The Guide to Merchant Cash Advance Loans (MCAs) 

Architect Contractors Reviewing BluePrints

Merchant Cash Advances, or MCAs, are a funding option for all types of businesses who need quick cash. But as a “quick fix” solution, it can come with a host of challenges that may lead to huge problems for small businesses, especially for those in the commercial construction industry.

That’s right. MCAs are bad for construction businesses. That includes YOU, general contractors and subcontractors reading this right now. 

And hey — MCA lenders and brokers, this is a good read for you, too. 

Let’s break down what Merchant Cash Advances are, how they work, and how they can create a vicious cycle of debt for construction businesses.

What is an MCA and how does one work?

Merchant Cash Advances, also called an MCA or Daily Debit Loans, are a type of funding that is based on the average amount of cash flowing through a business’ bank account on a monthly basis.

An MCA is actually not a loan, it is an advance on “future receivables” or future sales of the company. Therefore, the amount of the advance and the cost of that advance is based on the following information:

The business owner’s personal credit score. This is important to the lender because they use this to judge the character of the person and their likely desire to make sure the MCA is paid back. 

Did you know that just applying for an MCA can negatively impact your credit? Here’s why. Most MCAs are sourced through a broker and rarely does the business owner ever get to work directly with the actual lender. The broker gets an application signed and then sends it to multiple lenders who all pull the business owners credit score. 

Those multiple inquiries in a period of just days really hurt the business owners credit score. 

Bank account information. The lender will look at the number of deposits made into the account on a monthly basis to determine how frequent new money is coming into the account. They’ll also look at the total amount deposited into the bank account. This determines the likely revenue of the business. Finally, they’ll check the average daily balance in the bank account. This is used to determine how much can reasonably be auto-debited from the account every day without risk of a payment being bounced. 

Using this information, the MCA lender then decides how much the business is qualified to receive for an advance, the cost to be applied to the advance amount (this is the cost of the money to the business owner), and how many business days it will take for the advance to be repaid, (typically 6-12 months).

The cost of the advance is determined using a factor rate, which is a percentage of the lump sum for which the client is approved. Factor rates can vary from high single digits to as much as 50% or more. If a client is approved for a $100,000 advance with a factor rate of 30% then the cost of the loan is $30,000. 

The total repayment of the MCA is the lump sum of money plus the cost of the factor rate percentage. In the example above the total repayment amount would be $130,000.

The next important detail is the time frame to be paid back – typically 6-12 months. It’s critical in determining the actual repayment of the MCA and what the impact will be to daily or weekly cash flow. 

Contractor Reviewing Numbers

The real cost of a Merchant Cash Advance. 

As a general contractor or subcontractor business owner, you need to know what you are signing and what the real cost of that funding is to your business. If the factor rate is 30% and you can pay it back over 12 months that is very different than 6 months. At 12 months you are actually repaying the loan at an annual rate of 60% interest. 

Does that surprise you? If it does then we’re glad you’re reading this.

It is critically important for the client to know what the repayment structure is and how it will impact their business over the life of the repayment period. For example, if you only will be on a project for another three months and you have a six-month payback period then you need to know you have more work starting quickly and enough work to be able to actually afford the same daily payment in months four through six of the repayment period. If you do have the work, but you need your cash to get mobilized, then you will likely experience an even bigger problem due to the daily payments.

And this is where MCAs become an inescapable trap. If the borrower is struggling to make the payments, most brokers will try to set them up with another MCA. A second MCA is about half of the amount advanced originally and can be offered by the current lender or through another company. In the MCA world, this is referred to as “stacking” and can bring a situation from bad to worse.

If even a single payment is missed (most often, because the account was overdrawn) the borrower can be considered in default and be charged additional fees or other penalties. Further, each MCA  can (and will) place a UCC lien on the business. As long as those are in place, other lenders such as banks or factoring companies will not provide funding that could pay off the bad debt and get the business back on track. Instead, the business owner (who is already dealing with a huge drop in personal credit score) is told that the only option they have is to take out another MCA. 

It’s like trying to put out a fire by pouring gasoline on the flames.

