Merchant cash advances: how to figure out what you're really paying

Merchant cash advances (MCAs) are fast and easy to qualify for, which is why so many restaurants, shops and retailers use them. They're also one of the most misunderstood products in business funding, because they're priced with a factor rate instead of an interest rate.

How a factor rate works

Say you take a $50,000 advance at a factor rate of 1.35. You repay $67,500. The cost is $17,500, no matter how quickly you pay it back, unless the agreement offers an early payoff discount.

That looks like 35%. It isn't, for two reasons:

• It's paid back fast. If the advance is repaid over six months, that's the cost for half a year, not a full year.
• You repay every day or week. Your balance drops from the start, so on average you only have about half the money in hand over the term.

Put those together and an advance like this one works out to well over 100% on an annualized basis. That doesn't make it automatically wrong for your business, but it's the number to compare against other options.

Why the rules are different

Many MCAs are structured as a purchase of your future card sales or receivables rather than a loan. That's one reason they can be priced differently from term loans, which in Canada are subject to criminal interest rate rules. For business loans between $10,000 and $500,000, those rules currently cap the annual rate at 48%.

Questions to ask before you sign

• What is the total payback amount, in dollars?
• How often are payments taken, and how much each time?
• Is there a discount if I pay it off early?
• If sales drop, can payments be adjusted (a reconciliation clause)?
• What fees come off the top before I receive the money?

When an MCA makes sense

A short, specific need with a clear payoff, like stocking up for a busy season, or replacing equipment that's costing you revenue every day it's down. It makes much less sense for long-term needs, or as a way to cover payments on another advance.

Already carrying one or two?

Stacking advances is how cash flow problems snowball. If daily debits are eating your margin, ask about consolidating them into a single longer-term loan with one lower payment. An advisor can tell you quickly whether you qualify.