Why would you choose revenue-based financing over MCAs?
There’s been a lot of buzz lately about revenue-based financing as many merchant cash advance (MCA) companies are touting themselves as being providers of this type of alternative capital. Let’s set the record straight: MCAs are not revenue-based financing. While there are some similarities, it’s vastly different. So, what’s the difference? Let’s take a look.
Revenue-based financing at a glance
Revenue-based financing (RBF) is like a standard bank loan, but different. With RBF, investors like Founders First Capital Partners agree to give a company capital in exchange for a certain percentage of the company’s ongoing total gross revenues. Repayments are calculated using a multiple (usually 1.2x-1.4x) that gives investors a return that is higher than the original investment. The company does not have to provide collateral for revenue-based financing. In essence, its future revenues are collateral.
Founders First Capital Partners is able to provide revenue-based financing loans from $50,000 up to $2 million. Most lenders set a maximum loan of up to one-third of the company’s annual revenue or up to 3 times the monthly revenue. The debt obligation ends once the total repayment cap has been reached. If a company’s revenue grows much faster than projected, the loan will be paid off sooner. There are no penalties for repaying the loan early.
One benefit of revenue-based financing is transparency. Business owners know from day 1 how much the loan is going to cost. Payments will fluctuate with monthly revenues but the amount owed is not a changing number. As well, there are (usually) no financial covenants required, credit scores aren’t a factor, it’s non-dilutive and typically personal guarantees are not required.
Merchant cash advances defined
A merchant cash advance company provides a small business with a lump sum of capital. The MCA provider is essentially purchasing a company’s future sales or revenues, and those sales will be used to repay the funds — this can come at a great cost with interest rates significantly higher than a bank loan and repayments expected daily or weekly.
How are MCAs structured?
MCAs are usually structured in one of two ways:
- The traditional way: Most people think of a MCA where the provider automatically deducts a daily (or weekly) percentage of debit and credit card sales until the advance is repaid in full. Unlike with traditional loans, there isn’t a set repayment period. This is where MCA providers tend to compare their lending facility with revenue-based financing. While it’s true that revenue-based financing is repaid quicker when a company’s revenue is higher or the period is extended if sales slow down, an MCA is expected to be repaid much quicker. A typical merchant cash advance is expected to be paid in as little as three months and no longer than 18 months.
- The new way: The less traditional way is where the MCA provider withdraws funds directly from a company’s business bank account. The repayments are made at a fixed rate on a daily or weekly basis regardless of how much is earned in sales. The fixed repayment amount is predetermined based on historical monthly revenues. With this type of MCA repayment structure, a company knows exactly how long it will take to repay the advance. It’s better suited for companies that don’t rely on credit card sales.
Which is better?
MCAs can be enticing for businesses because the approval process is quick. So, when a business is in need of quick cash, that’s usually the only option available. The downside is that the quick cash comes at a high cost and generally puts the borrower on a cycle that’s hard to break free from.
On the flip side, a revenue-based financing facility with Founders First is more than a loan. Founders First offers wrap-around services (business advisory, leadership and accelerator programs, etc.) and true partnership to uplift diverse-led companies beyond an influx of cash into their business. As well, RBF loan terms are longer than an MCA, are a significantly cheaper form of capital and the payments are less frequent. At the end of the day, it’s up to the business owner to decide which type of financing is right for them.
If you have more questions about revenue-based financing and if it’s the right fit for your business, download the RBF Guide.
Casey Estrada is the Director of Investments for Founders First Capital Partners where he works with diverse founders to scale and grow their businesses.