providers. They should –

Check with Better Business Bureau and also check with others who have borrowed from them.

Verify the sales for past one year to ensure that the firm can easily pay the debt.

Avoid providers who pass on extra charges such as the application and the funding fee.

Final Thoughts

Small businesses, like retail, restaurant, and service companies, which cannot apply for a bank loan or fail to secure a bank loan, but have a daily cash flow are the buyers of Merchant Cash Advances (MCA). Unlike a bank loan, that requires a good credit score and a collateral security, an MCA firm necessitates consistent sales from its borrowers.

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