You might be misevaluating your Loan options by comparing IRR.
I've seen many "finance experts" advise CPG brands on how to assess loan terms. I'm here to say they are usually wrong - more so as it relates to Merchant Cash Advances (MCAs)….. well, at least not communicating the full picture.
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Here's why.
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1) ?? Single-perspective usage of IRR
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"Experts" will tell you that IRR is a way to annualize and account for timing of cashflows to get the apples to apples comparisons of different cashflow streams (or in this case, the loan options)…. They're not wrong - this is one of many ways to use IRR.
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BUT, on a deeper level IRR actually does much more.
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IRR is from the perspective of the person outlaying the money, and defined as the rate/measure at which your cashflow is Net Present Value accretive or dilutive (ie increases or decreases valuation). In capital budgeting, the best decision is to increase NPV.
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So the truth is, the IRR quoted when evaluating a loan is actually the lender's IRR.
Curbing professor Virgil Leung aside (feel free to reach out if interested in the finance math details) …. The MUCH more sensitive levers to increasing NPV is the growth of near term cashflows (ie profitable sales you are able to unlock with the loan) and increasing growth rates that COMPOUND over time.
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As NPV Grows, weighted average cost of capital drops.
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2) ?? IRR is annualized and assumes re-drawing of the loan.
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MCAs are very short term and a typical 6-month "term" that many MCAs offer is actually equal to a 3-month weighted average term.
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Therefore the IRR of the MCA implicitly assumes that you make the same decision 3 more times throughout the year.
In other words, an MCA's IRR is really only a 1/4 annual weighting, and if you are comparing it to an ABL or a Credit Card LoC % you are already comparing apples to oranges.
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To clarify, I am not here taking a stance on being for/against MCA loans. I am simply saying that just like everything else in this world - there's a time and a place for them past simply the IRR.
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So next time your "finance expert" advises about IRR, make sure they understand this themselves or you might be better off asking Chat GPT!
