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MCA Factor Rates Explained: Converting to APR
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A merchant cash advance uses a factor rate, not an interest rate, so it is hard to compare with a loan. You can turn the factor rate into a rough annual rate if you estimate how long repayment will take. The faster your card or bank takings repay the advance, the higher the annual rate. The simple sum shown here is a rough illustration and understates the true cost.
What a factor rate actually means
A factor rate is a multiplier. You multiply the advance by it to get the total you repay. If you take £50,000 at a factor rate of 1.30, you repay £65,000 in total, however quickly you pay it. The £15,000 difference is the cost of the advance. It is a fixed amount, not a yearly percentage.
Interest, by contrast, builds up over time. A factor rate has no time in it, which is why you need to estimate the repayment period before you can compare it with a loan.
The conversion formula step by step
Here is a simple way to get a rough annual rate. It is an illustration, not a legal APR.
Total repayment is the advance times the factor rate. The cost is the total repayment minus the advance. Divide the cost by the advance. Then divide that by the repayment period in years. For example, a £50,000 advance at 1.30 costs £15,000. £15,000 divided by £50,000 is 0.30. Repaid over nine months, which is 0.75 years, that gives 0.30 divided by 0.75, or 40% a year. Repaid over six months (0.5 years), it gives 0.30 divided by 0.5, or 60% a year.
Why the simple figure understates the cost
The simple sum assumes you keep the whole £50,000 for the whole period. You do not. Repayments start straight away and come out of your takings every day or week, so on average you only have about half the money for the period. If repayments are even, that roughly doubles the true annual rate.
Using the example above, we worked it out with equal daily repayments of £65,000 over nine months. The yearly rate on the money actually outstanding comes to about 73%, not 40%. A true APR, which also allows for compounding, would be over 100%. A loan's APR already allows for the fact that you pay it down over time. So when you set an MCA against a loan, roughly double the simple figure, or better, ask the provider to give you a proper annual rate in writing.
Why repayment speed matters
The provider takes a fixed percentage of your card or bank takings. Higher takings mean faster repayment, and a higher annual rate for the same factor rate. For illustration, take two businesses that each borrow £50,000 at the same factor rate. One takes £80,000 a month in card payments and the other takes £20,000. The first repays much sooner. Both repay the same total, but the first pays a much higher annual rate.
Before you sign, work out two cases: a fast one based on your best months and a slow one based on a cautious estimate. That gives you a range for the annual cost.
Comparing MCA cost against a term loan
Using the simple sum, a factor rate of 1.20 repaid over twelve months gives 20% a year (0.20 divided by 1). A factor rate of 1.35 repaid over eight months gives about 52% a year (0.35 divided by 0.67). As explained above, both figures understate the cost compared with a loan APR. Get real written quotes for a loan and for the MCA, and compare the total amount you would repay and over how long.
An MCA can still suit some businesses, for example one that cannot meet a bank's affordability checks, needs money quickly, or has takings that go up and down so much that fixed monthly loan repayments would be hard to meet. Cost is one part of the decision, alongside how the repayments fit your trading.
Holdback percentage and its effect on true cost
The holdback, sometimes called the retrieval rate, is the percentage of each day's card or bank takings taken to repay the MCA. It does not change the total you repay. It changes how fast you repay it, and so the annual rate.
A lower holdback means a longer repayment period and a lower annual rate. For illustration, if a 15% holdback would repay an advance in six months, a 10% holdback on the same takings would take about nine months (15 divided by 10 is 1.5, and six months times 1.5 is nine).
On the 1.30 example above, the simple rate falls from 60% to 40%, a cut of a third. Ask whether the provider will pause or reduce collections if your takings fall, and get any agreed change in writing before you draw the money.
Regulatory disclosure and what to ask your provider
The Consumer Credit Act protects individuals, and its definition of an individual includes small partnerships of two or three people but not limited companies (Consumer Credit Act 1974, section 189). So a limited company taking an MCA does not normally get those protections, and the provider is not normally required to quote an APR. Some providers give one anyway.
