Have you heard about payday loans? Chances are good you’ve heard nothing good about them. They trap customers in an endless debt cycle. You wouldn’t dare, right?
There’s a payday loan for businesses.
It’s called merchant cash advance (MCA). But not all merchant capital providers call it that.
Like payday loans, it traps your business in an endless debt cycle.
It’s tempting to use MCA for a quick fix.
But then it balloons like an overflowing toilet that won’t quit. Next thing you know, you’re addicted. It’s the way the loan works that forces you to keep feeding your MCA habit.
Say a business pulls in $100k per month. A prospect comes along that will add $30k per month. A big opportunity like that is most likely going to need serious working capital to support it.
What would you do?
Find a way to make it happen.
In this case, the biggest problem is that the team would need to work for about 60 days — if not more — before the client makes the first payment.
How is the business going to make payroll during those 60 days? Not paying employees on time is never acceptable. The business owner has a way to grow business yet he can’t do it without working capital. Although this $30k per month brings in working capital, he still needs more to cover the 60 days until the first payment comes in.
It’s like pressing the brake and accelerator at the same time.
How a business becomes addicted to MCA
He thinks he finds the answer when he learns about MCA and opts in for the working capital. He receives a 6-month loan for $45k and problem solved.
Or is it?
Take a look what happens each day.
Receives $45k in bank account.
MCA provider takes out $500, a percentage of the loan amount. The business now has $44.5k left on the loan to spend.
Another $500 disappears. The loan is down to $44k — a full $1k — in just two days.
Day 3 through 8
The merchant capital provider continues taking out $500 each day. The loan shrinks to $42k by day 7.
That’s $3k gone in one week.
Today, the business has $41.5k.
Payroll is due. The owner takes out $20k from the merchant cash advance loan to cover payroll and expenses to support the new client. The MCA loan is down to $21.5k.
There’s $13.5k left on the loan. Remember the business used $20k to make payroll. It continued paying pay $500 per day to the MCA provider.
It’s payday again. There’s not enough cash for payroll and expenses. This pushes the small business owner to take out another MCA loan to make up the difference. He’s now an MCA addict.
The MCA will have taken out the full $45k of the original six-month loan!
Remember the owner took out another loan to cover the difference on Day 25? Because of this, monthly payments have increased and he’s digging a deeper hole.
By the end of the six months, the owner owes $90k. Twice the amount of the original loan with a 50 percent interest rate. And that only covers the original loan.
When you add the second loan taken out on Day 25, the situation turns into an endless debt cycle.
How to end the MCA debt cycle
B2B companies with accounts receivable have a better option for working capital management. It’ll help whether they’re stuck in an endless MCA loan or need another option as they stay away from a merchant cash loan.
That option is known as factoring or invoice financing.
What is factoring?
You sell your accounts receivable for a small discount to a factor. A factor is a financial intermediary that offers the service.
The best part is that there’s no loan to pay back. This money is already yours.
Factoring is ideal for businesses that are growing fast and need the working capital to capitalize on new business opportunities. The service works well for companies that wait a long time to get cash from their invoices.
Accounts receivable financing can help a business break free from an MCA loan. Businesses that struggle with having to slash gross profit margin due to competition or financial accounting issues — without cutting expenses — benefit from factoring.
How to pay off merchant cash advance
The business owner who took out a $45k MCA loan can avoid sinking deeper with the MCA by selling his accounts receivables to a factor.
It’ll cover the difference until the MCA is paid off. And because it’s money his clients owe him, there’s no loan or high interest to pay back.
What accounts receivable financing does is get your invoices paid faster.
Getting cash now instead of waiting 30, 60 or more days makes a huge difference.
On day 9, the business owner needed $20k for payroll and other expenses. He has couple of unpaid invoices that are only one or two weeks old. (His gives clients 30 days to pay their invoices before charging a late payment fee.)
The factor buys those invoices within a day, saving him the need to take out another MCA loan.
He works out a plan with the factor to help him through the remaining months he’s stuck with the MCA. Once paid off, he’s free.
Going forward, when he needs money, he relies on the accounts receivable process.
Alternative to merchant cash advance
It’s very hard for a business to escape an MCA loan unscathed.
However, some small business owners feel like they have no choice. They’re low on operating cash flow and all other options take too long or turn them down.
Bank loans are slow. And they often don’t approve small business loans. You could have a good record and they still won’t approve.
That’s because it’s not profitable for banks to give out smaller loans.
The process of setting up a bank loan is the same regardless of the amount. Therefore, smaller amounts don’t justify the work it takes to set it up.
Here are 10 reasons why accounts receivable financing is better for managing your cash flow.
If it’s something you’d like to investigate, get questions to ask in seeking a small business loan for help.
Here at Capital Solutions Bancorp, we’ve helped B2B companies get out of an MCA situation. You can receive a customized plan that outlines how you’ll pay off your MCA loan with invoice financing.
Or if you’re trying to increase your gross profit margin, we can work with you to do that and get a better handle on growth.
If you’re not stuck with merchant cash advance, you might be able to make money off factoring. Let us show you how.
Whichever situation describes yours, email us or call us at 800-499-6179 for a no obligation conversation.
Image credit: Marcelo Braga