When the business is good you get rich. When it’s not so good, you get debt and crisis. So the last several years have seen a rise in the merchant cash advance, or MCA, as a way to secure a quick infusion of cash for a business. But an MCA can land a business deep in trouble. If you’re reading this, chances are your business, or someone you know, is in an MCA debt trap.
A merchant cash advance, or MCA, is a funding method that allows a business to get a lump sum of capital upfront in return for a percentage of the business’s daily credit card sales. There is no collateral required. MCAs have no interest; instead, they are paid for with a factor rate. Factor rates typically range from 1.1 to 1.5, and the dollar amount of the advance is multiplied by the factor rate. The total is divided in equal portions across the payments. That’s the opposite of a bank loan, in which the interest rate (expressed as an annual percentage rate, or APR) is paid off over the term of the loan. Interest rates are applied to the declining principal balance. Bank loans are generally repaid monthly over a period of three to five years. MCAs are paid back daily or weekly via automatic withdrawal through the merchant credit card processor. Typically, MCAs are repaid over a period of 90 to 180 days. An MCA is approved based on the business’s revenue and length of time in business. To apply, you need to provide bank statements and tax returns online, and funds are released within 24 to 48 hours.
For a cash-strapped owner, the MCA could be the answer to his or her prayers. Quick and easy access to capital. Easy funding. No collateral. Easy to get approved. All of which is convenient for the business owner, but there’s more to it than that. MCAs, often taken on impulsively or under duress, come with strings attached. It’s hard to say “no” to a quick infusion of cash, especially if you are in debt, or you are struggling to meet payroll and other bills.
Here’s the thing, though: what’s most common is that the owner was denied a loan from a bank, and isn’t able to get one. And why not? Often it’s because they already have too much debt. Lending to a business that is barely keeping its head above water can fairly be called predatory. So, they turn to a merchant cash advance. They feel better when they learn they don’t have to put up any collateral. It seems great. But, buried in that complex contract, is a personal guarantee, in which they promise to make the exact same payment every day or week, whatever percentage of sales is stated in the contract. In other words, they are on the hook for the same dollar amount every single day, even if they didn’t earn that much that day.
Owners are used to thinking in APR. So a 1.4 factor rate sounds like a 40% APR, right? Nope. The actual APR is much, much higher. Why? Because the MCA fee is fixed up front based on the original advance amount. It doesn’t go down as the MCA gets paid off. And it’s paid over a very short period of time. The math is complicated, or at least obfuscated. In fact, MCA debt isn’t considered a loan, so MCAs aren’t subject to regulation, and there’s no reason to think MCA providers are going to change their practices anytime soon.
Struggling to Keep up with the Daily Payments
So what happens when a business is struggling to keep up with the daily payments? Instead of paying down the advance, they may go back and get another advance to cover the first. MCA companies are extremely liberal when it comes to approving advances. They are reluctant to deny anyone. As a result, owners are stacking—i.e., taking out multiple MCA advances at a time—in order to get back on their feet. Some businesses that are stacking explore MCA consolidation. It’s only a little better than stacking.
But the worst part comes later. The negative aspect of an MCA is how aggressive funders can be, after a default. It’s very worrisome to hear one story after another, of funders being vindictive, suing, putting the merchant at risk of going out of business, etc. We’re hearing things like phone calls to the owner that verge on threats. Then come the 406 lien notices, which allow the funder to freeze the business owner’s business and personal bank accounts. The funder can also freeze the owner’s card processing accounts like Stripe, Square or Shopify. Additionally, the funder can contact the business’s customers directly and request that money that’s owed to the business be paid to the funder instead. This can cripple a business and permanently ruin the trust between the owner and customers. Many merchants don’t have any room for error, because they are operating on the edge. A funder can jeopardize everything in an instant, by hitting where it hurts most: in the cash flow.
Debt Settlement
So why not just settle? Most settlement companies still operate according to the model that worked a decade ago. That was a time before the MCA industry had really emerged. In that era, the basic idea of debt settlement was to build up funds in an escrow account and then send “lump sum” offers to the creditors to receive a discounted payoff. It worked. It works for unsecured debt, like credit cards, vendor debt, equipment leases, etc. but not for MCA’s. Here’s why: MCA funders’ aggressive collections put the MCA to the head of the line. All the other debts stop, but the MCA carries on with the attacks while you’re building your reserve. The damage done by the time you build enough cash might be too much for the business to recover from.
Picture it: you stop paying. And the funder comes after you. Hard. Months later, you finally have enough to make a lump sum offer. But by then, you might have already been sued. You might have already lost your bank accounts, and your card processing. Or you might already be out of business. It never gets to that “lump sum” stage.
Remember, the time to take control of an impending MCA crisis is before you get to the point where you can’t keep up with the payments. If you’re already on the road to catastrophic failure, then you need to understand all the options and don’t waste time on low-probability strategies. The bottom line: have a real plan. Demand a strategy from a settlement company that incorporates the realities of MCA collection efforts and the realistic impact of those on your business.
