One of the most common questions we are asked is this; what happens if I default on a second-position MCA? Usually the owner took a second advance from a different funder while still paying the first, and now the business can’t carry both.
Why Being the Second Lender Is so Risky
Second-position funding occurs when a funder places its lien (legal claim) on your business assets and or funds behind another lender’s claim. A first position is simply the first money you borrowed, and that funder gets their money back first. If there’s any money left after paying the first, then the second gets their money back. And so on. Banks rarely agree to stand second in line. Alternative funders will, but second is the riskier seat, so they’ll charge a higher fee for a second-position loan or MCA.
But the real question is what happens if you default? The first lien-holder (person or company who gets paid first) will generally collect all available funds (including whatever funds are recovered from liquidating the business and assets), and the funder who provided the second will recover less, if at all. Additionally, the first funder (the one with the first lien) can claim any personal assets that the owner has pledged. So that’s why being the second lender is so risky. If the first lender doesn’t get enough money to be paid off fully, the second lender gets nothing.
Break the Terms of Your Contracts
Stacking a second advance is legal, but it can break the terms of your contracts. Often the first funder’s agreement with you says that you can’t borrow again without their permission. The second funder’s contract may also say that the borrower can’t take another advance without its permission. If you default, the two funders can end up in conflict with each other over your assets. And if you break certain clauses, depending on the contract, the funder may have legal right to cancel out the advance and demand repayment right away. These are all bad things. A demand like that could end your business.
The risk for default gets progressively worse for each additional advance. When a business does default, the ramifications extend to your credit, your ability to get another advance or loan. The funder may also file a lawsuit to collect the funds advanced. That can lead to asset seizures or even bankruptcy filings.
How did you end up with two funders? Often a broker looking for a commission sees the UCC filing on your first advance, calls, and keeps coming back on the phone with proposals. You need more money to expand. So you take the second. It seems like a good idea at first, but what if it doesn’t work? Now you’re behind on both and out of cash. The funders behind those offers often lend with no application and no credit check. They are gambling that not everyone will default.
If you are tempted to take a third advance to pay the second, don’t do it. We understand that this must be an incredibly frustrating time, with a lot of pressure to keep the business and avoid personal default. Using money from one advance to make payments on another is robbing Peter to pay Paul. Stacking a third advance just adds to the debt you are already unable to pay. That’s just digging a deeper hole.
Instead, look hard at where the business plan went wrong, tighten the belt and make business decisions that will allow you to avoid deficits. Scale back if you need to. Consider why the business might not be profitable and if another loan will help solve the problem. Assess the expected cash flow and consider the impact of adding debt on that cash flow. One common alternative in this situation is to refinance one or both MCAs with a product that offers more favorable terms. Consolidating, which means taking one new loan to pay off the existing advances, is another route. You’ll be dealing with one lender instead of two. Whatever you do, review your agreements closely and get legal advice before you act.
At Delancey Street, we have seen the risks of taking multiple MCAs. We understand that debt can put a lot of pressure on business owners, and want to help you keep your company and life on track. We are a business debt settlement company, not a law firm or a lender. Our senior advisors negotiate with funders for less than the full balance owed, and when litigation or bankruptcy is the better path, we refer owners to an independent attorney. Isolation can make this kind of decision very difficult, so talk to someone early. The first consultation is free and confidential.
