HOW DO MERCHANT CASH ADVANCE (“MCA”) LOANS DESTROY GOOD, PROFITABLE SMALL BUSINESSES? 

Cost of Capital

It’s is extremely important to understand the true Cost of Capital when you are considering taking on any type of business debt financing.

This is the #1 reason that MCA loans destroy good, profitable businesses since MCA loan’s Cost of Capital is extremely high compared to all other business debt financing options.

Responsible Lenders

First let’s look into how responsible lenders such as banks and private credit investors (private term loans and lines of credit that are backed by private investors, not banks) determine a maximum approval amount for your business. 

Term loans, lines of credit, equipment loans, invoice factoring, merchant cash advances (MCA loans) or sale of accounts receivables (future sales deposits), etc are common ways to finance your business.  They all have different Cost of Capital as well as different durations or payback terms.

The Underwriting and Cost Difference

There is a huge difference between how banks or private term loan lenders underwrite compared to Merchant Cash Advance companies (MCA loans). 

Business financing is typically used to grow your business, bridge the gap between your AR and AP, buy equipment or finance a new business project or client, etc.

Private credit lenders (private investors) that provide bank-style loans for typically 7% to 13% more in APR then going bank rates)

A Multiple of your Business’ Earnings dictates a Loan Approval level

Your annual business earnings (if your business is profitable) are typically used to determine how much debt your business can afford to pay back (debt service).

EBITDA or “earnings before interest payments, tax payments, depreciation expenses and loan amortization” is one of the key metrics used by credit analysts to determine the amount of total debt load that your business can handle and service without potentially defaulting.

A traditional bank loan (term loan or line of credit) charges an APR or annual percentage rate based on the outstanding loan balance.

Banks typically have very stringent requirements for financing and will only lend up to 1.75 times your EBITDA.  Private credit investors will typically take more risk and lend up to 3.0 times your EBITDA.

An Example of Loan Underwriting Methodology

So for example, if your business’ EBITDA is $500,000 per year, a bank will typically lend up to $875,000 total against a $500k EBITDA. 

If there is other existing debt a bank or private term loan lender may refinance the existing debt and provide working capital up to the approval limits.

Banks and private term loan lenders consider net profit, EBITDA, free cash flow, business collateral, personal guarantees (owner’s personal credit worthiness) and a host of other metrics to determine if a business can support principal and interest payments over the term of the loan or line of credit. 

Bank rates for business term loans or lines of credit (if anyone can actually get a loan from a bank besides an SBA loan) are currently in the range of 6% to 11% depending on the overall loan risk.

The Importance of knowing your true Cost of Capital

When considering debt financing for your business, “Cost of Capital” (amount of fees and interest you pay on the outstanding balance) is one of the most important aspects to look at when considering taking on business debt. 

Private Lender rates for business term loans (higher approval rate than traditional bank loans) are currently in the range of 14% to 18% depending on the overall loan risk. 

How Banks and Private Credit Lenders Look at your Business

Banks and private lenders underwrite business term loans and lines of credit by looking at various business performance metrics.

Metrics such as net profit, EBITDA (earnings before interest, taxes, depreciation and amortization), free cash flow and other metrics that measure a businesses ability to pay and service principal and interest payments during the term of the loan or line of credit (2, 3, 5, 7, 10-years or whatever the term of the loan may be).

Giving away Earnings from Selling your Future Receivables *MCA loans)

So when you take an MCA loan, the “factor rate” (1.28x, 1.38x or 1.49x, etc) is a “Factor Rate” and not an APR (Annual Percentage Rate).

If you sell $100,000 (“Amount Purchased” or pay back amount) of your receivables for $75,000, you just GAVE AWAY $25,000 instantly to borrow $75,000 for 9-months or less.

That’s over 40%+ APR.

Keep your money. You worked for it. Stop giving it away to MCA.

Refinance your MCA loans today.