What is an MCA Buyout loan?
Let’s begin with the formal explanation of a merchant cash advance (MCA) and a brief history. A merchant cash advance is simply a lump sum advance of funds from one party to another with a set payback amount. For example, a restaurant that receives $10,000 and agrees to pay back $13,000 from future revenue is a typical MCA. If this sounds a lot like a loan, you’re right. That’s why a brief history and an explanation of the nuances is important.
Originally, merchant cash advances were paid back based upon a percentage of future revenue. By definition, the payback terms varied depending upon future earnings. This method was popular in the restaurant industry, among others, that had trouble securing funds from traditional banks and relied heavily on credit card sales. Take our example above, where a business owner received a $10,000 advance and agreed to pay back $13,000. If the terms of the advance called for 10% of monthly credit card receipts to be paid to the funder, then:
Example 1: 10% of $5,000 in monthly sales = $500. The payback would be 26 months.
Example 2 : 10% of $10,000 in monthly sales = $1,000. The payback would be 13 months.
The APR of Example 1 is obviously much more advantageous than Example 2.
Over time the MCA industry began to shift to set daily payback amounts— known as a “holdback”—sometimes through credit card receipts and increasingly through automatic debits known as an Automatic Clearing House (ACH) payment. This created more clarity for both the borrower and the lender, making it easier to determine the APR on a particular advance. But even though an APR is usually important to the business owner, it’s rarely presented in these terms by the MCA lender. They have two very good reasons for doing it this way.
- Acknowledging that a Merchant Cash Advance carries an interest rate means it looks and acts more like a loan. MCA companies explicitly state in their agreements that advances are not loans because they would be taxed differently and they would open themselves up to regulatory scrutiny.
- The APR’s on advances are extremely high and have the potential to spook borrowers. Even though the industry has become extremely competitive, APR’s on an MCA can range from 10% to 150%. In some cases, even higher.
For obvious reasons, even companies that historically offered loan products refer to them in the agreements as advances.
Why You Should Consider a Merchant Cash Advance
If you’re considering this type of funding, it’s probably because you’ve been turned down by a traditional financing company or you are in need of quick cash. If that’s the case, you can’t think about it in terms of percentage. You have to think about the opportunity cost of not getting the financing, the savings in time, and the value of the money to you personally based upon your situation. If friends and family aren’t an option, and you’re not in a strong enough financial position to secure a loan or a line of credit from a bank, then an MCA might be your fastest and best option.
Benefits of Taking a Merchant Cash Advance
- Unsecured. Most merchant cash advances are unsecured loans, meaning no tangible asset is pledged against the money. The funder is assuming the risk of the advance, which is why the fees associated with an advance are higher than normal lines of credit or bank loans. It’s important to know that the MCA is taking on 100% of the risk in this situation. Having said that, you will be asked to sign a personal guarantee, which means your credit score is at risk should you default. Moreover, the MCA can take steps to collect their money from you personally in the event of a default, which can be more than a headache.
- FastFunding. Merchant cash advances are typically turned around in less than a week if you’re deemed eligible by the funder’s underwriting standards and you have the proper documentation in place. These include:
- 3 to 6 months of business bank statements
- Prior year’s tax return
- Certificate of Incorporation
- Copy of a driver’s license
- Completed application with personal information
- Proof of tenancy. This includes a mortgage deed if you own your property or a valid lease. If you lease your business space, be sure you’re current because funders typically contact your landlord.
Most business owners are able to provide the documentation above with relative ease. Being prepared with these items will greatly speed up the underwriting process.
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