Small and mid-sized business owners have turned to merchant cash advances (MCAs) to fill the funding gaps associated with short-term cash-flow needs. Business owners use an MCA when they’re at the wall, with no other choice. MCA funds are at the bottom of the alternative lending barrel. After the first MCA is obtained, other transactions often follow. Having multiple MCA contracts is called “stacking.” Stacking sends a business down the rabbit hole with no clear way to climb out. Nothing about stacking makes sense, but once you are in it, it feels pretty desperate.
However, there are ways to manage merchant cash advance debt, if not wipe it out completely, thus enabling the business to turn a profit once again. It’s more difficult than before due to the economic impact caused by COVID-19, but business owners do have options. The solution to getting out of stacked MCA debt is to renegotiate with the merchant cash advance companies that hold the outstanding advances. But how can this be done when the business owner appears completely squeezed dry by the MCA advances? The answer starts with what you actually signed.
Contract to Purchase and Sell Future Receivables
An MCA is a contract to purchase and sell future receivables. It is not a loan. The contract is such that the merchant has to pay a fixed amount every week or every day until the contract is paid off. The payments are deducted automatically from the business’s bank account. In an attempt to ensure that an MCA is deemed a true sale and not a loan, funders will go out of their way to construct the contract such that an MCA would pass this test. Why do they do this? Because, if a court were to find that the MCA was in fact a loan, in most instances the rate charged would be usurious, and outside the maximum permissible interest rate in most states, in which case the funder may run into a host of troubles, including criminal charges. Annualized interest rates of 100% and above are not uncommon.
Most funders structure their MCAs under New York law, jurisdiction, and venue. The courts of the State of New York, historically, have been more lender friendly, and most New York rulings have found MCAs to be true sales, and consequently, funders did not often have to deal with usury issues in New York. Recently, however, in some state and federal cases, the courts are no longer shooting down merchants’ arguments that the MCAs in question were in fact loans. The law has also already shifted in one way that matters to almost every stacked merchant.
Confession of Judgment
What is a confession of judgment? A merchant typically signs this document when the contract is signed. It allows a funding company to enter a judgment against a defaulter without notice and without first filing and serving a complaint. Prior to August 2019 a COJ could be filed in New York against any merchant in default, regardless of where the business was located. Since there was no notice, the judgment and collection could begin without the merchant’s knowledge.
In August of 2019, the law in New York was changed. Now, COJs can be filed in the office of the county clerk, but only against a party that is located in New York. If the business is outside of New York, then the funder must file a complaint, serve a summons, and go through the ordinary lawsuit process. In other words, the merchant is now able to defend itself against the funder. Even if the judgment is entered in favor of the funder, it must bring a lawsuit against the business in the home state of the business to collect. That means the funder has to incur even more expense and it will take a lot longer. If your business is not based in New York, this matters a great deal to you. If you have multiple, stacked MCAs, they each will have to come after you one by one.
Negotiate for Relief
Even if you have a large amount of MCA debt, you can still negotiate for relief. Now, most of the businesses that have this debt also have a senior lender or a factor with a first-position perfected security interest in the company’s assets and a personal guaranty from the owners. The MCA funders are at best junior lienholders. If the business is liquidated, its assets would have to be worth more than the senior creditor’s claim for the funders to recover anything. They’re “out of the money.” As a result, and because they lost the fast-track right to go to court with the COJ change, the MCA funders are much more open to negotiation for relief. Of course, any agreement would need to be approved by the senior lender – so that gives you bargaining power. The funders would rather be paid something than nothing.
So what does that leverage actually get you? In practice, that means that the business can negotiate the amount that it owes to the MCA funders, and can negotiate lower payments. The first thing to ask for is some form of short-term accommodation, which usually entails reducing their debit for 30 to 60 days or more, perhaps by 50 to 75%. That kind of breathing room would give you an opportunity to renegotiate a more permanent resolution of the debt. That usually means negotiating a final payment for a significant amount less than the balance due, often 25 to 50% or more.
At this point, if the business cannot raise the money from current or projected cash flows, it can go to the mezzanine lending market and obtain sub-debt for the lump-sum payoffs. This is a debt restructure, where the cost of capital is much lower, but the payback period is much longer. For the senior lender, a stronger business and a reduction in credit risk is appealing; for the sub-debt provider, new business at an attractive return for a short time (usually nine to 15 months) is also attractive. The owner likes it because the high cost MCA is gone and replaced with lower cost debt paid off in a relatively short period of time.
All in all, I see the pendulum already moving in favor of merchants and the law continuing to evolve in their direction. This means that future options for resolving stacked MCA debt should only improve. Keep in mind that your senior lender or factor also has an interest in your survival, because you’re less of a credit risk that way. The bottom line: You aren’t helpless, and stacked MCA debt can be reduced and possibly eliminated. Being squeezed dry by multiple MCA funders may seem impossible, but it’s not. You just need to know what you have, how you got there and what your options are. It’s important to address stacked MCA debt in a proactive way before the next debit arrives or the next advance takes place.
