Key Takeaways
- A Merchant Cash Advance (MCA) provides small and mid-sized businesses quick access to working capital.
- MCAs provide faster approval than other types of financing and are growing in popularity.
- While investors face increased risk with MCAs, this emerging market offers higher returns.
With apologies to The Village People, we think answering the question, why MCA, could be a hit today for investors just like the 1978 song. Imagine you own a small bakery and you’re earning good money. Now imagine that a new COVID variant prompts lockdowns that throw you into a serious revenue shortfall. Rent, health insurance, and many other costs eat into your working capital. In other words, you’re close to going broke and there’s no time to line up conventional financing. Enter the Merchant Cash Advance (MCA).
MCAs are nearly-instant infusions of cash for the benefit of small to mid-size business owners that can eliminate the need to go to a bank for conventional financing. MCAs are considered a “sale of future revenue,” and as such are not subject to the same regulations or requirements. They are most often used for working capital but can be used for a wide variety of reasons, as the chart below demonstrates.
Potential Advantages for Borrowers
MCAs provide quick working capital and have certain advantages over traditional loans. MCAs can be completed in less than a week. They are typically paid back in 3 to 12 months, don’t have the same onerous regulatory or credit requirements as loans, and don’t require collateral. Rather than being asset-backed, they are asset-based— their repayment is contingent on remittances of future sales. Rather than paying a fixed payment of say, $800 per month, an MCA customer will send payments based on a percentage basis— say 8% of credit card sales or some other sales stream. Businesses that rely heavily on credit card sales, like restaurants and retail stores, can be found among the majority of MCA agreements.
They have become more popular due to the COVID-19 pandemic and its negative impact on sales. The chart below, from Shopify, shows the tremendous growth of MCA customers.
MCAs can be riskier than traditional forms of financing given the lack of traditional bank review. However, they offer a much higher potential return. The APR for MCAs sometimes reaches the triple-digits, far outpacing traditional bank loans, online small business loans, and business credit cards. APRs for MCAs are typically in the 40% to 350% range, while traditional bank loans earn less than 10%, online small business loans 8% – 99%, and business credit cards 12.9% – 29.9%.
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How MCAs are structured
MCA repayments are normally percentage-based, but can sometimes be structured in the form of fixed payments. The APR is determined by the likelihood of repayment from the borrower. This likelihood determines what is called the factor rate— the factor of repayment owed to the lender. Factor rates generally range from 1.2 to 1.5. The factor rate is determined by an assessment of the financial health of the business, its potential for future revenues, and the financial health of the owner.
The cash advance is multiplied by the factor rate to find the total repayment obligation. For example, if your bakery needs a $100,000 MCA and the risk is determined to be on the lower end, at 1.25, the amount that you owe will total $125,000. Given the percentage-based repayment structure of MCAs, the speed of repayment is decided by the volume of credit card sales or other sources of revenue.
Many small businesses may consider MCAs to survive short-term setbacks as pandemic restrictions lift. Public demand for a return to something approximating pre-pandemic life could assist many MCA borrowers and help them repay MCAs at a higher rate than they were able to during earlier stages of the pandemic when sales were weaker.
At Yieldstreet, we are working to help small businesses find MCAs. Yieldstreet’s American Small Business Financing II will pool capital for MCAs available to small to mid-size businesses that may otherwise find it difficult to obtain financing. It may not be as much fun as dancing to the song YMCA at a wedding or bar mitzvah, but we believe investing in MCAs could be a hit.
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1. “The Difference Between a Merchant Cash Advance and a Loan”, Lightspeed, 3-23-2021
2. “Is a Merchant Cash Advance Right For Your Business?”, Nerdwallet, 1-27-2021
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