MCA Holdbacks, Factor Rates, and Net Funding Explained

Merchant Cash Advances (MCAs) have unique terminology that can be confusing for business owners. Understanding these key terms—holdbacks, factor rates, and net funding—is crucial for making informed decisions. This guide provides a clear explanation of each.

1. Factor Rate:

• What it is: The factor rate is not an interest rate. It’s a multiplier used to calculate the total repayment amount of an MCA. It’s expressed as a decimal, typically ranging from 1.1 to 1.5.
• How it works: You multiply the advance amount by the factor rate to determine the total amount you’ll repay.
• Example: If you receive a $10,000 MCA with a factor rate of 1.3, your total repayment amount will be $10,000 x 1.3 = $13,000. This means you’ll repay $3,000 more than the initial advance.
• Key takeaway: A lower factor rate means a lower total repayment amount.

2. Holdback Percentage (or Holdback Amount):

• What it is: The holdback is the percentage of your daily or weekly credit card sales that is automatically deducted by the MCA provider for repayment. Sometimes, instead of a percentage, a fixed daily or weekly dollar amount is agreed upon as the holdback.
• How it works: Each time you process a credit card transaction, a predetermined percentage (or amount) of that sale is automatically sent to the MCA provider. This continues until the total repayment amount (calculated using the factor rate) is paid off.
• Example (Percentage): If your holdback percentage is 10% and you have $1,000 in credit card sales in a day, $100 (10% of $1,000) will be deducted for repayment.
• Example (Fixed Amount): If your agreed daily holdback is $200, then $200 will be deducted from your merchant account each day, regardless of your sales volume.
• Key takeaways:
  • A higher holdback means faster repayment but lower daily/weekly cash flow.
  • A lower holdback means slower repayment but higher daily/weekly cash flow.
  • Fixed amount holdbacks provide predictable daily/weekly deductions, but can be problematic during slow sales periods.

3. Net Funding Amount:

• What it is: The net funding amount is the actual amount of cash you receive after all fees are deducted from the approved advance amount.
• How it works: Before you receive the funds, the MCA provider may deduct various fees, such as:
  • Origination fees: A one-time fee for processing the MCA.
  • Underwriting fees: Fees for assessing your business’s risk.
  • Processing fees: Fees for handling the daily/weekly repayments.
• Example: If you’re approved for a $10,000 MCA but there’s a $500 origination fee, your net funding amount will be $9,500.
• Key takeaway: Always focus on the net funding amount, not just the approved advance amount, to understand how much cash you’ll actually receive.

Relationship Between the Three:

These three terms are interconnected:

1. The factor rate determines the total repayment amount.
2. The holdback percentage/amount determines how quickly you repay that total amount, impacting your cash flow.
3. The net funding amount is the actual cash you receive after fees are deducted from the initial advance.

Example Combining All Three:

• Approved Advance: $20,000
• Factor Rate: 1.4
• Total Repayment: $20,000 x 1.4 = $28,000
• Holdback Percentage: 15%
• Daily Credit Card Sales: $2,000
• Daily Holdback: $2,000 x 0.15 = $300
• Origination Fee: $1,000
• Net Funding: $20,000 – $1,000 = $19,000

In this example, you’ll receive $19,000 upfront. Each day, $300 will be deducted from your credit card sales until you’ve repaid the total of $28,000.

Conclusion:

Understanding holdbacks, factor rates, and net funding is essential for evaluating MCA offers and making informed decisions. Always ask for a clear breakdown of these terms from any potential provider and compare offers carefully before committing to an MCA. Remember to consider the impact on your cash flow and the overall cost of the financing.