Merchant Cash Advances, or MCAs, are a funding option for all types of businesses who need quick cash. But as a “quick fix” solution, it can come with a host of challenges that may lead to huge problems for small businesses, especially for those in the commercial construction industry.
Let’s break down what Merchant Cash Advances are, how they work, and how they can create a vicious cycle of debt for construction businesses.
What is an MCA and how does one work?
Merchant Cash Advances, also called an MCA or Daily Debit Loans, are a type of funding that is based on the average amount of cash flowing through a business’ bank account on a monthly basis.
An MCA is actually not a loan, it is an advance on “future receivables” or future sales of the company. Therefore, the amount of the advance and the cost of that advance is based on the following information:
The business owner’s personal credit score. This is important to the lender because they use this to judge the character of the person and their likely desire to make sure the MCA is paid back.
Did you know that just applying for an MCA can negatively impact your credit? Here’s why. Most MCAs are sourced through a broker and rarely does the business owner ever get to work directly with the actual lender. The broker gets an application signed and then sends it to multiple lenders who all pull the business owners credit score.
The Guide to Merchant Cash Advance Loans (MCAs)
Bank account information. The lender will look at the number of deposits made into the account on a monthly basis to determine how frequent new money is coming into the account. They’ll also look at the total amount deposited into the bank account. This determines the likely revenue of the business. Finally, they’ll check the average daily balance in the bank account. This is used to determine how much can reasonably be auto-debited from the account every day without risk of a payment being bounced.
Using this information, the MCA lender then decides how much the business is qualified to receive for an advance, the cost to be applied to the advance amount (this is the cost of the money to the business owner), and how many business days it will take for the advance to be repaid, (typically 6-12 months).
The cost of the advance is determined using a factor rate, which is a percentage of the lump sum for which the client is approved. Factor rates can vary from high single digits to as much as 50% or more. https://paydayloanstennessee.com/cities/lafollette/ If a client is approved for a $100,000 advance with a factor rate of 30% then the cost of the loan is $30,000.
The total repayment of the MCA is the lump sum of money plus the cost of the factor rate percentage. In the example above the total repayment amount would be $130,000.
The next important detail is the time frame to be paid back – typically 6-12 months. It’s critical in determining the actual repayment of the MCA and what the impact will be to daily or weekly cash flow.
As a general contractor or subcontractor business owner, you need to know what you are signing and what the real cost of that funding is to your business. If the factor rate is 30% and you can pay it back over 12 months that is very different than 6 months. At 12 months you are actually repaying the loan at an annual rate of 60% interest.