An Open Advance Can Turn a Lender’s Yes into a No
At Delancey Street we negotiate merchant cash advance debt for business owners, and if a bank has turned you down because of an open MCA, the best place to start is to take a step back and think like the bank does. Merchant cash advances may be a vital source of liquidity to small businesses that cannot access traditional financing. However, MCAs create challenges for banks and lenders underwriting deals involving a business with an MCA, because the MCA remains off the balance sheet. Here are seven reasons an open advance can turn a lender’s yes into a no.
The first is that the advance was never mentioned. Lenders know that merchants often withhold the new MCA debt from the bank or lender. Sometimes they reveal it later, but other times the MCA stays hidden until someone discovers it in due diligence. It is hard to quantify the lack of trust felt by an underwriter. From the lender’s side, the thinking can go: we now know the owner is not truthful and things are much worse than we thought.
The second reason is what those debits do to your cash flow. When an underwriter does her cash flow analysis, she cannot ignore that money is flowing out of your account to pay the advance. Your new loan should improve your cash flow, not make it worse, and that is not possible if your cash flow is already tight, and you have to keep making the payments on the open MCA. Lenders check bank statements regularly for sudden drops in deposits, which could be caused by merchant cash advances. The underwriter might wonder about your ability to weather a period of slower sales, or if your projections for future sales are realistic.
The third reason is cost. Many merchant cash advance agreements, when converted to an APR, show an interest rate of more than 100%. Some disclosures for MCAs show interest rates that are as high as 922%. A lender who sees that on your statements will have some obvious questions. The underwriter may not like that you have shown a willingness to accept extremely expensive financing that harms your cash flow. The bank underwriter may also wonder how you expect to afford your new payments if you are struggling to make those advances.
The fourth reason is the lien. Lenders run regular checks on any UCC-1 liens filed against a business’s assets. Sometimes an MCA company files a UCC-1 anonymously. But once the lien is in the merchant’s file, a lender can figure out it belongs to an MCA company. For a bank that expects to be first in line, that filing can be a deal breaker. Some MCA companies market themselves as willing to take second, third, or even fourth position behind other lenders. To an underwriter, a rival lien raises the possibility that the owner will seek additional MCAs and further muddy the priority picture.
The fifth reason is stacking. Lenders call it ”stacking” when a merchant layers multiple MCAs one on top of another. This can be a fast track to insolvency, with the borrower “falling down a rabbit hole.” One industry veteran has described clients with as many as 16 advances open at once, totaling $8 to $9 million. When a lender sees several open advances on one file, it is worried about a domino effect. No lender wants to provide a loan just to become the last one in line. The pattern creates the impression that the business will have a hard time breaking the cycle of needing more advances.
The sixth reason is what a funder can do when payments slip. When an MCA company decides to take action, they may sweep the business bank account, send a lien notice that freezes the merchant’s lockbox, or levy the account on a confession of judgment. Lenders also look out for levy notices or judgments filed by MCA companies. That matters, because any one of those techniques makes it hard for you to repay a loan. Underwriters generally do not want to take that risk. Even the hint of this, much less an active situation, is a serious red flag for a bank. There are quality MCA providers out there. There are also bad actors. One of the primary differences between a legitimate funder and a predatory lender is the way they react to a merchant’s request for relief. Good funders will adjust payment terms in the case of a temporary setback, while predatory lenders will refuse any modification and add legal fees to the bill. A lender has no way of knowing in advance which kind it will face.
The seventh reason is what the advance says about the business. The typical use of a merchant cash advance is to meet an obligation, either expected or unexpected, when the merchant does not have the necessary cash flow to do so. Merchant cash advances are intended to provide a short-term solution for these situations. To a lender, the fact that you have an open advance means there was a problem that was at least severe enough for you to use one. Does it mean there is still a problem? That you will need to seek more? The underwriter may be justifiably concerned that the borrower will need another advance in the very near future.
Talking to Your Funders Early
So what can you do? Start by talking to your funders early, before you default. In the experience of one industry veteran, MCA companies don’t expect to receive 100% of the contract. They would much rather hear from a merchant who says “Cash is tight but I want to continue paying you,” rather than not hearing from a merchant at all. When the merchant comes to them before default, they can usually accommodate by adjusting payment terms over 30-day cycles. However, some companies refuse to negotiate and demand repayment in full plus extra fees. Doing nothing is the wrong thing to do. In some cases the MCAs can be settled for less than the amount due, and if you think about your business as an investor does, reducing liabilities reduces risk.
The Stacking Trap
And before you take another advance to cover the ones you already have, be sure you fully understand the math — in simple terms. Many small business owners could avoid the stacking trap by seeking cheaper financing options first, even if it meant waiting a week. If you are already stacked, there is another route. Debt settlement firms negotiate with MCA funders and lenders for less than what is owed. However, they do not offer another loan. That is the work we do at Delancey Street. The first consultation is free and confidential. If a cheaper option exists, we will say so on the first call.
