Merchant Cash Advance APR: How to Convert a Factor Rate to Real Cost

A factor rate is a multiplier on the advance. You receive the advance and agree to repay the advance times the factor. The fee is the difference. There's no rate per year and no reduction of the fee as you repay, so paying early usually doesn't save money.

An interest rate charges for the time the money is outstanding, and the amount owed changes as principal is repaid. A factor rate is fixed at the start, and the annualized cost depends on how fast you repay. The same factor over three months costs far more per year than over twelve months. Legally, an MCA is often structured as a purchase of future receivables, not a loan, so some lending rules may apply differently. Some states require certain disclosures, so check the rules where you operate and ask an attorney about your contract.

Use these steps, with a spreadsheet:

1. Compute the repayment: advance times factor rate.
2. Find the number of payments: term in business days if debits are daily.
3. Divide the repayment by the number of payments to get the debit amount.
4. Compute the internal rate of return on the cash flows: the advance is received once, and each debit is paid.
5. Annualize: multiply the periodic rate by the number of periods per year (about 252 business days for daily debits).

Say you take a $50,000 advance at a 1.35 factor rate, repayable in 126 business-day debits. In this example, the repayment is $67,500 and each debit is about $536. In this example, a simple calculation shows a cost of $17,500 on $50,000, or 35 percent, over half a year, which annualizes to 70 percent. But because you repay a bit each day, the average amount you owe is much lower than $50,000, and in this example the internal rate of return is about 0.5 percent per business day, or roughly 125 percent a year on a nominal basis.

Always compute the version based on cash flows, since it reflects what you pay for the money you actually have.

Because the fee is fixed, faster repayment raises the annualized cost. Say the same 1.35 factor is repaid over about 12 months instead of six. In this example, the annualized cost is lower, but you pay $17,500 for a full year of tight cash instead of half a year. Neither is cheap.

Also watch for:

• Fees on top of the factor: origination, underwriting, ACH or legal fees, which raise the cost.
• Daily or weekly debits: they reduce cash every day, including slow ones.
• Split withholds: a percentage of card sales taken at processing, which makes the payment depend on sales.
• Stacking: taking a second advance to pay the first, which multiplies cost.

Compare any offer with the same math for a term loan or an SBA loan, using the SBA 7(a) payment calculator, and see debt service coverage to check whether your cash flow can cover it.

Act before you miss a payment, because default terms can be severe. Steps to consider:

1. List every advance: balance, debit amount, frequency and contract terms.
2. Build a weekly cash forecast that includes the debits so you can see the real shortfall.
3. Ask the funder about reducing or restructuring payments. Some will reduce debits or extend the term for a fee.
4. Look for lower-cost refinancing, such as a term loan, SBA loan or line of credit, and use the proceeds to pay the advance if the contract allows it and the cost is lower overall.
5. Talk to an attorney experienced in MCAs before you stop payments or change your bank account, because contracts may include security interests, guarantees and other remedies.

More options are covered in merchant cash advance restructuring and consolidation. Don't stack a new advance on top without calculating the combined debit.

Keep payroll and tax cash in a separate account that funders don't debit, and give the funder access only to the account named in the contract. Changing banks or blocking debits without legal advice can breach the agreement, so speak to an attorney first.

For future financing, compare the effective cost of each option side by side, including revenue-based financing, and check buying a business with an SBA loan if you're financing an acquisition. Set a rule that you'll accept financing only when the effective annual rate has been calculated, the debits fit in your forecast and someone besides the founder has reviewed the terms.