Merchant cash advances – funding at a price

Published by Abbey Watkins on 14 December 2023

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With cashflow the lifeblood of a retail business anything that can release sales revenue faster is to be welcomed, but at what cost? Abbey Watkins looks at the rise of merchant cash advances, and some of the alternatives.

A merchant cash advance (MCA) is a financial product that provides short term funding for retailers that accept credit or debit card payments in-store on online.

Typically, the credit or debit card merchant services provider advances an agreed amount of cash to the business, applies a factor rate (effectively an interest rate based on the cost of the service) and, in return, the business agrees to repay a percentage of their daily card sales or bank deposits to the MCA provider.

This daily remittance continues until the agreed amount, including the uplift from the factor rate, is repaid in full.

One of the main advantages of MCAs is the speed at which businesses can access funds. The application and approval process is typically faster and more straightforward when compared to traditional loans, making it a viable solution for businesses in need of immediate financing.

Since MCAs are based on daily sales and business performance, approval rates tend also to be higher than for traditional loans. Even businesses with sub-optimal credit may be eligible for an MCA. MCAs are also unsecured, meaning directors and business owners do not have to provide a business asset or their home as security.

Arguably the biggest advantage of MCA is that, unlike traditional loans, MCAs offer a flexible repayment structure, as repayments are directly tied to the business’s daily sales. This can provide a real benefit for seasonal businesses, with MCA repayments lower during quiet trading periods. This flexibility can help businesses to better manage their cash flow.

However, MCAs are, like many other forms of alternative lending, unregulated and do not fall under the scope of the Financial Conduct Authority. This means the terms and conditions of borrowing need to be carefully considered.

MCAs have come under criticism for both the cost of borrowing and the often-opaque factor rates and repayment schedules.

Repayment rates, according to The British MCA Association, typically range from 10% to 18% but have been reportedly as high as 25%. This represents a considerable percentage of a retailer’s daily sales.

More worrying is the lack of clarity on factor rates. Not to be confused with interest rates, they can vary from a factor rate of 1.1 to as high as 1.5 with the factor rate multiplied by the amount borrowed. If a retailer were to take an MCA of £10,000 with a factor rate of 1.5, they would repay £15,000 – the equivalent of an 14.5% interest rate if repaid over a three year period.

And then there is the question of cash payments. MCAs work only on card payments and encouraging customers to pay by cash, perhaps through special offers, could see retailers in breach of the conditions set by lenders.

So what are the alternatives?

Firstly, businesses need to understand the scale of the problem they might be facing and how that might impact the business in the short and medium term. Forecasting and scenario planning, asking and answering the ‘what if’ questions, will be helpful, and your accountant can guide you through this exercise. Only then should funding options be considered.

In some instances, reviewing and perhaps extending overdraft facilities might be the simplest and easiest answer. Where borrowing is already in place, perhaps through the Covid support programmes, restructuring that lending or taking a repayment holiday might also help.

Where additional borrowing is needed, retailers might want to consider a more conventional bank loan. Interest rates are likely to be lower and with greater clarity of the terms of the loan. Banks, however, are unlikely to loan to cover a shortfall in cashflow and will require greater scrutiny of the business and may ask for security for the loan.

Banks and specialist invoice financing companies too may be able to offer some form of invoice financing, where a percentage of revenue is released against sales. Working in a similar way to MCA, invoice financing companies are regulated by the Financial Conduct Authority with the protections that offers.

Whatever route a retailer chooses to take, it is advisable to first take independent and expert advice. Please get in touch here.

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