Quick overview

Short-term merchant funding covers products that deliver fast capital to businesses—merchant cash advances (MCAs), short-term term loans, and revenue-based financing. Two common pricing models are factor rates and APR. Factor rates apply a flat multiplier to the advance (e.g., 1.25 means you repay 125% of what you received). APR (annual percentage rate) is an annualized measure of cost that includes interest and some fees and is standard on regulated loans (per Truth in Lending Act).

This guide explains how each pricing method works, shows conversion examples, highlights practical pitfalls, and gives a checklist for comparing offers. In my 15+ years in financial services I’ve seen owners pick offers that look cheap until repayment patterns and holdbacks drive effective cost far above expectations.

How factor rates work (and why they feel simple)

  • Structure: Lender gives an advance (A) and requires repayment of A * factor (F). Example: A = $50,000, F = 1.2 → total payback = $60,000.
  • Repayment mechanics: MCAs often collect as a fixed percentage of daily card sales or via daily ACH debits. Some short-term loans use fixed daily/weekly payments. Because repayment happens quickly and often before principal declines much, effective annualized cost can be very high.
  • Key point: Factor rates do not show time value — a 1.2 factor on a 30-day advance is far more expensive (annualized) than the same factor on a 365-day advance.

Advantages

  • Simple to explain and calculate total dollars owed.
  • Predictable total repayment amount.

Disadvantages

  • Hard to compare to APR-quoted loans without a conversion.
  • Often much more expensive on an annualized basis, especially with fast repayment.

How APR works in short-term business loans

  • APR is an annualized metric that expresses the yearly cost of borrowing, including interest and many finance charges (not always every fee; see TILA exceptions). Lenders that qualify as insured- or bank-style lenders will commonly quote APRs.
  • APR lets you compare pricing across lenders only when payment patterns and fees are similar.

Advantages

  • Standardized metric under consumer/business lending rules for many loan types.
  • Easier to compare when terms and payment frequencies match.

Disadvantages

  • APR assumes an annual basis; very short terms and nonstandard payment flows (percentage-of-sales remittances) can make APR comparisons misleading unless calculated properly.

Converting a factor rate to an approximate APR

There is no single conversion that fits every product because repayment timing matters. Use these two methods as practical approximations.

1) If the full payback occurs in a single lump sum at the end of T days (rare for MCAs):

Fee = A * (F - 1)
APR ≈ (Fee / A) * (365 / T) * 100%

Example: A $50,000 advance, factor 1.25, repaid at day 90 in one lump.

Fee = 50,000 * 0.25 = $12,500
APR ≈ (12,500 / 50,000) * (365 / 90) * 100% = 0.25 * 4.0556 *100% ≈ 101.4%

2) If funds are repaid by equal daily payments (amortizing over T days): compute the internal rate of return (IRR) using the actual payment schedule and annualize that IRR. This requires either a spreadsheet or a financial calculator and produces a lower APR than method (1) because principal declines with each payment.

3) For percentage-of-sales remittance (typical MCA): model expected daily/weekly receipts and create a cash-flow schedule, then compute the IRR. Because payments are front-loaded when sales are strong or slow when sales are weak, the APR can vary widely.

Practical rule of thumb: Short-term factor rates between 1.1 and 1.5 commonly translate to APRs ranging from about 30% to well over 200% depending on term and collection method. For a realistic read, always build an expected payment schedule and compute IRR.

Direct comparison example (side-by-side)

Scenario: Business needs $30,000 and has two offers:

  • Offer A (factor rate): Advance $30,000, factor 1.30, collected via daily percentage of sales, expected payback ~120 days.
  • Offer B (APR loan): Loan $30,000, 30% APR, fixed weekly payments over 120 days.

Quick estimate for Offer A using lump-sum approximation:

Fee = 30,000 * 0.30 = $9,000
APR ≈ 0.30 * (365 / 120) = 0.30 * 3.0417 = 91.25%

Offer B total cost (simple approximation for short-term fixed loan):

Total interest ≈ 30,000 * 0.30 * (120/365) ≈ $2,958 → effective cost ≈ $2,958

Why the difference? Factor-based Offer A charges a large upfront fee and accelerates the effective cost because repayment occurs quickly and is front-loaded. Offer B spreads the cost across equal payments and uses standard interest accrual.

Notes: The approximations above deliberately simplify. For precise comparisons, compute IRR on the actual payment schedule for each offer.

Important questions to ask the lender (checklist)

  • Is this a sale of receivables (MCA) or a loan (subject to TILA)? Ask for contract language that defines the product.
  • What is the exact repayment schedule (daily %, fixed ACH, fixed installments)? Get the sample amortization or payment projection in writing.
  • Are there origination, processing, or ACH fees? Where do they appear in the contract and in an APR disclosure, if any?
  • How is a returned payment handled? What are NSF or late fees?
  • Can I pay early, and if so, is there a prepayment penalty or discount?
  • Will the provider place a holdback on my merchant account funds? If so, for how long and what percentage?

Who should use each product?

  • Factor-rate MCAs are most appropriate for businesses with unpredictable cash needs that need immediate funds and have strong daily card volume (restaurants, retail with high card use). Use when you can tolerate a high effective cost for speed and flexible repayment tied to sales.
  • APR-priced short-term loans are generally better for businesses with steady cash flow and the ability to make scheduled payments. They typically produce lower effective costs if term is longer and payments amortize principal.

Common mistakes and regulatory notes

  • Mistake: Comparing factor multiplier to APR without considering loan term and payment frequency. This is the most common way owners underestimate cost.
  • Mistake: Ignoring non-interest fees and holdbacks that increase effective cost.
  • Regulatory note: Many MCAs are structured as sales of future receivables and are not classified as loans, so TILA APR disclosures and consumer protections may not apply (see Consumer Financial Protection Bureau guidance: https://www.consumerfinance.gov). The SBA provides guidance on small-business financing alternatives (https://www.sba.gov).

Alternatives and mitigation strategies

  • Consider a short-term bank line of credit or SBA microloans if you qualify — costs are often lower and terms more transparent.
  • Negotiate for a capped daily remittance rate or a longer repayment window to lower effective APR.
  • Improve working capital through faster receivable collections, inventory management, or short-term vendor terms rather than external financing.

Practical tips from my practice

  • Build a simple spreadsheet showing projected cash flows under each offer and compute IRR. I’ve helped more than 500 small-business clients do this; once they see the annualized cost, choices become clearer.
  • Ask the lender to produce a worst-case payment schedule (slower sales) and a best-case schedule (higher sales). Compare IRRs for both scenarios; this reveals sensitivity to revenue volatility.
  • If you must use an MCA, treat it as bridge financing for immediate needs only and avoid rolling short-term advances into new short-term advances — that snowballs cost quickly.

Bottom line

Factor rates and APR describe cost differently: factor rates state total dollars to be repaid; APR annualizes cost so you can compare across products. For short-term merchant funding, timing and repayment mechanics drive effective cost. Always model actual payments and compute IRR when comparing offers, and use the checklist above to surface hidden fees and collection mechanics.

References & further reading

Internal resources

Professional disclaimer: This article is educational and does not constitute legal or financial advice. Speak with a qualified financial adviser or attorney to evaluate your unique situation.