Defining APR In A Merchant Cash Advance



Defining APR In A Merchant Cash Advance

Liberty Capital represents small businesses struggling. Under the condition of lack of cash flow to properly operate a successful business, the business has very few options to go to. However, there is a solution if done right. We’ll explain below to fully make you aware of it before you make your next MCA decision.

Whether your business is facing a cash flow shortfall or unexpectedly high and ever-increasing prices, and those who cannot meet the daily operating capital can cause a very stressful life for small business owners. When a bill piles up, a credit score is damage trying to juggle what bills to pay first doesn’t provide comfort that your local bank doesn’t have your back. What option will you have in this situation when most businesses are either living paycheck to paycheck to cover operating capital neglecting personal credit in the hope business will improve. When credit cards are maxed out, a credit score is damaged with very little collateral to put up to qualify for any decent form of funding, what does a business owner do to make sure his/her business survives another day.

A situation happens quite often more than we can imagine, of course prior to such advent of the cash advance, such a powerful representation option for business owners has to give them a fighting chance albeit expensive but better than zero option. That’s a tough pill to swallow for many when cash flow is limited; your options are limited too. You can do the following: 1) sell everything to get liquidity to use for working capital. 2) Borrow from your immediate family 3) Close and file bankruptcy to protect whatever assets are left. The choice must not be taken lightly.

Many believe merchant cash advance is a trap. The argument whether it’s a trap or it’s a solution is still open. When done right it’s the best program for those who are un-bankable, those who have had prior credit blemishes, and those who have not been able to build history but rather have the revenue to support short-term borrowing.

Just like personal loans, when abused it’s detrimental. A merchant cash advance isn’t a long-term solution however a short-term infusion for emergencies and as a stop-gap. Additionally, peace of mind is priceless when you know you have an option. When you know you have a place that has your back.

This product is not meant to end up on the same advance as a long-term solution. There must be an exit strategy. If credit, cash flow, and sales aren’t increasing then there’s a problem, borrowing from Peter to pay Paul is not a viable option for anyone. Borrowing to survive just prolongs the inevitable.

An industry has propped up due to merchant cash advances. It added a new vertical for those who are in the debt relief industry. Helping clients consolidate cash advances can work when done right but might limit the future possibility of accessing funds. But if the cash flow savings can be used toward turning the company around, then that might be a suitable solution.

To learn more, contact our office today before you apply for another merchant cash advance. Sometimes you might be surprised to get a line of credit or longer-term loan rather than remaining in the same cash advance cycle.

Here are some things to learn about merchant cash advances so you can properly make the best business decision.

What is a Rate Factor?

A merchant cash advance (MCA) is future purchase-based business funding. A fee or price based on a rating factor, which is expressed as a decimal figure, unlike an interest rate or an APR (annual percentage rate). On a traditional loan that is a percentage reflect the cost of capital. Rate factors are typically between determine the cents on the dollar or cost to dollar i.e., 1.1 and 1.4, and depend on:

  • Risk factor
  • Type of industry
  • Length of time in business
  • Average monthly sales deposits
  • Credit FICO
  • Business credit history
  • Advance amount
  • Length of the term

MCAs typically use rate factors rather than APRs, and accelerated repayment terms invariably lead to higher rates making payment considerably higher than an amortized loan as principal is paid with the fee in a very short time. Because repayment of the advance is based on a percentage of your future credit or debit card sales, or monthly bank deposits, the repayment amount can increase or decrease depending on your daily sales if you opt to have your payback retrieved through a percentage of your daily sale (remittance or % withhold against daily sales).

Withholding percentage is the number of percent of your sales withheld toward a fixed payback for a fixed specified time. If you opt for this remittance, there is a chance that you end up paying higher than a fixed amount because if your sales have increased, payback accelerate even further to your disadvantage for paying a note sooner than a term at the same payback doesn’t benefit you relative to a loan that is amortized.

Typically, payback on the merchant cash advance is fixed no matter when you pay it off. If you pay it off two months early, your rate factor will not be reduced. This form of accelerated payback will make the cost of capital even higher as the time value of money isn’t factored in.

Determining the actual cost of funding requires converting the rate factor into an annual percentage rate, however, which can result in an APR in the triple digits. In short, such a high cost of capital increases the risk of default on a merchant cash advance for the lender as well as for the client who must survive.

What’s the difference in a merchant cash advance’s Rate factor, Interest Rate, & APR.

A rating factor is multiplied by your cash advance amount to show the total cost of funds, while an interest rate reflects the percentage of the principal charged on a traditional business loan, amortized loan that fully determines the true APR. APR is for comparison purposes only not a true measure of risk a lender’s risk. The APR is annualized to reflect the total cost of funds for one year, including the interest and additional fees, expressed as a percentage.

