Summary: Merchant cash advances (MCAs) are a popular but very expensive form of business financing. Companies with excessive cash advance debt often look to refinance (or consolidate) these advances to reduce their high weekly payments.
In this article, we take you through a merchant cash advance refinancing transaction and discuss why merchant cash advances are not a good refinance option. We review the transaction details and discuss potential alternatives. We cover the following:
- How does a merchant cash advance work?
- Is there a benefit to paying off an MCA early?
- Should you refinance an MCA with a new cash advance?
- The true cost of refinancing with an MCA
- Why is this transaction so expensive?
- A better way to refinance an MCA
- Our loan consolidation/refinancing program
1. How does a merchant cash advance work?
Merchant cash advances, often called cash advances, are relatively simple to understand. The provider gives you upfront funding and then debits your bank account regularly until the balance has been repaid.
The key figures in a merchant cash advance proposal are the advance amount, factor rate, and repayment period. You can use these figures to calculate the total repayment amount, your weekly payment, and the financing charge. The financing charge is important because it shows how much you will pay above the amount advanced.
Some basic definitions:
- Advance: Funding amount that your company gets
- Factor rate: Multiple used to calculate the total payment
- Repayment period: Number of weeks (or months) needed to pay back the provider
- Total payment: Total amount of money you will pay the provider
- Weekly payment: Weekly payment amount
- Finance charge: Difference between the total payment and the advance amount
If you need more details, read “How Does a Cash Advance Work?“
Let’s look at an example:
Provider A
| Advance | $250,000 |
| Factor Rate | 1.35 |
| Repayment Period | 36 Weeks |
With this information, we can calculate the total payment, weekly payment, and finance charge. They are as follows:
| Total Payment | $337,500 ($250,000 × 1.35) |
| Weekly Payment | $9,375 ($337,500 ÷ 36 weeks) |
| Finance Charge | $87,500 ($337,500 − $250,000) |
Calculating these numbers is simple. We used these formulas:
- Total payment = Advance × Factor rate
- Weekly payment = Total payment ÷ Number of weeks
- Finance charge = Total payment − Advance
2. Is there a benefit to paying off an MCA early?
Most cash advance companies do not offer a discount for early repayment. Your company must still pay the full repayment amount, including the entire finance charge.
This differs from how most conventional amortizing loans work. This distinction is important and is why refinancing an MCA with another cash advance is usually not a good option.
a) Conventional loan
Conventional business loans are typically amortizing loans. This process keeps track of interest and principal in separate categories. The payment is used to pay interest and reduce the principal’s balance. Consequently, the principal decreases as you pay off the loan (e.g., a mortgage).
Paying off the loan early can save you money because you pay only the remaining principal and accrued interest. You don’t have to pay off any remaining future interest. Consequently, you get a financial benefit if you can afford to pay off the loan early.
Note: This description has been simplified. Some loans have prepayment penalties.
b) Merchant cash advances
Merchant cash advances are different from conventional loans. There is no interest and principal as in an amortizing business loan. You owe a fixed amount that includes the financing charge. Each payment reduces the amount you owe.
You can close a cash advance only by paying off the remaining balance. Furthermore, most providers don’t offer discounts for paying off the advance early. Paying off Provider A’s cash advance early only accelerates payment of its $87,500 finance charge. This is why it’s not a good idea to refinance an MCA with another one.
3. Refinancing with a new cash advance
Let’s see what happens if you refinance a cash advance with another cash advance. Assume a business gets the cash advance from Provider A. The advance has the terms discussed in Section 1.
Provider A
| Advance | $250,000 |
| Factor Rate | 1.35 |
| Total Payment | $337,500 |
| Finance Charge | $87,500 |
| Weekly Payment | $9,375 |
| Repayment Period | 36 weeks |
Things go as planned for the first few weeks and the business makes the $9,375 weekly payment without a problem. However, after 12 weekly payments, the business owner determines that they overestimated their ability to pay for the advance. This table shows the cash advance’s status.
| Initial Balance | $337,500 |
| 12 Weekly Payments | $112,500 ($9,375 × 12 weeks) |
| Remaining Balance | $225,000 ($337,500 – $112,500) |
a) The new provider
The business owner decides that their preferred option is to refinance their cash advance with an advance that has a lower weekly payment. After some research, they find Provider B.
