Why are Merchant Cash Advances from Kabbage or Square Capital so expensive?

At Honeycomb Credit, we have the opportunity to speak with hundreds of small businesses every week and it’s becoming clear that Merchant Cash Advances, a new alternative form of lending is on the rise. In the past five years, Merchant Cash Advances have grown from funding about $8 billion to $19 billion in 2019. We’ve seen first-hand the stress they can put on business owners who suddenly see their monthly cash flow dry up as they repay these short-term, high-interest loans.

In this blog post, we'll cover the following:

• What options are out there as alternatives to MCAs?

• What is an MCA?

• Why are MCAs so expensive?

What options are out there for businesses to refinance their Kabbage or other MCAs?

Honeycomb Credit’s platform is designed to make it easier for small businesses to get the capital they need through crowdfunding.

Throughout the COVID-19 pandemic, we have helped small businesses get the short-term help they needed through our relief loans. We’ve also helped many small businesses refinance their MCAs, including Iron Born Pizza in Pittsburgh and Slate Point Meadery in New York.

Check out what options Honeycomb has to offer, whether you’re ready to grow or ready to get out of a high-interest loan situation, we’re here to help: https://www.honeycombcredit.com/refinance.

Get more information about Honeycomb crowdfunded loans by signing up below:

What is an MCA?

First of all, a Merchant Cash Advance (MCA) isn’t a loan. Instead, they offer you a lump sum of cash in exchange for a cut of your future sales for a period of time. This can really add up - some Merchant Cash Advances end up having an APR between 80-350%!

For many small businesses and startups, sudden expenses can come up really fast. We all saw this in 2020 as businesses were forced to temporarily close, furlough employees, and make a ton of adjustments for working throughout the pandemic.

But even unexpected costs such as expanding capital for large incoming orders, opportunities to buy new equipment, and more can pop up, and often small businesses aren’t at a state in which big banks would even give them a shot at a loan. So, they often turn to MCAs, like Iron Born Pizza in Pittsburgh did.

However, MCAs can get quite pricey. According to Forbes, for every $100 a small business receives from an MCA, they have to pay an extra $32 in interest.

Why are Merchant Cash Advances so expensive?

It boils down to 3 key reasons:

1. Marketing Expenses

MCAs are lucrative, with on average super-high APR. So, Merchant Cash Advance companies stand to make large amounts of money on these loans.

That means they are willing to spend a lot of money on marketing. From an SEO standpoint, “small business loans” has a lot of competition, and in order to be on the top of the search page, companies will shell out a lot for that prime spot.

2. Source of Capital

Unlike a bank that lends small businesses money from their deposits, Merchant Cash Advance companies often rely on money from institutional investors on Wall Street, like hedge funds.

This source of capital is highly demanding, often volatile, and comes at a very high expense, often costing the Merchant Cash Advance companies in excess of 10%.

Think of it this way, if the MCAs are borrowing the money they are going to lend at 10% or more, they are going to have to lend that money at a very high rate to recoup their expenses.

3. Negative Selection Bias

Many Merchant Cash Advance players like Kabbage and Square Capital offer incredibly fast turnaround times for their loan applications. Many can even get money into your bank account in less than 24 hours. How convenient!

But, it also means that the most desperate small businesses are attracted to the product. For example, businesses that are about to miss payroll, are behind on paying key vendors or missed a rent payment are very likely to use Merchant Cash Advances as a loan of last resort to try to stabilize their business.

Because these highly risky businesses are drawn to MCAs, the product gets more expensive for everyone, which especially harms the healthiest small businesses who are using MCAs for their convenience.