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In Focus: MCA Holdbacks

Is your small business considering a merchant cash advance (MCA)? If so, it is crucial to understand the term holdback amount and how it differs from the interest rate. In the event of a downturn in business, you may default on the MCA agreement, placing both your business and personal assets at risk. Let’s take a look at how a “holdback” impacts the repayment of a merchant cash advance

MCA Credit Criteria

MCA providers rely on different criteria than banks and other lenders that look to your credit score, among other factors. Alternative funders focus on your daily credit receipts to assess whether your business can repay the advance. 

Ultimately, the cost of an MCA is higher than other financing options. In particular, the repayment terms of a cash advance differ greatly from a traditional bank loan. The main difference is the so-called “holdback” or holdback amount. This is the percentage of daily credit card sales the funder will apply to repay the advance. 

The holdback percentage can range from 10 to 20 percent until the advance is paid off, and a holdback is not the same as an interest rate. In the grand scheme of things, the more debit and credit card transactions your business does, the faster you’ll be able to repay the advance.

Holdback Amount v. Interest Rate

The difference between the holdback and interest rate you’re being charged for the advance is noteworthy. 

The interest rate is based on a factor rate, usually between 1.2 and 1.5. Unlike a traditional term loan, the factor rate is not amortized over the term of the advance. When that rate is expressed as an annual percentage rate, however, the actual rate may range from 60 to 200 percent.

The holdback is the daily draw from your merchant account until the advance, plus interest is paid in full. In short, the interest rate is the cost of the advance and the holdback amount is a percentage of your daily receipts.  

For example, if you take a $10,000 MCA at a factor rate of 1.2 ($10,000 x 1.2 = $12,000) the cost of the financing would be $2,000. If the holdback percentage was 10 percent and $2,000 was deposited into your merchant account today, your daily payment would be $200.

Why This Matters

An MCA does provide a business with ready access to working capital, but the costs are high. It is critical to understand the holdback and factor rate, and how the payment will affect your cash flow. 

In the end, repaying a merchant cash advance requires having a consistent flow of daily debit card and credit card receipts. If there is a business downturn, you may experience a receivables shortfall and default on the cash advance. For this reason, it is wise to consult with an experienced merchant cash advance attorney if you need assistance with an MCA or any other type of business funding.