For an owner who has hit a wall with an MCA, the question in the title is an urgent one. The short answer is, that once you miss a payment, the funder can pursue a lawsuit, or enforce a confession of judgment they had you sign when you applied for the MCA. We said “miss a payment.” Not “miss ten payments,” or “miss more than your total due.” Because of this, it is all the more important to know how to recognize a default coming on a merchant cash advance before it happens.
An MCA is a type of financing that’s granted in exchange for a portion of future business sales. The funder advances cash to the business that’s deposited directly into the company’s bank account. The cost of an MCA is based on a factor rate rather than an interest rate. For example, a business might receive $50,000 against future sales with a factor rate of 1.5. The total cost of the advance would be $75,000, plus any origination, underwriting/funding and administrative fees. Repayment is typically daily or weekly, withdrawn from the business’s operating account. Repayment may be a holdback of a percentage of the business’s card sales, usually around 10-20%, or a fixed dollar amount. If the business repays via a fixed amount, they will know the length of the term, but there is no flexibility to extend the term if their revenue slows down.
An MCA is a relatively easy form of financing. Almost any business that has receivables coming in can qualify, even if they have bad credit. In many instances, there is no collateral required, since repayment comes out of future revenue. Often times small businesses are very tempted to get an MCA when they need to make ends meet. But that is exactly the danger: business owners get MCA advances, and while the payments may not appear to be that great at the outset, eventually they can land in default.
The documents you signed are what make that so serious. A confession of judgment is a document that waives the owner’s right to a defense of any lawsuit filed by the funder. Some funders also require the business owner to sign a personal guarantee, which means that the owner’s personal assets can be collected against. The combination of these two documents means that an MCA default is more severe than one on a traditional business loan.
Warning Sign
There are four things to look out for to determine if you are close to defaulting.
The first warning sign is that the daily or weekly withdrawals are beginning to seriously impact your business cash flow. The payment schedule looked doable at the outset, but you never know when sales will slow down. Sales always ebb and flow, and sometimes the rhythm of withdrawals just doesn’t work. When that happens, the owner is often faced with three options: try to catch up, borrow to cover the shortfall, or let it go and feel the consequences of a default. If the withdrawals are starting to eat into the cash flow you need to keep the business going, that’s a big red flag. You need to watch the numbers closely to see if your business can handle that payment schedule.
The second warning sign is that you are locked into a fixed payment while your revenue has slowed. Fixed payments are one of the sticking points in MCA agreements, and they have a huge impact on an owner when sales decline. If your MCA is repaid with a holdback, you know that the withdrawal amounts will vary based on your sales. As your sales decline, the withdrawal amounts will also decrease. A fixed withdrawal does not. In this scenario, your business’s cash flow decreases even as the payments stay the same. That payment won’t stretch as sales slow, so now you’re cutting elsewhere, sacrificing your business for the advance.
The third warning sign is that you are taking out a new advance to fund an old one. It can look like a fix. It’s a big mistake. Most companies who reach a point where they have to take out an MCA to cover a previous advance likely have cash flow or working capital problems. Each time an owner borrows to cover an existing advance, the costs can escalate and begin to spiral, putting the viability of the business itself at risk.
The fourth warning sign is the true cost. The factor rate plus other fees adds up to an effective rate far higher than many conventional loans, and often well above 100% a year. As a business owner who’s been struggling to make payments to a merchant cash advance, this can be the most worrisome sign of all. Usury laws cap the interest rate on loans that can be made in your state, but because MCAs are structured to try to avoid qualifying as loans, they sometimes are not subject to those limits. Litigation over that very issue is going on in bankruptcy courts today. The business can’t benefit from paying their MCA early, as they’ll have to pay the full amount regardless. They also don’t report to the credit bureaus, so they don’t build any credit.
These signs can feed each other. The payments may have looked workable, but sales started to dip. The withdrawals keep coming until the advance is fully repaid, so another advance starts to look like the answer, the costs climb, and the next missed payment is the default.
Just Don’t Try Another MCA
Time for some advice. If your business is already showing signs of an MCA meltdown, just don’t try another MCA. Instead, consider looking into traditional, conventional business loans for financing before you try to secure yet another MCA. MCAs are notorious for charging a lot in fees and costs, having abysmal terms on a default, and leaving you potentially with never-ending debt. If you are already in financial trouble because of MCAs, bankruptcy might be a viable alternative for you. Depending on your situation, it might be a Chapter 7 business liquidation, a Chapter 11 business reorganization, or a Subchapter V (for small businesses) bankruptcy.
Delancey Street is a business debt settlement company. Our senior advisors will negotiate with your MCA funders to reduce the amount you owe to less than your total balance. We do not issue a loan. We are not a law firm and if bankruptcy is the better option, we’ll refer you to independent bankruptcy counsel. Our first consultation is free and confidential, and if there is a less expensive solution for you we’ll tell you on your first call. As soon as you start having difficulty repaying your MCA, and certainly before the MCA company even notices that payments are late or missed, get in touch with us!