Calculating Rate factor for Merchant Cash Advance

Determining how much you would pay for a Merchant Cash Advance (MCA), simply multiply the amount of the advance (funding amount) by the rate factor given in decimal also called a buy rate. The total is the amount you will pay back to the funder – payback or purchased price.

For instance, if you get a $10,000 MCA with a 1.3 rate factor the calculation would be: $10,000 x 1.3 = $13,000. This means you pay $3,000 for borrowing $10,000. Without specifying the time of the advance, and the cost of the advance is $3,000, Without comparing to anything cost can be relative which is high compared to the cost of a traditional business loan if the term is, say, 6 months, compared to the same rate factor but for 12 months.

Converting MCA Rate Factor to an Interest Rate – Simple Interest

In the example above, we can quickly assume the interest rate on a $10,000 was $3,000 with a rate factor of 1.30 percent. From a simple math, $3000 cost of funds/$10,000 advance = 30%). But there are three steps involved in converting the rate factor to an interest rate:

  1. Multiply 365 by the rate: 0.3 x 365 = 110.
  2. Divide the result by the repayment term of the MCA. If the term is 126 days (6 months), the result will be 110/ 180 = .60
  3. Convert the result into a percentage. .60 x 100 = 60 percent interest.

As you can see, a 60 percent interest rate is far higher than the rate once the time is factored in. A merchant cash advance is a purchase and sale of future receivables, however, not a loan; the transaction is not governed by usury laws as the business can cease to exist thus ceasing future revenue to retrieve however, the key question is the personal guarantee.

What is Personal Guarantee?

The best way to understand what a personal guarantee is to read up WIKIPEDIA’s definition. From the lender’s perspective, it’s securing the lender’s interest but rather to specific assets or business assets, it’s to a specific person, owner, or stakeholder in case the business cannot fulfill its obligations, a personally liable individual must cover any deficiencies.

Personal guarantee wasn’t much of a factor for merchant cash advance however most lenders have implemented personal guarantees even on merchant cash advances. So, you can’t just technically shut your doors and go scot-free from your liabilities. Your business might be gone, but if the lender deemed the guarantor has capital or assets, they have the right to execute default judgment they seem necessary to secure their interests.

A personal guarantee is like a UCC filing for business but to personal in case of a default. The lender can claim any interest they have against the person for any amount personally guaranteed making it a powerful tool for lenders to recover any uncollectable debts.

Converting MCA Rate Factor to an APR

To derive an annual percentage rate, which is calculating the total repayment amount including interest and fees into the total cost of borrowing. For example, if the MCA buyer or provider charges a 2.5 percent origination fee and a $150 admin fee, the total amount of your payment will be $13,400 ($13,000 financing payment + $250 origination fee + $150 admin fee).

  1. Multiply 365 by the rate: 0.34 x 365 = 124
  2. Divide the result by the repayment term of the MCA. If the term is 126 days (6 months), the result will be 124/ 180 = .69
  3. Convert the result into a percentage. .69 x 100 = 69 percent interest.

This means the total cost of the advance is $3,400 which gives you a new rate factor: divide the total cost by the advance amount ($3,400 / $10,000 = 0.34) for a rate factor of 1.34. By plugging this higher rate factor into the interest calculation above, the result is an APR of 69 percent.

Again, APR will go up when factoring in admin and origination fees. However, if the term extends longer, the APR conversely will go down. So, the cost of capital can be measured through the lens of an APR.

What Happens if you Default on a Merchant Cash Advance?

The risk of default on a high APR merchant cash advance can be detrimental to small business owners and their assets. Not to mention the black eye your business would suffer if it survived. The best way to confront such a dilemma is to work with a professional who can navigate you through the best process to retain your business and assets. Negotiating with your lender is the best route before it turns into a judgment that will just preclude you from future borrowing. An agreement will include a reconciliation provision, which requires the funder to restructure the payments if you are facing a receivables shortfall, as long as you can show your business will return to profitability. However, the is not a way out but a way to revolve that’s suitable to both parties.

Before you decide whether you need to borrow a merchant cash advance, there might be better options, please contact us at 888-789-4365, we might have a better solution than a merchant cash advance. Although, credit and cash flow sometimes limit you to this option so before you borrow think deeply about the impact of whether this plan of borrowing is for one time or it’s for long-term.

Decide whether this fund will increase revenue to supplement cash flow, or whether the reason for your borrowing can justify high payment, high APR, and high payback.

Liberty Capital does offer Merchant Cash Advance as well as other products other than MCA such as term loans, equipment finance loans, commercial truck loans, and unsecured revolving business lines of credit. We’re a full suite small business funding provider.