One Percent Ventures Corrects the APR To MCA Conversion In Favor Of The Merchants.
New York state law makers buckled to the bank lobbyists and forced the introduction of APR conversion into the merchant cash advance (MCA) industry. The law allegedly gives the merchant a common measurement to compare the costs of bank loans versus MCA loans. This paper will prove that scientifically it is impossible to convert an annual measurement like APR to an MCA that is not priced in the same way.
This paper will further prove that while we can create a formula that closely converts the APR measurement to MCAs, the formula must concede to minor deviations. We will also see that without the OPV weekly pause, the APR deviation benefits the funder, whereas with the pauses the deviation shifts in favor of the merchant.
It’s Complicated
There are several complicated issues with regard to the conversion of APR to a daily payment system. The original MCA, where the payment is a percentage of the sale, represents an obvious challenge for APR conversion, which the NY law addressed. The issue of reconciliation has also been properly discussed. There is however a fundamental mathematical deviation in the conversion of APR in order to compare it with MCA, the space which uses fixed daily payments, that very few if any have addressed.
What is the Goal?
First, let’s establish the goal of converting and disclosing the APR. The banks want to force this disclosure since to the layman, it seems as if the APR of MCAs are outrageously high relative to the banks. However, to correctly address this issue, we must commit to a true conversion. Otherwise it is just a mockery of the financial institution.
The Essential Questions
In order to convert one measurement to another, we must ask two basic questions.
- A) What formula will be used to convert the two measurements, and is the formula scientifically accurate?
- B) Is the converted measurement applicable enough to this product, to project an accurate mirror image of the product it is being compared to?
Does the disclosure of APR for MCAs with fixed daily payments project an actual scientific comparison to the APR of credit cards? Or is it an optical illusion designed to make the APR of MCAs appear high?
If the intended purpose of disclosure is to provide a common measurement by which the merchants can shop and compare within the MCA industry, why not use factor rates, which are the natural measurements of the product? If I can figure out a way to measure the weight of my house, and it is five tons, does this information matter when I appraise the value of the house, or is it useless clutter?
If the purpose of disclosure is to give the merchant a familiar yardstick used for bank loans and credit cards (APR loans), then the formula needs to be established on an equivalent basis. Otherwise the yardstick is not based on the same measurement, and we are just giving the stick the same name. The result – the goal of a familiar yardstick is not reached.
An Example Shows The Flaw In The Logic
Think of it this way. Mr. T-Bone, a popular strongman from the meat packing industry, becomes governor and decides that the tax calculations are too confusing. He declares that people should start paying taxes by measuring the weight of their income. Governor T-Bone instructs his staff to design a calculator that will convert currency to weight. The treasury secretary googles how much USA currency weighs and quickly learns that every dollar bill weighs 1 gram.
Mr. T-Bone tweets that a digital income to weight calculator will be made available for those who don’t have an actual scale. The calculator is designed. As a side note, Mr. T-Bone is disappointed to learn that a ton-a-money is worth only $908,000. The electorate is very pleased, and proud of a governor that is delivering on his promises to simplify the tax code, and make it easy for everyone to understand.
The Logical Flaw Appears
The new tax conversion measurement doesn’t work out too well for the Bacon family. Mr. & Mrs. Bacon don’t believe in things like digital calculators. They believe that the government is installing fake algorithms in the backend of the calculator, that multiply the weight of their income. The Bacons decide to ditch the conversion calculator and weigh their annual income on their own good old scale.
Every week Mr. Bacon places the proceeds of his cashed salary check on the scale, and keeps a record of the weight. This uncanny and labor-intensive process solves only half of their problems. The Bacons are penny collectors, and a penny weighs 2.5 grams. Since T-Bone’s calculator is based on 1 gram per dollar bill, the Bacons have to deliver all their pennies to T-Bone’s tax collectors.
We can argue and perhaps even ridicule the governor’s logic behind the conversion, but it could have technically worked – had the lowest currency been a dollar bill. The reason the formula is fails is because pennies do exist, so the formula should have been based on the pennies. It is similar to the concept of the lowest common denominator when calculating fractions. When you create a conversion from an annual measurement of APR and divide it in 365 to convert it into a daily APR for the MCA industry, it can technically work, if we have 365 daily payments annually.
But the problem is – we only have 250 bank days.
Yes, there is a popular APR conversion calculator for the MCA industry, but that calculator divides the APR x 365 and the result is – as good as T-Bones tax policy.