Provider B appears to offer more manageable terms. Its offer is as follows:
Provider B
| Advance | $225,000 (just enough to pay off the MCA from Provider A) |
| Factor Rate | 1.40 (higher rate due to risk) |
| Total Payment | $315,000 |
| Finance Charge | $90,000 |
| Weekly Payment | $5,625 |
| Repayment Period | 56 weeks |
The new cash advance covers only the $225,000 payoff balance owed to Provider A. It also has a lower weekly payment than Provider A’s cash advance. This enables the business owner to refinance the old cash advance with a new one.
While the new cash advance has a higher factor rate, it also has a longer 56-week term. The longer term lowers the weekly payment to $5,625. Keep in mind that the lower weekly payment does not mean this cash advance is ‘cheaper’ than Provider A’s cash advance.
b) The refinancing transaction
The business owner proceeds with the transaction and pays off Provider A’s cash advance. Going forward, they keep only Provider B’s cash advance open. Provider A gets a great deal because it receives the full repayment of $337,500 early. It also receives the $87,500 finance charge for a cash advance that was open for only 12 weeks.
Some would say that the business owner got a good deal too. Their company lowered its weekly payment from $9,375 to $5,625. Arguably, that’s a substantial decrease. But is it a good deal?
4. The true cost of refinancing with an MCA
Let’s look at the costs of the transaction and determine if it was a good deal:
- Payments received by Provider A: $112,500 + $225,000 (Provider B’s proceeds)
- Payments received by Provider B: $315,000
- Total repaid by the business: $427,500 ($112,500 + $315,000)
It’s important to note that the $225,000 proceeds of the MCA from Provider B were used to pay off the MCA from Provider A. Consequently, the business actually pays $427,500, which consists of the $112,500 paid to Provider A and the $315,000 paid to Provider B.
a) Let’s look at the cost
Let’s look at this transaction from a different perspective. The business paid a total of $177,500 in finance charges to have access to a $250,000 cash advance for around 16 months, as shown in the table below.
| Original Advance | $250,000 |
| Provider A Finance Charge | $87,500 |
| Provider B Finance Charge | $90,000 |
| Total Repayment | $427,500 |
b) Can they keep both MCAs open?
The business owner could have left both MCAs open instead of using Provider B’s MCA to pay off Provider A’s MCA. The second cash advance gives the business access to more funds to use in its operations. However, the business would be responsible for both weekly payments.
| Provider | Weekly Payment |
|---|---|
| Provider A | $9,375 |
| Provider B | $5,625 |
| Total | $15,000 |
The business would have to pay $15,000 every week for some time to keep both facilities open. This is unsustainable for many small businesses and can lead to a financial spiral.
Having multiple cash advances open at the same time is called “stacking.” Financial experts recommend against stacking. We agree with their recommendation.
5. Why is this transaction so expensive?
Refinancing a cash advance with another one can be very expensive. This is because most cash advance providers don’t offer early-payment discounts.
Part of the new advance covers the finance charge from the original MCA. The business then pays another finance charge on the new advance.
6. A better way to refinance an MCA
In our experience, the best way to refinance a cash advance is with a conventional amortizing loan. These loans are often more cost-effective, and many allow early repayment without a prepayment penalty.
Note that the Small Business Administration no longer allows SBA 7(a) loan proceeds to be used to refinance a merchant cash advance. Consequently, your main alternatives are to work with a bank or a specialty finance company.
Finding a lender may be challenging for companies with debt balances below $1 million. Some specialty lenders can handle smaller amounts, but they tend to be very selective.
7. Will you qualify for a debt consolidation loan?
To qualify for a consolidation loan through our program, the owner and the company must meet some basic criteria. They must have:
- At least $2,000,000 in debt
- At least three years in business
- Equipment and/or real estate
- Current taxes (or a payment plan in place)
- Reasonable personal credit
- A profitable company (or one that would be profitable with better financing)
Learn more about qualifying for business refinancing.
Looking to refinance your cash advance?
For information about our business debt refinancing and consolidation program, please don’t call the number above. Instead, fill out this form – a specialized agent will contact you.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.