Finally, many MCA companies will include a Confession of Judgement in their agreements, meaning that as soon as the borrower defaults, the company can file the confession in court. Within a matter of hours, the borrower can find its bank accounts frozen. Some MCAs will even start calling around to the general contractor requiring immediate payment of the advance.

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The hard truth: Why MCAs are bad for construction businesses.

The nature of the construction business in terms of payments and finances make Merchant Cash Advances particularly risky. Let’s talk about the reality of how subcontractors get paid on commercial construction projects: 

A contractor’s costs are often more than they are able to collect from their invoice to a GC or owner, especially in the first one to three months on a job. Invoices are only sent once per month, and after the invoice is approved, the contractor has to wait 30-45 days to be paid. 

When the invoice is paid retainage is held back by the owner of the project – typically 10% of the total invoice. Retainage is held until the whole project is finished. So, the contractor only gets 90% of what they invoiced for the month. In some instances, a GC may not release payment to the subcontractor until they know all of the sub’s suppliers and vendors have been paid in full. This puts an even bigger squeeze for cash on the subcontractor. 

Despite these facts, the contractor has to pay their own employees every week, their suppliers when they pick up the materials, or if they have terms with the supplier then perhaps it is only a deposit at first and the balance in 30 days. Either way, it is still before they are actually paid from the project.

Profit on a construction job is NOT evenly distributed throughout the project. In short, what this means is the contractor’s costs are not directly in line with the amount they can bill each month and therefore even though the profit on the overall job may be very good the costs associated to some months as compared to what the subcontractor is being paid can be negative. 

This is where contractor construction payments and MCA loans collide, and it’s not pretty. 

Unless the MCA lender is willing to: 

  • (a) take one payment per month
  • (b) only on the day that the sub-contractor is paid from the project(s) 
  • and (c) only if that month’s costs are less than what the subcontractor is actually being paid 

the subcontractor will 100% be in a very bad spot and likely default on the daily repayment structure.

Concrete Pour Contractor

For example: A concrete contractor working on a five-story building can bill a certain portion of the contract each time a floor is poured. Imagine if the contractor spent their first three weeks on the project at the end of one month, but the actual concrete pour wasn’t until the start of the following month. In this example, the contractor would have incurred nearly 100% of the cost of the floor but received none of the revenue associated with it.

The gross profit margin of the average construction business is 20% or less. The overall cost of the advance to the client is more than the profit they will be able to make on the advance amount. 

Remember the construction business example from earlier? That company took a $100,000 Merchant Cash Advance and needs to repay $130,000. That contractor company will need to invoice and be paid $1.3 million in order to create $130,000 of free cash to pay off the MCA loan without any problems. 

Also, this means the example construction business will not be able to use any of that profit for their own overhead expenses. It only goes to repay the MCA loan. Also, don’t forget the business will only get paid one time per month and need to pay all of the project-related costs out of the money they receive or their project will start to go very bad and the rest of the money they are owed for the project will be in jeopardy.

MCAs can be useful tools for businesses that have daily incoming revenue, such as a restaurant or retail store, but they don’t work well in the construction industry. Are they fast and easy? Yes. Is that worth the long-term trouble they can cause? NO.  

Yellow hard hats and one green hard hat

We are the alternative to MCAs. 

Many business owners are unaware of the alternative options available to them. Frantically trying to make payroll every week, with slow-paying clients and unforeseen expenses taking a toll, the fast cash of an MCA can seem like a good idea, regardless of the high cost.

We get it! There are times you need money quickly to do your work. You just need some additional cash so you can focus on what you do best: Getting the job done. 

Mobilization Funding is a smarter option for construction businesses that need short-term working capital for a particular project.

We offer: 

  • Competitive rates
  • No early payoff fees or penalties
  • Loan repayment schedule based on when you will be paid for your work
  • Flexible funding schedule depending on when you need it
  • Qualified customers can also receive assistance in paying off MCAs

So whether you’re laying asphalt on a new highway, clearing debris after a hurricane, installing solar panels or replacing the windows in your county library, we built a program designed to help your business perform. 

Do you need to talk to an expert about what to do with your MCA debt? Call us toll-free at 866-442-7759 or click here.

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