If you’re having trouble making your cash advance payments, you’re probably anxious about what will happen next. It is easy to assume that default means the same thing for an MCA as it does for a business loan, and it does not. This distinction is significant because when a business is unable to repay an MCA, the consequences and the path to resolution are different than a default on a conventional business loan. At Delancey Street, a business debt settlement company, we negotiate with funders and lenders on behalf of owners in exactly this position, so here is how the two compare.
When a business defaults on an MCA contract, it means it has missed its agreed-upon repayments. Repayments on MCA contracts are often based on some percentage of daily or weekly sales. One week a good sales day might mean you pay back more, the next week when sales drop the amount deducted goes down. Merchant cash advances are not technically considered a loan. An MCA is structured as a purchase of your future sales, and as a result they are not subject to the same regulation as a bank loan.
That difference shows up in how often each one goes bad. The default rate for MCAs is estimated by some to be 7-12%. To compare that to a bank loan, as of early 2024 the default rate for business loans is 1.13%. Even the all-time high for business loan defaults in April 1987 was 6.75%. Still below the current default rate for MCAs.
Several factors drive MCA defaults. Businesses may struggle to keep up with payments if their income fluctuates due to seasonality or irregular sales patterns. Poor financial planning, lack of budgeting, or insufficient savings can also lead to cash flow issues. Recessions or increased market competition can reduce consumer spending, leading to a significant decline in sales. Businesses that have taken on multiple financial obligations, such as other merchant cash advances or debts, may find it difficult to manage all their payments. Unexpected costs like equipment failures, emergency repairs, or legal disputes can drain a business’s cash reserves. Supply chain disruptions, staffing shortages, or inefficiencies can hinder a business’s ability to operate smoothly and generate revenue.
Payment Collections
So what happens when the payments stop? Some MCA funders regularly check the sales and bank account activity of merchants they provide MCA funding for, to detect when they’re showing signs of distress like changing financial patterns, but there are generally two methods for payment collections if the merchant falls behind. Soft collections are the gentler of the two, consisting of email reminders and phone calls. This method generally works for merchants that are struggling temporarily and are willing to work with the funder. Some funders employ soft collections first, then escalate to hard collections if needed. Hard collections are harsher, less personal, more expensive, and often involve hiring a collections company.
The Funder Might Sue
For a struggling business owner, what’s the likelihood your funder will sue you? The funder might sue, but even the funding industry’s own advice treats litigation as a last resort. Because an MCA is a purchase of future sales rather than a loan, it is not regulated the same way, and that can make a lawsuit tricky for the funder. However, litigation can be expensive and time-consuming, and since many MCA clients are small businesses with limited assets, it may not be worthwhile.
None of that makes a lawsuit harmless to you. Small businesses can suffer greatly from legal proceedings, as they can jeopardize their financial position and prospects for future funding. Many owners may not have intended to default but may be struggling with repayment, and past defaults may still be considered a high-risk indicator for several years, making it difficult to secure approvals.
Negotiate a Way Through the Problem
This is where the structure of an MCA can work in your favor. Sometimes, the terms of an MCA do not match up well with a merchant’s revenue flows. However, due to the flexibility of MCAs, there may be room for adjustments. In a default situation where the issue is temporary and the merchant is willing to cooperate, the MCA funder may restructure the advance - this can involve re-pricing the advance, adjusting the MCA percentage based on seasonal fluctuations, or freezing payments temporarily.
That only happens if the funder hears from you. You should talk to the funder. Early, honest communication is better than silence. When you know you’ll have trouble paying back your cash advance, alert the funding company ahead of time. They’ll sometimes be able to negotiate a way through the problem and prevent a default situation from happening. Explain your situation, the reason for the shortfall, and show a plan. Clear communication maintains your credibility and can lead to mutually beneficial resolutions.
If those conversations go nowhere, or you are carrying more than one advance, settlement is another route. In a settlement, a third party negotiates the MCA agreement and attempts to reach a solution that both the funder and the merchant can agree on, and typically involves a partial payment to resolve the debt. That is the work our senior advisors do at Delancey Street: we negotiate with MCA funders and lenders for less than the full balance owed, and we do not sell you another loan. We are not a law firm, and when bankruptcy or litigation is the better path, we will tell you and refer you to an independent attorney. The first consultation is free and confidential.
There’s a lot to figure out, and it can feel daunting. But you need to look forward and don’t postpone work on your situation. Start digging into it as soon as you can.
