It’s the start of the week, and you can’t make an MCA payment. MCAs can be one of the last financing options available to a business, but they come with a lot of terms that don’t always make sense: specified percentage, purchase price and receipts purchased amount are a few examples. And, since MCA providers don’t disclose an APR, it can be difficult to figure out how to compare the cost. At Delancey Street we talk to owners in this spot all the time, and the first thing we tell them is to find out exactly what kind of deal they signed.
Repaid in One of Two Ways
Merchant cash advances can be repaid in one of two ways. With some MCAs, a percentage of your sales is automatically withheld until the advance is paid in full. With others, a set amount is pulled out of your business checking account every day or week by ACH withdrawal, plus all the fees, until the balance is paid in full. It matters which type you’re doing if you’re having trouble making this week’s payment.
In the event of a slowdown in business, a real Merchant Cash Advance (MCA) has the feature that its payments are linked to sales. If sales go down, the payments should go down as well. A “true” MCA is one where the contract requires the funder, upon the business’s request, to reconcile daily (or weekly) payments with the actual amount collected in receivables. Why? Because the funder took the risk of the business’s ability to collect receivables from customers. As a business owner, if you can’t pay an MCA this week because sales are down, find out if your MCA contract allows you to request a reconciliation and ask for one.
How that clause is worded matters. Many courts ruled that the reconciliation must be mandatory and absolute. A contract that says the merchant may reconcile instead is more like a loan. We will come back to why that is important.
Before you simply let the payment bounce, look for two more documents. Many MCA providers will insist on a personal guarantee as a condition of getting an advance. That means you’ll be on the hook to pay back the advance yourself if the business is unable to pay. Many will also insist on a confession of judgment, which is another way of saying that you’ve waived your right to defend yourself in court if the MCA provider ever chooses to take legal action against you.
This is also why we tell owners not to cover this week’s payment with a second advance. Merchant cash advances are fast and easy, and can leave you in a loop of debt. One advance could be enough to keep you afloat, but the high fees and regular repayments can leave your business short on cash, meaning you need another advance right away, and so on and so on. A daily payment of hundreds of dollars can easily be crippling for a small business and put it at risk of default. There’s also nothing to be gained from paying back an MCA early: the fees are fixed, and you’ll pay the full amount of the agreed fees if you refinance, potentially with an early repayment charge added.
A Loan in Disguise
Lately, the courts have been treating some merchant cash advances as loans. A personal guarantee and a confession of judgment are two signs of a loan, as is a repayment schedule based on a fixed daily or weekly amount with no “mandatory reconciliation” clause. If the funder is permitted to collect via other methods, too, that might be a sign that it’s a loan. If that’s the case, the advance is subject to your state’s usury laws. Whether your agreement is a true MCA or a loan in disguise is worth knowing before you decide what to do about this week’s payment.
New York’s criminal usury limit is 25 percent. The effective annual rate on a Merchant Cash Advance (which includes the purchase fee and other charges) typically falls between 40 percent and 750 percent. Contracts above the limit may be declared void by a court. Most MCA providers are based in New York and thus governed by New York law. Massachusetts, California, Texas, Florida, and roughly 30 other states also impose usury limits.
Two recent cases make the point. In New York, the State Attorney General is suing a handful of MCA companies and their owners in state court, arguing that the deals are actually loans that are subject to New York’s criminal usury statute. If those arguments are accepted, then the entire transaction is void. Meanwhile, in a separate case in federal court, the Federal Trade Commission is suing in response to the deceit used to lure in vulnerable businesses. While there is no federal regulation of MCAs (due to their being structured as commercial transactions and therefore governed by state law, the Uniform Commercial Code) funders are subject to federal truth in advertising laws enforced by the FTC.
It’s a risk assessment for both the owner and the funder. Merchant cash advances look tempting to a small business because the money shows up fast. But the fees, predatory behavior and risk of spiraling debt can often do more harm than good to struggling businesses. Another risk is that the MCA is really a loan in disguise, because its structure lowers the funder’s chance of not being paid back.
Debt Settlement
If you can’t make this week’s payment, that is where Delancey Street comes in. As a business debt settlement company, we negotiate with merchant cash advance funders and lenders on behalf of business owners (including owners with stacked advances) for less than the full amount. We do not sell another loan. We are not a law firm: when litigation or bankruptcy is the right call, we refer the owner to a vetted independent attorney. The first consultation is free and confidential, and if a cheaper option exists, we say so on the first call.
