The merchant cash advance (MCA) industry has seen significant growth in recent years, as more enterprises turn to this alternative form of financing to meet their short-term cash flow needs.
As the industry expands, competition among funders and brokers has intensified, leading to an unfortunate side effect: unsustainable lending terms and “stacking” practices that lead to overleveraged merchants.
In today’s article, we’ll explore the importance of adopting a “win-win” approach to MCA deals, where the priority is to foster sustainable relationships and benefit all of the involved parties—merchants, funders, and brokers.
Why the MCA Industry Is Growing
The rapid growth of the merchant cash advance industry can be attributed to a wide range of factors—here are three of the main ones:
- High Demand for Alternative Financing: The alternative lending industry is growing, and MCAs have emerged as a more accessible financing option compared to traditional lenders, catering to the needs of underserved merchants.
- Economic Conditions: Because of the current economic uncertainty—especially the Fed’s consistent rate hikes over the past year—many merchants have limited access to working capital, so they seek alternative financing options.
- Advancements in Technology: Software like automated loan management platforms have enabled MCA providers to streamline their underwriting and risk assessment processes, allowing them to serve a broader range of businesses more efficiently and effectively.
In summary: high demand + tough times + fast, flexible, and tech-infused funding = the current MCA boom.
What “Lose-Lose” MCA Deals Look Like
The MCA industry’s exponential growth has attracted more participants, leading to increased competition, and, unfortunately, some bad actors on the funder and broker side. These actors are increasingly turning to what we call “lose-lose” MCAs—deals with terms that harm merchants, hinder sustainable business practices, and tarnish the industry’s reputation.
Skeptical? Look no further than the recent rise of merchant-focused MCA regulations and Federal Trade Commission bans of MCA companies (here and here).
The most common “lose-lose” scenario involves MCA providers approving advances for SMEs that far exceed what they can realistically afford to repay.
Struggling to cover the costs of repayment, these merchants are then persuaded by the MCA provider to take on an additional advance or two in order to refinance their existing obligations.
This cycle of borrowing with high-risk MCA providers and bad-faith brokers leads to the merchant becoming overleveraged, creating a debt spiral. As the burden of repayment grows unmanageable, merchants find themselves unable to make payments or meet the high repayment rates on each transaction.
The worst-case scenario?
It becomes more desirable for the merchant to cease operations entirely, halting future receivables and leaving the MCA provider with no recourse to recover their funds.
Since MCAs are structured as advances against future sales (i.e., they are not loans), the MCA provider has no claims to the business’s assets in the event of bankruptcy or liquidation.
A Simple Example
The chart below highlights a very basic “lose-lose” scenario.
| MCA 1 | MCA 2 | MCA 3 | |
| Revenue | $15,000 | $15,000 | $15,000 |
| Net Profit (Before MCA) | $3,000 | $3,000 | $3,000 |
| MCA Payment | -$1,500 | -$3,000 | -$4,500 |
| Merchant Profit | $1,500 | 0 | -$1,500 |
Here, we see a merchant with monthly revenues of $15,000 and three MCAs, each with repayments of 10% of monthly revenue:
- With just one MCA, the merchant still pulls a profit.
- With two MCAs, the merchant breaks even.
- With three MCAs, the merchant is in the red. Why? Because they are paying 30% of monthly revenue to the MCA provider, over a monthly net margin of just 20%.
Now, two important points.
First, real MCAs will include more complicated financial components that MCA providers and merchants will need to weigh (factor rate, holdback percentage, daily payments, etc.).
Second, it’s crucial to highlight that there’s nothing wrong, per se, with being an MCA provider holding second or third (i.e., high-risk) position paper.
In fact, this position can be advantageous for both the provider and the merchant (i.e., less competition for the provider, more capital for a struggling merchant), as long as the provider has a comprehensive understanding of the merchant’s business.
The point is, reputable MCA providers understand merchant financials and know when a merchant runs the risk of becoming over-extended.
By carefully assessing the merchant’s financial position, business performance, and growth prospects, providers can strike the right balance between offering support and avoiding excessive risk. This can be achieved by maintaining open communication with merchants, monitoring their financial health, and conducting thorough due diligence.
In a true “lose-lose” scenario, one where the merchant is clearly over-extended, all parties suffer.
A merchant will likely be forced to close its doors, while MCA providers will be left with unpaid advances.
5 Benefits of a “Win-Win” Approach to MCA Deals
So, if “lose-lose” means knowing a merchant is over-extended and providing them with financing anyway, what does “win-win” look like?
Well, the exact opposite: adopting a sustainable, merchant-centric approach to MCA deals that puts the long-term success of all parties front and center.
By prioritizing a mutually beneficial outcome, funders and brokers can enjoy a range of benefits that contribute to the overall health and growth of their business, and of the MCA industry as a whole.
1. Builds Trust and Credibility
Establishing trust and credibility is paramount in the MCA industry.
By offering fair terms that lead to sustainable relationships, funders and brokers demonstrate their commitment to a merchant’s success, positioning themselves as reliable partners in the long run.
This can result in increased customer loyalty, referrals, and repeat business, all of which contribute to the growth of the MCA provider and broker.
2. Improves Repayment Rates
When merchants are provided with terms that allow for manageable repayment schedules, they are more likely to meet their repayment obligations.
This reduces the risk of defaults, benefiting both the funder, who recoups their investment, and the broker, who earns commissions based on successful deals.
A solid track record of successful repayments can also lead to better financing opportunities for merchants, ultimately fostering growth and economic stability for all parties involved in the deal.
3. Enhances Reputation in the MCA Industry
Offering terms that promote sustainable relationships can bolster the reputation of MCA providers and brokers within the industry, and the industry as a whole.
As more merchants share their positive experiences, other enterprises will be more likely to seek financing from these providers. This is a point that Mike Dell of Wall Street Funding raised in our recent interview.
In a competitive market, a strong reputation is invaluable for attracting new clients and retaining existing ones. Additionally, adopting a “win-win” approach can open opportunities to fund deals in states that are now introducing disclosure regulations, as MCA providers that don’t want to abide by the rules are sure to disappear.
4. Encourages Responsible Lending Practices
By prioritizing sustainable relationships, funders and brokers contribute to responsible lending practices within the MCA industry. This can help counteract the negative perception some have of the industry due to a few bad actors who engage in predatory MCA practices.
5. Leads To Long-Term Growth for All Parties
Ultimately, sustainable deals lead to long-term growth for funders, brokers, and merchants.
When merchants succeed, they are more likely to seek additional financing in the future or refer other businesses to their MCA providers.
This creates a cycle of growth for everyone involved, which reinforces the importance of fostering strong, mutually beneficial relationships.
By embracing a “win-win” approach, the MCA industry can continue to thrive, as they support the success of countless SMEs and contribute to a more vibrant and resilient economy.
Onyx IQ: A “Win-Win” Approach Powered by SaaS
As an industry leader in alternative lending technology, at Onyx IQ, we’re ready to help MCA providers earn back their good names and establish the merchant cash advance industry as a reliable source of capital for SMEs.
The Onyx IQ platform harnesses the power of automation to provide funders with a powerful lending ecosystem—one that helps them better manage their application workflows and customer success as they provide merchants with the funds they need.
We aim to help drive MCA profitability the right way—the “win-win” type of way.
Interested in learning more? Reach out and demo Onyx IQ today.
