You need money and you need it fast. But you are worried about making a mistake. This post will help you make a better decision and sleep at night.
Index
- Some definitions and cautions
- Your MCA prioritized checklist
- A google sheet calculator where you can compare multiple products against real daily cashflows (or your own CF’s)
- More resources & some history of the debate
I am going to define a MCA (Merchant Cash Advance) as non traditional, short term loans you pay back in less than 12 months that advance you cash or pay your bills, use an accelerated and automated underwriting tied to your platforms and is offered by an entity that is not a bank. Wayflyer, Shopify Capital, ClearCo, Settle, Gynger, Tranch, Parker, Stenn et al are all MCA’s in my definition. It’s really the type of borrower that matters to the grouping i.e. as an ecomm brand when you need cash fast, you look to this group.
Much of this is applicable to other types of businesses, but I am gearing this to ecomm leaders.
First, MCA’s are not inherently evil. As @DrewFallon12 correctly points out, who else is falling over themselves to offer you hundreds of thousands of dollars in 48 hours with minimum underwriting, no security and no personal guarantees?
Second, focusing on the APR is silly because (a) where else are you getting the money? and (b) APR is not the right metric, IRR is. That’s as spicy as this post gets.
Third, MCA’s can serve a valuable purpose. But if you are using them constantly and are chronically short of cash, loading up on MCA’s and stacking lots of debt will supercharge your problems. Debt spirals kill companies. I will fix the issues in your business. Reach out.
Let’s face it. Your company is a lousy credit risk. If you want a ton of money quickly, it’s going to be expensive. And if you turn your habit from once a year at Burning Man to ‘well, it’s Monday afternoon…’ it will kill you. All that said, let’s do it right.
MCA Comparison Calculator
I created this calculator to help you see the difference between the various products and lenders using daily sales. Drop your own sales or projections in or copy the logic into your own model.
Your MCA prioritized checklist
Even if you are desperate for cash, run through this checklist!
#1 Avoid Personal Guarantees (PG’s). Most MCA’s don’t have them. If you do run into one (read the damn docs), you can find another option that doesn’t require a PG.
#2 Access to future capital is essential. Be careful about restricting your access to future capital through security, covenants or other restrictions. Again, read the docs.
#3 Matching cashflows is critical. In my opinion this is the most misunderstood and unappreciated aspect of borrowing. Matching cashflows is more important than the cost of the capital. Let’s say you are borrowing to pay your supplier in China and it’s going to take 5 months for them to make the goods, ship it, and then get them in your 3PL. If you borrow money that you have to pay back in 3 months, you have a mismatch. And you will have to fund that mismatch. And because you had to borrow 3 months ago, you probably will have to borrow again now. And that’s how the debt spiral begins.
The large majority of your borrowing needs come from inventory and marketing. Think of these expenses like investments. You are investing money today, to make more money in the future.
With an MCA, you are borrowing money today, to make that investment in order to make more money in the future. But if you have to pay back that borrowed money before your investment returns, you have a problem.
Hopefully previous investments have returned enough to pay off the borrowing. But if they haven’t, you now need to borrow again to pay off the current loan and will need to borrow yet again to make your next investment. This is the negative debt spiral.
The mismatch of cashflows is the biggest risk of MCA and a common killer of companies.
#4 Relationships matter. Don’t be fooled by the transactional and self-serve front ends of the lenders. Behind the screen are relationship managers and behind them are Chief Credit Officers. These are the people who will decide to keep your credit limits or even increase them or keep from dropping them. All credit starts skeptical and will get less skeptical over time as you prove payment and your relationships grow. Build relationships.
#5 Negotiate. Longer term (more time to repay) is always top of your list. As in any negotiation, the quality of your relationship and reality of your other options will give you leverage to get better terms.
#6 Get the right amount of capital. If you need $250K, look for providers offering that or more. Don’t start grabbing $50K at a time. This isn’t a friends and family round with SAFE’s. Not only will this take longer, but there can be unintended underwriting consequences to using lots of partners which can negatively impact your chances of getting more lenders and more money. If you really have no other options, then get what you can from who you can.
#7 Be accretive. The cost of capital is less important than your ability to profitably use it.
You personally wouldn’t borrow money at 25% to invest it at 15%. So don’t do it in your business.
#8 APR is not the right measure. Use IRR. Fair warning, I am going to get wonky here. First, let’s define terms.
APR (Annual Percentage Rate) is expressed as a percentage that is the actual annual cost of a loan including fees over a year. It uses simple interest and does not account for compounding. An example of simple interest is taking an annual rate of 18% that is paid monthly and dividing it by 12.
https://www.investopedia.com/terms/a/apr.asp
APY (Annual Percentage Yield) accounts for compounding. It’s APR, but using compounded interest, not simple interest. If you loan is compounding monthly, weekly or daily, APY is a more accurate measure of your cost of capital. Compounded interest takes the interest earned and then adds it to the principal. It’s interest on interest.
https://www.investopedia.com/terms/a/apy.asp#toc-apy-vs-apr
APY is also called the Effective Annual Rate.
https://www.investopedia.com/terms/e/effectiveinterest.asp
What is IRR? The financial definition doesn’t help much. The IRR is the discount rate that makes the Net Present Value of all cashflows zero. https://www.investopedia.com/terms/i/irr.asp
Yikes. What the hell does that mean?
Think of your mortgage, your car loan, senior debt. Most loans have defined payments at defined periods. They are highly predictable. And investors like predictable. Now think of your business. Your sales change daily. It’s not predictable. For MCA’s that tie their repayment to your sales (e.g. Shopify Capital or Wayflyer), you need a tool that accounts for the variability in your payments.
More importantly, as discussed above, how quickly you return your principal is critical to understanding how well it matches your cashflows and therefore how valuable it is to you.
Would you rather I give you $100K and ask for $120K 365 days from now or I give you $100K and ask for $120K tomorrow?
In both cases, I am making $20K from giving you $100K. In the first case, you can actually use the money. In the second case, you better be Matt Damon in Rounders.
IRR accounts for the speed of repayment as well as the variability of the payments. And because it’s expressed annually, it accounts for the time value of money as opposed to an ROI calc which just simply tells you how much you made (or lost) on an absolute basis but without reference to how long it took.
IRR is also the tool you can use to understand if your borrowing is accretive. You can do a simple IRR of an inventory purchase - I paid these amounts out, I got these net sales back over these months - and then compare that to the IRR of your borrowing to understand if you are borrowing at 20% to invest in something that makes you 50% or if your are borrowing at 20% to make 10%.
If you need help with any of this, reach out. And let me know your feedback!
More resources and history
Drew’s post that re-sparked this debate in Sep 2024.
https://x.com/drewfallon12/status/1829191845383119300
Drew Fallon (@drewfallon12)
Bill D’Alessandro (@BillDA) whose pot was stirred and his sticking point about egregious APR’s.
Andrew Faris (@andrewjfaris) who recognized a good topic for a podcast and let Drew and Bill go at it on this episode.
Giving props to Eugenio Labadie’s (@eugeniolabadie) and his APR calculator. I expanded to enable daily and variable payments and then multiple options. If you need capital, check out Eugenio’s firm, Carondelet Partners or reach out for an intro.
DM’s are open so reach out, comment and let me know your questions and thoughts.