Invoice Factoring vs. MCA Advances: You Be the Judge

Memo stick about cash advance and calculator.

One of the most common questions asked by new factoring brokers and consultants, when first launching their finance consulting business in our industry, is whether factoring or merchant cash advance is the best way to solve the cash flow problems a non-bankable business owner in need of quick capital.  This is a common question asked by your business owner / prospect and it is important that you, the trusted financing consultant know all the answers.  So, lets take a look at a side by side contrast and comparison of these two popular funding solutions and then you be the judge as to which is most advantageous for a particular client.

Are These Financings Apples to Apples?

When you first begin to compare factoring vs. merchant cash advance (and we will include ACH financing as well), the first important concept you need to understand is what kind of financing is this?   Both of these financings are considered “off-balance sheet” because neither are considered loans.  They are NOT new money for a business, such as an asset-based business loan or standard SBA loan.  They are an advance.

  • Factoring is:  the purchase of the current invoices of a business and as such, it is only available to business that operate B2B.  The factors advance is a purchase of the business accounts receivable.  It converts an account receivable to immediate cash.
  • An MCA / ACH is:  an advance on future and anticipated sales revenue and usually from credit card sales or over the counter cash sales.  Although it can also represent invoice sales as well, the MCA / ACH provider is NOT a buyer of the sales because they do not yet exist.  It only advances on anticipated sales based on anticipated historical data.

So while both compare as a source of business funding, the contrast of the two is significant.  A factor advances as a purchase mechanism on existing sales that were invoiced.  These are sales that already exist and have generated an identifiable income for the business that can be counted on.  MCA and ACH financing represents cash that is projected as a “best guess” of future credit card sales or over the counter sales.  

Another way to compare these two financings is that factoring as a method that a business owner uses to finance its “loan business“.  Factoring is used to finance the business’s “terms of payment”.  When a business offers 30, 45, or even 60 days for a customer to pay an invoice, that business is actually providing a short term loan to its customer.  Such invoice “loans” to customers are part of the working capital of a business.  Factoring is used literally to accommodate those invoice loans to customers.  And, as a additional benefit, such liberal payment terms lead to more customers and larger orders.

Lenders offering MCA and ACH financings have nothing to purchase or loan against.  It is often called “crystal ball financing” which is offered to typically non-bankable business owners in need of emergency capital for some business equipment or for a location upgrade or similar.  MCA and ACH advances are seldom used for financing B2B business owners and are more typically used to finance consumer service businesses such as restaurants or convenience stores.

Client’s Risk of Repayment of the Advance

All advances, whether through factoring or through merchant cash or ACH advances, must be repaid.  Here, factoring simply wins hands down as an option since the only risk a business owner shoulders regarding repayment of the advance to the factor, is the risk that an invoice is declined for payment by a customer because of a trade dispute or if a customer actually goes bankrupt while an invoice is being financed.   But, these situations are rare and factors additionally review the credit of the customers of a business prior to financing.  So, the repayment for the factor’s advance as part of the purchase of the invoices is assured.

In contrast, an MCA or ACH advance financing is always at risk due to a decline in future sales.  For example, what if your client’s business suddenly faces a competitor that cuts their pricing and forces your client to do the same?  Future sales are at risk.  Profits are also at risk and not assured. And now, the ability of the repayment of the “crystal ball” advance to the financing company is anything but assured.  Evidencing additional risk, the MCA provider typically automatically draws its portion of daily sales cash , known as the retrieval rate, out of the business’s bank account.  If the sales are down and cash is not available, serious penalties for the business owner can apply.  In some instances, when a business is in default, MCA lenders require refinance or “stacking advances“, forcing an owner to pay an addition payment on a new advance which can often become completely impossible to manage.

Financing Your Clients:  Factoring vs. Merchant Cash and ACH

So when do you recommend factoring to a one of your clients and when do you recommend an MCA or ACH advance?  As a valued broker or consultant to your client, your knowledge in this area is important, since the business owner will be, to some extent, depending on you.  And the general rule is this.

If the client’s business operates business-to-business B2B, generates invoiced sales, and traditional bank financing is not an option, you will always, always, always recommend factoring or at least rule it out as a ready option. 

The good news is that the vast majority of B2B businesses qualify easily for a factoring arrangement so long as their invoices are not pledged for some other pre-existing loan to another lender.  Factoring is also relatively inexpensive when compared to MCA and ACH advances and also provides many additional benefits to the owner.

Merchant Cash and ACH business loans should be typically view as “loans of last resort” for retail businesses and those that operate B2C rather than B2B.  These types of cash advances can be viewed as similar to very short-term loans and usually for business emergencies or for equipment purchase but only when equipment leasing is ruled out.  There is a place and time when MCA and ACH advances can be used very successfully and especially in retail.  But as valued brokers and consultants, before you opt for these “crystal ball” loans, make certain you have eliminated all other asset-based lending options first.

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