A Loan Example
To explain this in detail, let’s use an example of $100,000 loan that pays 12% APR. In case T-Bone reads this paper, I will break it down in real estate terms. Let’s call the lender a landlord, the borrower will be the tenant, the loan is the property, and the interest payment the rent. If we work with an annual lease, the math is simple – the tenant (borrower) pays the landlord (lender) $12,000 rent (interest) for usage of the property ($100,000) for one full year.
The lender isn’t sure that he will need the property for the entire second year, so he negotiates a monthly rate based on the annual lease (APR) which is $1000 per month. After six months, the tenant tells the landlord, “look I don’t really need the property for a full month, but if we convert the rent to a weekly rate, based on the original annual lease of $12,000 per year, I will continue for another few weeks.” The annual rate is divided by 52 to establish a weekly rate. Then it is divided by 365 to give the tenant a daily rate of $32.88 for 24 hours of usage of the property.
The 365 Day Flaw Appears
With this math concept it may seem simple to convert APR to the MCA industry – you just divide the APR into 365 days. However, this is where Governor T-Bone went wrong. MCA “daily” payments exclude non-banking days, meaning you only make 250 payments per year. If the tenant pays a daily rate of $32.88 and keeps the property for a full year he will pay a total of $8,220 ,which is quite a bit less than the $12,000 annual lease rate (APR) this “daily” rate was supposedly based on.
Some have corrected this by dividing the lease rate (APR) into 250, which gives you a daily rate of $48.00, which effectively means that in the event the tenant uses the property for a full year while paying a daily rate, he will pay $12,000.
The Problem With The Correction
However, there is a fundamental problem with this formula which we must address. When you divide an annual measurement into smaller periods, like months, weeks, or days, the intervals between the periods must be equal – otherwise the conversion collapses. Assume the tenant negotiates a monthly rate but wants July and August as nonpaying months due to a holiday season. To adjust for that “pause” we use the same concept as in MCA.
Instead of dividing the annual lease by 12, we divided it by 10 – the paying months – and the rate was converted to $1200 as a “monthly” rate. Say this deal was signed in June and pays the first monthly payment of $1200. The tenant then skips July and August and pays another $1200 at the end of September, and then returns the property. The tenant used the property for four months but only paid two “monthly” payments.
In a true loan environment, the interest would be adjusted for September, but in a situation where adjustments aren’t possible, then the intervals in between the periods must be equal, or you don’t have a true balanced rate. In the MCA space where “daily” payments are made only Monday through Friday, the Monday payment covers for the three days of the weekend at the same “daily” rate as the other days that pay the same “daily” rate for only one day.
Without an adjustment to the Monday payment there is a scientific deviation from the annual measurement conversion that cannot be corrected.
Who Really Benefits From This Method
We at OPV decided to dig a little deeper and find who actually benefits from the deviation. In an effort to not repeat T-Bone’s mistake, we started with the pennies and began converting the APR down to an hourly rate. In our $100,000 12% APR loan, we divide the annual rate by the number of hours covered in the annual period, which is 8760 hours, which gives us a rate of $1.37 per hour. Now that we have an hourly rate, we can calculate this way:
Hourly rate X 24 = daily rate
30 X daily rate = monthly rate
12 X monthly rate = APR
We have already established that in a daily payment environment where non-banking days are skipped, the daily payment would be $48.00. If you divide the daily rate by the hourly rate, you will find that your “daily” rate covers a lot more than a day. You actually pay for 35.40 hours to be exact.
Every daily payment is equivalent to a day and a half of rent.
The Flaw Resolved – Performance-Based APR
Now let’s continue with the basic math. After five “daily” payments (Monday through Friday) of which each represent in actuality 1.5 days’ worth of interest, the merchant will have overpaid 2.5 days’ worth of interest.
This means that even after you give the merchant back the two weekend days that are nonpaying days, he still overpaid by a half a day. The OPV weekly payment pause gives the merchant an additional extra day, so it erases the half day disadvantage.
The pause in fact shifts the half a day advantage in favor of the merchant.
Some have argued that since the OPV pause award depends on the merchant’s timely payment, it cannot be part of the calculation. This is why we call it performance-based APR, because we are saying that if you perform well, we will award you a pause that lowers the APR and shifts it in your favor.
The Bottom Line
The reality is that the MCA industry has resolved the flaw in the APR method of evaluation. If the comparison can be made on a fair basis, the MCA performance-based APR is a great deal.