When I was learning to drive, we had this terrifying roundabout near my house that was unavoidable if you wanted to get on the highway. As a new driver, I can’t tell you the number of times that I found myself stuck inside the roundabout endlessly circling until finding the courage and the right technique to take the correct exit for the highway.
The feeling of being stuck in an endless cycle is the same effect that Merchant Cash Advances (“MCA”) can potentially bring to your company. They pull you in with the 24-hour response time and ease of funding approval when you are desperate for the additional capital, but the results can be devastating.
Why is that? Because the costs can be astronomically higher than they first appear. The offer might only be 1.1x the money, but that same 1.1x multiple for 3 months equates to around a 45% APR assuming monthly payments or about a 70% IRR. However, if you’re making weekly or, worse, daily payments, the IRR is well north of 100%. If you’re asking yourself why the IRRs are changing based on the frequency of the payments, the answer is because of the time value of money: $1 today is not worth the same as $1 tomorrow.
The applied effect of frequent payments and a high IRR means you are not really getting to utilize the dollars you are borrowing. You’re just going to end up paying a lot of interest and quite often the end result is that you’ll need to take another MCA to pay off the first one, and then most likely a third one to pay off the second one. Now we are back to that dreadful roundabout from my childhood, but the result of not getting out of that endless loop means running out of gas or for your business that means bankruptcy or being forced to sell it.
Revenue financed capital (RF or RFC) often gets compared or even grouped together with MCAs, however the two are completely different. If we were to bring it back to the roundabout metaphor, RF would be the equivalent to providing you with an alternative route that avoids the roundabout but still gets you to your original highway. RF is structured to give you more time to pay back the investment, improving your cash flow and enabling you to make strategic deployments into your revenue engine. From a cost of capital perspective, it usually is structured around the 25% IRR target making it significantly more affordable than an MCA.
Now, I’m not saying that there isn’t a time and place for an emergency loan like an MCA, but ensure you have prepared for an exit plan. How are you going to pay it back? Could you find a longer term solution that might provide you with some time to outgrow your short term problem? Can you work with your existing clients and vendors to get paid faster or pay them back slower?
Another potential pothole: review their terms carefully as all MCAs are NOT created equal. Some have very onerous terms included in their agreement such as personal guarantees, pledging your collateral, and early payoff penalties. So before jumping onto a route that looks fast, easy and cheap, take a deep breath (as my father would say to me before entering the roundabout) and look at all of the options available to you and find the best path for you and your business.
About Sage Growth Capital
Sage Growth Capital makes revenue-financed investments in companies at any stage who need growth capital. It is our mission to provide a more flexible funding option to growing companies who do not fit traditional equity or lending models. To learn more about Sage Growth Capital or to apply for funding visit: www.sagegrowthcapital.com.
About Revenue-Financed Capital
Revenue-financed capital (RFC), also referred to as royalty financing, revenue share or revenue-based financing (RBF), is a non-dilutive form of growth capital where investors receive a percentage of monthly revenues until a set amount has been paid. RFC differs from equity financing as the investor does not obtain ownership of the company and it differs from debt financing as there is no collateral required and payments are variable. RFC is designed to empower entrepreneurs to grow their businesses with non-dilutive capital that aligns with their sales cycles.