Predatory MCA lenders want creditors to think that their MCAs are just as trustworthy as a bank loan. But the fact is, an MCA and a loan are two very different things. Whether you're a CPA trying to make sense of a business's debts, or a business owner looking to borrow money for your company, this blog will help untangle the complex differences between a merchant cash advance and a loan.
Merchant Cash Advance vs. Loan: What's the Difference?
The two biggest differences between a merchant cash advance and a loan is the cost of the money (effective interest rate) and how the money is to be paid back.
Merchant Cash Advance
In a merchant cash advance, an MCA company gives you what is essentially a cash advance against the business's future sales at 0% interest — which sounds great. This lump sum advance of money is called a Purchase Price. In return, you agree to a fixed payback amount, called the Purchased Amount. Then you must start making daily or weekly payments almost immediately and do so until paid off. As the payback is fixed, there is no benefit to paying it off early.
Loan
When your business takes out a loan, the lender is agreeing to give you a certain sum and you agree to pay back that sum plus interest over a specific period of time. If you pay it back faster, it costs less as interest is charged on the principle balance.
The difference is that in a loan, a lender is lending you money for which you can reduce the cost by paying it back faster. A merchant cash advance company claims to be purchasing your future sales, and then requires you to pay that back, even before those sales come to fruition — or worse — even if they never come to frution.
Merchant cash advances are complex and confusing, so let's take a little more time to sort out what exactly they are, and how they work.
Understanding Merchant Cash Advances
As mentioned, a merchant cash advance is an advance on the money that your business expects it is going to make. The MCA company is not technically lending you any of their money. They take a portion of your credit and debit sales and charge a factor rate, which means that early repayment won't actually help you save money.
For example, let's say a company took a $10,000 advance with a 1.2-factor rate. That means that no matter how quickly that company pays back the advance, they'll still have to repay $12,000. And that's with no interest, which we'll talk about next.
So, are there any positives to a merchant cash advance? Why would any business take one?
Pros of Merchant Cash Advances
Merchant cash advances are generally not a great idea for any business, but they do have some tempting benefits that make them popular:
- Get the money your business needs, regardless of credit. Merchant cash advance lenders do not adhere to typical regulations, and they do not require you to have good credit to get an MCA. This is an advantage for many businesses that have tried and failed to get a more traditional loan, but it's important to remember that access to fast money has consequences.
- Get money quickly. Because there aren't regulations or red tape, a merchant cash advance company can often offer money to your business in just days. For businesses that are struggling to make payroll or rent, this is an attractive benefit that solves an immediate problem.
Cons of Merchant Cash Advances
- MCAs are unregulated and can have an APR of 250% or higher. Merchant cash advances aren't regulated. That's why these companies can offer so much money, so quickly. But, the problem with no regulation is that they can make whatever rules they want. For many businesses, that means they have to start paying their MCA back immediately and make huge daily or weekly payments with interest rates higher than 250%.
- MCAs are not loans. You're not borrowing money with an MCA. Your business is selling its future returns to gain cash right now, which will eventually put your business in a tougher spot than where it is now.
- MCAs charge a whole host of hidden fees. To start, most MCA companies require your business to repay them on a daily or weekly basis. If you miss a single payment, they will charge a massive fee. What's more, with 250%+ APR, MCAs carry exponentially higher repayment fees than a traditional loan. Because MCA companies are largely unregulated, they can make up whatever rules they want, which means a whole host of hidden fees that only continue to drive up your cost.
- Many MCA contracts disallow loans. It's an MCA company's goal to make your business as dependent on them as possible. In many cases, their contracts will disallow you from getting a traditional loan, because this traps you into taking out more MCAs from them. They will often offer additional "services" like a reverse consolidation, that will only continue to drive up your business debt.
Understanding Traditional Loans
Unlike MCAs, bank loans are an extremely regulated method of securing funds for your business. In general, there are two types of traditional loans available to your business, unsecured and secured.
Secured loans are loans that are backed by collateral that the lender can seize if the business stops making payments.
Unsecured loans are loans that are not backed or secured by collateral. If a business stops making payments, the lender's only real option is to sue for that unpaid option.
Learn more about Unsecured vs. Secured Debt here, but know that all loans, unlike MCAs, have fixed repayment schedules and a final repayment date. Let's discuss some of the pros and cons of traditional loans.
Pros of Traditional Loans
- You get the money you need. When you apply for and receive a traditional loan, your business gets the money it needs to keep going.
- You get a fixed repayment plan with a determined end date. Because traditional loans are regulated, they have dedicated repayment plans that tell your business exactly how much it needs to pay back, and when. The end of your repayment plan is fixed, unless you decide to pay that loan back in full sooner.
- In Texas, traditional loans have a regulated max of 18% APR. This means that a bank or lender cannot charge more than 18% interest on the money you borrowed.
- A loan costs much less to repay than an MCA. Traditional lenders are held to much more conservative interest rates. They're also required to be much more upfront about their costs, which means there's typically fewer hidden fees.
- You can pay early to save on interest fees. In the event that your business starts seeing significant profitability, and ends up with more money than it needs, you can always pay a loan off early, saving you years of interest payments. This is not possible with MCAs, as their factor rate means you always end up paying back more than you borrowed, and usually significantly more.
Cons of a Traditional Loan
- Traditional loans can be slower to obtain. Because banks and lenders have to work through some red tape, information filing, loan approvals, and more, it can take longer to get a traditional loan than an MCA.
- It can be more difficult to get a traditional loan, especially if a business or business owner has poor credit. This is one reason that many business owners end up looking at MCAs in the first place. But, if you're worried about not getting a loan for credit reasons, check out this blog Can I Get a Business Loan with No Credit Check? for a few better alternatives.
MCA vs. Loan: Which is the Best Option?
In every situation, a loan is always the better option. Merchant cash advances may make getting cash easy, but the consequences are disproportionately greater than the benefits. In the long run, MCAs do significantly more harm than good.
Loans, on the other hand, are regulated and can be paid back with reasonable terms. Most businesses are able to secure some sort of regulated loan to ensure they have the funds they need to operate.
In any case, MCAs should always be a last resort, and it's always better if you don't use them it all.
My Business Already Has an MCA — What Do I Do?
If your business already has an MCA, it's best to talk to a reputable merchant cash advance attorney. Attorneys like those at The Lane Law Firm can help you make sense of your business debt, get you out of a merchant cash advance, and develop a plan to get back on track financially.
It's never a good idea to handle an MCA company on your own. These predatory lenders will stop at nothing to harass you and try to take more of your business's money. Get support from attorneys who have taken care of these unscrupulous lenders for years. Get in touch with The Lane Law Firm.
