When business owners are desperate for cash, it can seem like a great idea to get a MCA. Many see them as the fast and easy way to get the cash they need to cover a cash flow problem or short-term expense. Many sign up without understanding the terrible payback terms. Repayment of an MCA is not easy, and not cheap, and many business owners end up crushed by it. When you have a cash advance the problem you thought you were solving ends up eating the very thing you were hoping to save, your monthly cash flow. If that sounds like your situation, it helps to understand exactly why it is happening and where it can lead.
A merchant cash advance or MCA is technically not a loan, but it acts like one. The business takes money and has to pay it back, but it’s a commercial transaction, not a loan, and so it’s not subject to the same federal laws, like the Truth in Lending Act. The MCA company gives a business a lump sum in exchange for a slice of sales, or accounts receivable, or fixed payments out of the business bank account, plus fees. MCAs are advertised as “fast cash,” but it’s the business equivalent of a payday loan.
There’s no interest rate in an MCA, it’s all about a factor rate, usually between 1.1 and 1.5. The MCA company looks at how long you’ve been in business, how many debit and credit card transactions you do, your type of business, your revenue, your personal credit score, and if they think you’re riskier, they’ll charge you a higher factor rate. Multiply the amount you get by the factor rate, and that’s the amount you have to pay back. So if you get $100,000 at a factor rate of 1.3, you have to pay back $130,000. That extra $30,000 is paid in addition to the $100,000, and it’s paid back in a fraction of the time it would take to repay a conventional loan, and that does not include any administrative, underwriting, or other fees, which can be quite high. MCAs have some of the highest annual interest rates out there—triple digits, even, and sometimes as high as 300% or 400%.
In most states, MCA companies are not legally required to even provide an APR, a disclosure of how much over the original advance amount the business will repay, or any explanation of the legal and financial penalties of default. The contracts themselves are complicated, so it’s hard to figure out how much you’re really going to repay. Some MCA companies charge high rates and try to dodge state usury laws, which limit how much interest a company can charge on a loan. Some have taken advantage of fairly lax regulation to practice deceptive marketing and mislead businesses about how the fees and rates are calculated and how repayment will affect their business.
There is more in the fine print. Depending on how the contract reads, you may give up legal rights, like defending yourself in a dispute over the repayment. And you don’t have a lot of say in how it gets repaid. And paying off the MCA doesn’t help the business’s credit. And unlike the good old loan, you can’t save money by paying it off early: the business still has to pay all the fees it agreed to, regardless of how quickly it does.
MCA repayment terms are usually short: anywhere from three to 18 months. If the amount is repaid based on future sales, the MCA company will take a percentage from daily (or weekly) debit and credit card sales until the advance is repaid. Alternatively, it might take a fixed amount from your business account every day (or week), no matter what your sales are. If you are having cash flow trouble, this could make it difficult to meet your payroll and other business expenses, and might lead to the need for another advance to pay off the first, and you’re caught in the classic MCA trap. The money gets taken out first, leaving very little for payroll, supplies, and rent. If you have multiple advance companies, the money can get eaten away faster than it comes in. Even if you do manage to survive the MCA and pay it off, you can be left broke or with very little left over.
When You Fall Behind
The real danger comes when you fall behind: if you don’t have the money in your account (or enough sales) to cover the agreed payment, the MCA company can call the loan, and you’re on the hook for the entire balance, which they’ll take out of your account any time they can. It can even happen after one missed payment. Then there are the confession of judgment clauses that a lot of MCA companies insist on. You might have to sign one in order to get the advance, and if you do, you’re giving up the right to defend yourself in a lawsuit — which means that if you miss a payment, the MCA company could file suit and seize assets. Some MCA companies also require a personal guarantee, which gives them the ability to go after your personal assets.
If you are already behind or close to it, get out the contract and find the factor rate, the fees, and whether it has a confession of judgment or a personal guarantee. Don’t take a second advance to pay off the first one. Talk to someone who works with business debt before you miss a payment — not after. That is the work we do at Delancey Street, and the sooner you call, the more room there is to act.
