When a merchant cash advance first lands in your account, it can feel like a dream come true. You’ve been struggling to stay afloat and this advance is the life preserver you’ve been seeking. Many businesses around the country live on a revolving cycle of MCA debt, feeling like they’ve unlocked a shortcut to success. But ultimately, the trap is the same. Eventually the debt becomes too much to handle, and you’re left in a complicated financial quagmire that you didn’t realize you were stepping into. The thing about MCAs is that they can stack up on top of each other. Business owners often fall into the habit of borrowing more MCA funds to pay off the old debt. Sound familiar?
By the time someone suggests Chapter 11, most owners are well aware that something is wrong. They know their debt is excessive and they’re drowning in it. But they’re unsure of what their options are and how to get out of the mess they’ve found themselves in. There are alternatives to Chapter 11, but the situation needs to be understood. The question is, is Chapter 11 your only option? Not necessarily. But before weighing the choices it helps to understand what you are dealing with.
The MCA Trap
Part of the problem is that an MCA is not technically a loan. It is an advance against your future sales, and therefore not subject to the same protections of an ordinary business loan. You get cash up front instead of waiting for revenue, and in return the funder takes a percentage of your future receivables, often through daily or weekly automatic withdrawals from your bank account or a cut of your credit card sales. When you first get an MCA, it will have a factor rate associated with it, not an interest rate, which makes the real cost hard to see. Typical factor rates run from 1.1 to 1.5 or higher, so a $100,000 advance means repaying $110,000 to $150,000. Worked out as an annual rate, effective APRs land anywhere from 70% to 400%, and origination fees, administrative fees and hidden charges come on top. The danger is that the unremitting takeout of daily or weekly remittances can eventually bankrupt the business entirely.
Each new advance was meant to fix the last one. Owners bought themselves time, but at the cost of higher daily payments and a tiny margin for error. In cases like these, business owners are not just trying to pay back their merchant cash advances. They are trying to survive the MCA trap. The funders begin to call and email asking for payment, on top of the regular bills that are coming due. The stress of worrying about who is going to get paid when, in a time when funds are so limited is a very high-pressure situation.
Once you fall behind, the funder can send letters to your customers telling them to pay the MCA company directly instead of you. It can send restraint notices to your credit card processor. With customer payments diverted, it can become impossible to cover basic expenses, including payroll. You are out of money to make money.
When you believe in your business, it is easy to think one more cash infusion will help you turn the corner. Using an MCA to pay back an MCA is like shoveling yourself deeper and deeper into a financial hole. But the debt breeds more debt, until all you are doing is struggling to keep your head above water. That’s the trap. One advance after another digs the hole deeper. Many owners later say the MCA was the worst business decision they ever made, and the old adage applies: if it sounds too good to be true, it probably is. To address your situation, the first step is figuring out what type of debt you are dealing with.
Negotiation or a Challenge to the Contract
So what are the alternatives? The first is negotiation, and for some businesses it may be enough. You can negotiate to reduce the factor rate, extend the payback schedule, or both. That can be a short-term solution, but what if the problem gets worse? A reasonable plan for dealing with the debt may provide some breathing room. But the advance may already be beyond the point of renegotiation or you may not know how to negotiate it yourself.
The second alternative is to question what the MCA really is. Strip away the paperwork and an MCA can look a lot like a loan, and some courts are beginning to treat it as such. Judges are starting to see MCAs as loans disguised as purchases of receivables, and a recent New York case highlights the shift. In other words, even if the MCA is not technically a loan, the court may treat it as one. That matters, because a loan may be subject to loan laws, which opens the door to having the debt disallowed, particularly in bankruptcy court. The old way of hiding behind a misleading label may be dying.
None of this means negotiation or a challenge to the contract is a waste of time. On the contrary, they are a viable path forward for many. But when the funders are calling and writing to customers and you can no longer pay your employees, then it is time to look seriously at bankruptcy.
Chapter 11 Bankruptcy
Chapter 11 doesn’t have to be the very end of the world. It all depends on what you are dealing with. At the end of the day it is just a means to an end, a tool you can use to solve a problem. Chapter 11 is a type of reorganization under the United States Bankruptcy Code that allows companies to restructure their debts while continuing to operate their businesses. Depending on your circumstances and eligibility, a small business may qualify for Chapter 11 Subchapter V. Once filed, the automatic stay steps in to halt every creditor’s collection effort immediately. That includes aggressive MCA withdrawals, threatening phone calls and restraint notices, and MCA companies must retract their restraint letters after the business files. By stopping the cash‑flow drain, the stay buys the debtor time to develop and implement a plan to resolve the debt issue. A Chapter 11 plan can resolve all of the debt and let the business come out of bankruptcy in a better position. If you are already drowning in MCA debt, Chapter 11 may be one of the best moves you can make.
Chapter 11 bankruptcy is not for everyone. Far too many try and avoid bankruptcy and fail to take full advantage of their rights. Others assume they must file, when in fact they do not. Many owners put off bankruptcy at all costs and spend a lot of money on avenues that never work, when dealing with the debt through bankruptcy might have been the affordable way to survive and rebuild. Without taking action, your business will continue to sink deeper into debt. You need to evaluate where you stand and what you are prepared to do. Regardless of what route you choose, it’s best to deal with these things sooner rather than later. If you put off action too long you’ll be left in the dark where your options are concerned. No matter your circumstances, bankruptcy should be on the table as a possible solution.