Ask the provider for four things in writing: the total you will repay in pounds, the repayment period they expect, the holdback percentage, and any other fees such as set-up or admin charges. With those you can work out the rough rate above and compare the offer with other options. If a provider will not give you these figures clearly, be wary of the offer.
| Factor Rate | Advance (£) | Total Repayment (£) | Cost (£) | Repayment Period | Rough annual rate (simple sum) |
|---|---|---|---|---|---|
| 1.15 | 50,000 | 57,500 | 7,500 | 6 months | 30% |
| 1.15 | 50,000 | 57,500 | 7,500 | 12 months | 15% |
| 1.25 | 50,000 | 62,500 | 12,500 | 6 months | 50% |
| 1.25 | 50,000 | 62,500 | 12,500 | 12 months | 25% |
| 1.35 | 50,000 | 67,500 | 17,500 | 6 months | 70% |
| 1.35 | 50,000 | 67,500 | 17,500 | 12 months | 35% |
| 1.40 | 50,000 | 70,000 | 20,000 | 8 months | 60% |
| 1.20 | 100,000 | 120,000 | 20,000 | 10 months | 24% |
These are illustrations using the simple sum (cost divided by advance, divided by years). Because you repay as you go, the true annual cost is higher, roughly double.
Step-by-step
- Get the factor rate and advance amount from the MCA offer.
- Work out the total repayment: the advance times the factor rate.
- Work out the cost: the total repayment minus the advance.
- Estimate the repayment period in months: the total repayment divided by the amount the holdback will take each month (your average monthly takings times the holdback percentage).
- Turn the period into years: months divided by 12.
- Work out the rough annual rate: the cost divided by the advance, then divided by the period in years. Remember this understates the true cost.
- Compare the result, and the total repayment, with other options such as term loans, revolving credit or asset finance before you commit.
Illustrative example
This is a made-up example. A business with four sandwich shops is offered an MCA of £60,000 at a factor rate of 1.28, so the total repayment is £76,800 and the cost is £16,800. Its card takings average £40,000 a month. At a 10% holdback the provider collects about £4,000 a month, so repayment takes about 19 months (£76,800 divided by £4,000 is 19.2).
That is 1.6 years, so the simple rate is 0.28 divided by 1.6, about 17.5% a year. At a 12% holdback the provider collects £4,800 a month, so repayment takes 16 months, or about 1.33 years, and the simple rate is 0.28 divided by 1.33, about 21% a year. The higher holdback repays the advance sooner and so costs more per year, even though the total repaid is the same. In both cases the true annual cost is roughly double the simple figure.
Frequently asked questions
Is APR a reliable comparison tool for merchant cash advances?
Only as a rough guide. MCA repayments go up and down with your takings, so nobody knows the true term in advance. A busy month repays the advance faster and makes the annual cost higher. The simple sum in this guide also understates the cost, because you start paying back straight away. Use it to compare offers, and ask each provider for its own cost figures in writing.
Do UK MCA providers have to disclose APR to limited companies?
Generally not. The Consumer Credit Act protects individuals, which includes sole traders and small partnerships of two or three people, but not limited companies. So the rules that make lenders quote an APR do not normally apply to an MCA taken by a limited company. Some providers give one anyway. Always ask for the total repayment, all fees and the term the provider expects, so you can work out a rough figure yourself.
What factor rate should a UK business expect?
It depends on the provider and on your business, including how long you have traded, how steady your takings are, your sector and your credit history. Providers do not publish standard rates, so get written quotes from more than one and compare the total repayment.
Can I repay an MCA early to reduce the total cost?
Usually not. With most MCAs you repay the full agreed amount however fast it is paid, because there is no interest building up over time. Some providers offer a discount for early settlement. Check the agreement before you assume paying early will save money.
How does holdback negotiation work in practice?
The provider usually proposes a holdback based on your average monthly takings. You can ask for a lower percentage, especially if you can show seasonal dips or that the proposed holdback would leave you short of cash. Back up your request with three to six months of bank or card statements, and get any agreed change confirmed in writing.
By Adam Parker, Founder & Managing Director, Muswell Rose. FundBiz is owned and operated by Best Business Loans Ltd, directed by Oliver Mackman. Published .