In recent years, a wave of new commercial financing disclosure laws has been sweeping across states—aiming to bring more transparency to the process of acquiring working capital.
But the way they’re being implemented is causing quite a stir, especially when it comes to disclosure requirements related to the Annual Percentage Rate (APR).
Put simply, the APR requirement is not a reliable metric for communicating the true cost of revenue-based financing products like merchant cash advances.
Why? Because for MCA providers, the challenge of applying APR calculations accurately can lead to confusion and potential inaccuracies in the cost presented to borrowers.
So, what’s the alternative?
Enter Total Cost of Capital (TCC)—a method that provides a much more comprehensive view of the total cost of MCA financing.
Below, we dive into the TCC vs. APR debate and explore how new regulations are affecting MCA providers, the industry, and small business merchants.
MCA Disclosure Regulations: Background
Over the last few years, several states have been rolling out commercial financing disclosure laws.
Some of these laws require providers of revenue-based financing products (like merchant cash advances) to share details akin to those found in consumer loans—including disclosing the Annual Percentage Rate (APR).
The main idea behind such regulations is to set clearer standards for transparency and accountability—helping build trust between small businesses and funders while making it easier for small business owners to understand the true cost of acquiring working capital.
Unfortunately, calculating APR is no easy feat and disclosure requirements can vary significantly from state to state—which makes communicating that “true cost” a rather challenging experience for MCA providers and merchants alike.
And not only that—commercial financing providers can face hefty fines if they don’t follow the requirements correctly.
Understanding APR
In 1968, Congress passed the Truth in Lending Act (TILA), requiring lenders to disclose clear information about loans and credit products.
One key part of TILA is APR—a standardized way to show potential borrowers how much it costs to borrow money over a year.
Lenders can use the original “actuarial method” or U.S. Rule Method to calculate APR, which:
- Is expressed as a percentage, and
- Discloses the actual yearly cost of funds throughout the life of a loan—including not just the interest rate, but also any additional charges or fees.
The APR can be a helpful metric for borrowers who wish to compare credit cards and traditional consumer loans like mortgages, car loans, or personal loans.
However, APR is only a dependable measure for fixed-term loans with predictable payments and a constant interest rate—where the repayment terms are straightforward and consistent.
In other words? The APR just isn’t as useful a metric for other types of financing, such as merchant cash advances.
APR: Why It Doesn’t Make Sense for MCAs
At Onyx IQ, we’ve said it many times before, and we’re never going to stop saying it: merchant cash advances are not loans.
Yes, like with traditional loans, small business owners do receive a lump sum of funding upfront. And yes, there is a repayment process involved.
However, with MCAs, repayments fluctuate based on the merchant’s daily or weekly sales or revenue (not to mention economic and market realities).
Moreover, as part of their flexible nature, MCAs do not have fixed terms or compounding interest. And unlike traditional loans, MCA costs aren’t based on the time it takes for the business to pay back its obligations.
Because of MCAs’ variability and often-complex fee structures, it can be challenging for MCA providers to apply APR calculations accurately.
For instance, if a merchant’s sales drop even one month, their repayment amount will decrease, thereby prolonging the advance’s term. This can potentially inflate the APR, making it seem higher than the actual cost to the business owner.
To clarify, if MCA providers are forced to disclose an estimated APR on revenue-tied financing contracts, that information will likely be misleading and inaccurate—potentially preventing small businesses from accessing much-needed capital.
Again, revenue-based financing products like MCAs are not loans, and thus should not be regulated the same way.
Total Cost of Capital: A Better Fit for Revenue-Based Financing
So, what’s an alternative metric that will uphold the key interests of both merchants and commercial funders?
More and more, industry stakeholders are speaking out against APR disclosures for commercial financing products—and in favor of “Total Cost of Capital” (TCC).
By adopting the TCC, revenue-based financing providers can simplify payment structures and expectations so merchants can:
- More easily understand what they’re getting themselves into, and
- Compare different offers from funders with greater accuracy.
For example, in Connecticut, the commercial financing disclosure law opts for TCC and small businesses are required to receive several key disclosures under the law including:
- Total amount of the commercial financing
- Disbursement amount
- Finance charge
- Total repayment amount
- Estimated time to repay
- Payment amounts (whether fixed or variable) and corresponding schedule
- Potential extra fees, charges for early repayment, collateral requirements if applicable, and any compensation paid to brokers from the financed amount
Ultimately, the TCC metric makes the financing process simpler and more transparent for everyone involved—offering borrowers a more accurate picture of both financial commitment and the total repayment amount, regardless of revenue fluctuations.
The MCA Industry Responds
The MCA community and advocacy groups have been pushing against APR disclosures for a while, sparking nationwide discussions about the best way to present financial terms to small business owners.
The Revenue-Based Finance Coalition (RBFC) has been a major player in this debate. Representing responsible finance companies, they argue that disclosing the Total Cost of Capital instead of APR would benefit merchants as well as the industry.
But while the RBFC has managed to help convince some states to switch from APR to TCC, not every jurisdiction is on board.
Take the ongoing legal battle between the Small Business Finance Association (SBFA) and California’s Department of Financial Protection and Innovation (DFPI).
The SBFA challenged new APR disclosure rules back in 2022. Then in December 2023, a federal judge ruled in favor of the state.
That said, the SBFA isn’t giving up—they’ve since appealed to the Ninth Circuit Court of Appeals, and the case is still ongoing.
Future Outlook: Navigating the Debate
As of early 2024:
- APR disclosure is required in California and New York
- It’s likely that Maryland and New Jersey may soon also jump on board the APR bandwagon and introduce similar mandates
- Five state legislatures—including Florida, Connecticut, Virginia, Utah, and Georgia—have adopted the TCC model of disclosure for commercial financing products
So, what’s the business case for shifting to TCC?
Put simply, TCC could make things easier for providers in offering a more accurate picture of the total cost of a financing deal. This could help small businesses make better, more informed decisions.
Additionally, when all financing options are disclosed with the same clear metric, funders may be motivated to improve their terms and pricing to stand out—leading to better deals and enhancing small businesses’ access to cost-effective funding solutions.
But with APR still being required in some states, providers face challenges, especially those operating across multiple states with varying rules. It will also make it tough for merchants to compare different offers if the information is presented differently in each jurisdiction.
If this patchwork of regulations continues, we could eventually see more pressure for the federal government to step in—possibly adding even more complexity and red tape to the issue.
Stay Ahead of Regulatory Changes with Onyx IQ
Today’s takeaway: APR isn’t the best fit for determining the cost of revenue-based financing products like merchant cash advances.
The unique structure of MCAs does not justify the use of APR. Therefore, APR should not be used as a metric for these types of financing agreements.
That said, the regulatory landscape continues to shift—and that means MCA funders must remain adaptable. Staying compliant while offering clear and competitive financing options is crucial to business survival.
One effective way to keep up with these changes is by leveraging a SaaS (software-as-a-service) funding platform.
Built by funders for funders, Onyx IQ is designed to handle evolving regulations and ensure you’re always compliant—automating the compliance process, tracking and auditing disclosures, and helping you create contracts that meet state-specific disclosure laws.
Curious to see how it works? Book a free demo of Onyx IQ today and discover how it can simplify your compliance management, help you avoid potential penalties, and stay ahead of regulatory changes.
