Many small business owners have recently found themselves in financial hardship, and unfortunately have fallen prey to the aggressive and seemingly abusive practices of certain merchant cash advance funders. Not all MCA funders are bad, but some appear to be. Business owners are looking for a way out of their financial struggles. Once an MCA has taken over their daily or weekly income, it can feel like there’s nowhere to turn other than taking on another advance. When you understand what an MCA is, how it works and how it is paid back, then you can determine which of your relief options are right for you.
A True Merchant Cash Advance Is Not a Loan
Technically, a true merchant cash advance is not a loan at all. The advance is a cash payment from the funder to the business, in return for a portion of future receivables, in theory purchasing a percentage of receivables before they are collected. MCAs originally targeted businesses in the retail sector that took credit and debit card payments, but their use has spread far beyond that. The funder gets direct access to the business bank account, withdrawing an agreed upon daily or weekly amount, supposedly in accordance with a percentage of revenue collected.
You can repay an MCA one of two ways. The first way is that the funder simply withdraws a predetermined percentage of your sales, as outlined in your contract, until the advance is repaid in full. The other option is that they take a fixed sum from your business bank account every day or week, plus fees, until the advance is repaid in full - these are called ACH withdrawals. Since MCAs are not technically loans, they are not regulated in the same way, and they feature factor rates instead of interest rates. At Delancey Street, the owners we talk to are usually trying to find out which of their options can actually take some pressure off those withdrawals.
When your payments are based on a fixed percentage of your sales, they should decrease when your sales decrease. This is known as a reconciliation provision. In an authentic MCA, that provision requires an honest funder to adjust the daily or weekly payment to what was actually collected in receivables upon request by the business. The theory is the funder is taking a risk on the ability of the business to collect receivables and therefore its recovery is limited to that. So, the first step is to look in your contract for the reconciliation clause and request a reconciliation when sales are low.
Many courts have ruled that a reconciliation is required to be mandatory and absolute. If the contract only says the merchant “may” reconcile, and the business is not able to “force” a reconciliation, courts have found the business’s inability to make a reconciliation is more akin to an attribute of a loan. Fixed daily or weekly payments with no mandatory reconciliation also point toward a loan. So do a personal guarantee and a confession of judgment. If the funder can collect in other ways, those can be signs the agreement is actually a loan, and a loan is subject to the state’s usury laws.
Many MCA contracts require a personal guarantee, which means you’ll be liable to repay the advance out of your own pocket, and a confession of judgment, which means you surrender your right to defend yourself if the funder takes you to court. Many courts view a confession of judgment as a way of guaranteeing the funder repayment of its money, and so interpret the agreement as a loan subject to the state’s usury laws. Contracts are often written in unfamiliar language like specified percentage, purchase price and receipts purchased amount, and MCA providers don’t provide APRs, so it is impossible to compare them with other financing.
Usury Laws
The overwhelming majority of MCA companies are based in New York and are subject to New York law, including its criminal usury statute. In New York, the criminal usury rate is capped at 25%. MCA rates, on an annual percentage rate, usually range from 40% to 750%. Any transaction over that cap could be declared invalid by a court. Other states, including Massachusetts, California, Texas, Florida and about 30 more, also have usury laws. The New York Attorney General has sued a few specific funders, arguing their deals are really loans and are therefore subject to the criminal usury statute, and the Federal Trade Commission has filed a case over the deceptive ads used to target vulnerable businesses.
Don’t hold your breath waiting for some federal regulator to step in. The MCA industry is not regulated at the federal level because MCAs are structured as commercial transactions, not loans. Instead, they are regulated by the Uniform Commercial Code (UCC) in each state rather than by banking laws. They are, though, subject to truth in advertising laws enforced by the Federal Trade Commission.
No Interest Savings from Early Repayment
Refinancing or paying off an advance early will probably not be much of a relief. With an advance you have to pay a fixed amount of fees no matter how fast you repay it. There are no interest savings from early repayment like you might get with a regular amortizing small-business loan. If you refinance you still owe the full amount of agreed-upon fees, and you may also face an early repayment penalty. A second advance to pay off the first one is how the debt cycle begins: Because of the very high costs and frequent payments, some business owners can end up needing another advance shortly after the first one. A daily payment of hundreds of dollars can strain the cash flow of many small businesses and put them at risk of default.
Is your contract a true MCA, or is it a disguised loan? Those are legal questions that determine your options. We are Delancey Street, a business debt settlement firm, not a law firm. Our senior advisors negotiate with MCA funders and other lenders on your behalf to get you settled for less than what is owed, including stacked advances, and we don’t sell you another loan. If it’s time for litigation or bankruptcy, we refer you to a vetted independent attorney, and you establish the attorney-client relationship directly with that attorney.
Merchant cash advances might sound appealing because of how quickly and easily they can be funded, but the cost, predatory practices and potential to get stuck in a debt cycle can do more harm than good to a business that’s already in trouble. If MCA payments are strangling your company, review your contract, watch out for the reconciliation clause, personal guarantee and confession of judgment and don’t jump to take another advance to cover the last one until you’ve fully explored your alternatives.
