In the course of the various analyses we perform at NISO, we have noticed a variety of results in the refinancing of MCA deals. In contrast to asset-backed lending, where the risk-reward tradeoff often relies on collateral value rather than the borrower’s cash flow cycles as MCA does.
For funders engaged in Merchant Cash Advance (MCA) transactions, the decision to refinance an existing cash advance by issuing a second one – or many more - can have a significant impact on profitability, cash flow, and overall risk exposure.
While refinancing offers the potential for higher returns through compounding and reinvestment, it also introduces complexity in cash advance management and increased default risk.
Understanding how to measure the performance of these deals and when to apply refinancing strategies is crucial for maximizing returns while safeguarding capital.
The Financial Impact of Refinancing
Refinancing an active MCA—particularly when using part of the second cash advance to pay off the first—fundamentally changes the funder’s financial structure since MCA transactions focus on the borrower’s revenue streams and daily or weekly payment structures.
1. Cash Flow Acceleration: By refinancing, the funder reinvests funds earlier than expected. In MCA transactions, where payments are deducted frequently, refinancing allows continuous reinvestment into higher-yield opportunities, potentially increasing profitability faster.
2. Compounding Returns: The funder benefits from a high effective return when the second MCA cash advance is structured to generate significant additional revenue. Since MCAs are often structured with fixed factor rates, the yield on refinanced deals can be significantly higher.
3. Increased Risk Exposure: While refinancing provides new revenue potential, it also extends the borrower’s obligations. In MCA transactions, this could result in overburdening a borrower’s daily cash flow, like a house of cards, if the second deal falters too soon, then the potential benefits of the first and the second deal can collapse.
Evaluating the Commercial Viability of Refinancing
The decision to refinance an MCA should be based on several key performance metrics and commercial considerations, among others:
- Internal Rate of Return (IRR): Measures the effective annualized return considering the timing of cash flows. When assessing refinancing, IRR should be calculated as a continuous return metric, combining cash flows from the initial advance with those from the renewal. Since part of the second advance may be used to pay off the first, IRR should reflect this reinvestment cycle. Additionally, origination fees that are deducted upfront and repaid later should be accounted for, as they impact the true return profile.
- Equivalent Annual Annuity (EAA): A useful complementary metric, EAA converts cash flows into an equivalent annual payment, making it easier to compare refinancing options across different durations. EAA helps funders evaluate whether renewing an advance is more profitable than issuing a new one, considering capital turnover.
- Return on Equity (ROE): A better measure than ROI in MCA transactions, ROE evaluates profitability relative to the funder’s capital base. Since funders frequently reinvest repaid capital into new advances, ROE captures the compounding effect and efficiency of capital deployment more effectively than a simple return metric.
- Repayment to Revenue Ratio: In MCA transactions, analyzing the percentage of daily
or weekly revenue used for repayment is crucial. Overleveraging the borrower can lead to unsustainable repayment structures.
- Debt Service Coverage Ratio (DSCR): While traditionally used to evaluate a borrower's ability to meet debt obligations, DSCR is also relevant in MCA transactions to assess the borrower’s revenue strength.
The Role of Funding Structures in Refinancing Decisions
Funders often rely on different capital structures, such as Syndicates, loans, or their capital, to finance cash advances. These structures influence how revenue is recognized and the financial hurdles that must be overcome when structuring a renewal:
1. Syndicate-Based Funding: When funders rely on syndicates, they distribute returns and capital recovery in proportion to each participant’s stake. While the IRR of the deal itself remains unchanged, funders must consider whether refinancing enhances their overall retained return and whether syndicate terms allow for flexible reinvestment. Additionally, participation structures—such as fees charged to syndicate investors or differential return sharing—may impact the net profitability of the funder.
2. Debt-Financed Funding: Funders who rely on loans to finance cash advances must consider their cost of capital. If refinancing does not produce an IRR that surpasses the loan's interest rate or hurdle rate, it may not be a viable strategy. Additionally, lenders may impose covenants or restrictions that influence refinancing decisions.
3. Self-Funded Model: Funders using their capital have the most flexibility but must ensure that ROE remains high to justify continued reinvestment. Since capital is being recycled, maintaining a strong compounding effect is critical for sustained profitability.
When Should a Funder Refinance?
Not all MCA cash advances are suited for refinancing. The funder should consider:
1. The Borrower’s Revenue Stability: MCA transactions depend heavily on the borrower’s revenue cycles. If revenue fluctuations suggest instability, refinancing could increase the risk of default.
2. The Competitive Cash Advance Environment: The presence of other MCA providers willing to offer refinancing may impact borrower behavior and pricing strategies.
3. Market Conditions: Economic downturns or changes in industry trends can heavily impact revenue-based repayment models.
Measuring Refinancing Performance
To assess whether refinancing is a beneficial strategy in MCA transactions, funders should implement during and post-cash advance performance reviews. Key indicators include:
- Actual vs. Expected Cash Flow Performance: Tracking whether the borrower meets the refinanced obligations as projected.
- Comparison of IRR, EAA, and ROE: Evaluating whether the refinancing achieved a higher effective return compared to maintaining the original cash advance structure. A focus on continuous IRR ensures that reinvestment profitability is accurately measured, while EAA provides an annualized profitability comparison across deals of different durations.
- Borrower Retention and Refinancing Cycles: MCA transactions often rely on repeated refinancing. Measuring borrower retention and refinancing frequency can indicate long-term profitability.
- Default and Delinquency Trends: Monitoring borrower performance to adjust future refinancing strategies accordingly. MCA cash advances, due to their frequent payment cycles, require more immediate oversight.
Conclusion
Effective refinancing strategies also on having the proper tools to monitor deals, track cash flows, analyze default profiles, and assess overall portfolio performance. A data-driven approach enables funders to integrate information from individual transactions upwards, providing a comprehensive view of trends and risks. By leveraging technology and analytics, funders can make instantaneous, informed, and strategic decisions that optimize capital deployment and enhance profitability.
Refinancing in MCA transactions presents a unique opportunity for funders to accelerate cash flow and compounding returns. However, it requires careful assessment of borrower revenue stability, repayment sustainability, and market conditions.
Additionally, the funding structure plays a crucial role in determining whether refinancing improves the funder’s overall return, as syndicates, loans, and self-funding models have different revenue recognition methodologies and cost structures.
By focusing on ROE, IRR as a continuous return metric, EAA for standardized deal comparisons, and borrower financial health, funders can make informed decisions that balance profitability with sustainability. Ultimately, the success of refinancing depends on structured evaluation, prudent risk management, and strategic commercial considerations tailored to the nature of MCA transactions.
Rodrigo Fritis
NISO
305-205-8465
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