MCA loan’s deceiving math (Merchant Cash Advances)
A lender recently told me a story about how entrepreneurs often get deceived by the cost of MCA (Merchant Cash Advances) loans. As an example, one owner recently mentioned he was about to get a $121,000 loan that required the company to pay back $165,000 in 9 months and the company calculated the cost of the loan to be 37%.
What is a merchant cash advance loan? A merchant cash advance (MCA) is an alternative financing loan that provides small businesses with a lump sum upfront payment with repayment based on a percentage of business sales. The provider typically deducts a percentage of your business or credit card sales until the loan has been repaid, typically over the course of 3 to 12 months.
The banker responded, “Ugh, no its not. The interest cost is actually 99%!!” Here’s his math. The loan is paid back in even weekly payments over 9 months so the average principal outstanding over the 9 months is actually $60,500. So if you look at the interest cost of $44,000 against the average loan amount outstanding, it’s 74%. Then since the loan is only outstanding 9 months, the effective annual interest rate is 99%.
So what’s the point?
First, do everything you can to avoid these loans in the first place! But if you already took one or need to make payroll in couple of days, you may have no choice. Instead, look for other options! There are a variety of other lenders such as asset based (ABL) lenders and revenue based financing lenders (RBF), that can provide capital at much better terms with lower cost and lower payments. These funds often take a few weeks to close, so allow some time to look around and find one. If you are in a MCA loan now, look to refinance out or once its paid back, be resolved to find a new solution for the future. One that is not only at a much lower cost but also gives the Company much needed breathing room with lower payments made over a longer period of time.