What can I do if my business can’t repay a merchant cash advance?

A merchant cash advance is where a business sells future revenue or receivables to a funder at a discount for cash up front. The funder gets their money back through a daily or weekly ACH debit from the business’s account. The amount you sold is called the Purchased Amount. The cash that you receive is called the Purchase Price.

In New York, usury at the criminal level begins at 25 percent. Most MCA funders annualized, earn far more than 25 percent on their advances. The question of legality will always be debated.

The funder has you sign a personal guarantee of your business’s performance. Therefore, a default on the agreement has consequences for the business and for you, personally.

Funders have argued that an MCA is not a loan because repayment is not absolute, they can lose everything if the business closes, fails or goes bankrupt, the contract has to have a reconciliation provision to lower payments if sales drop and an open-ended term. Only some courts agree with this argument. In a nutshell: if the funder is taking all the risk, there should be a reconciliation clause in your agreement and no definite end date.

The reason a lot of businesses choose an MCA is because they can’t wait for the vetting process. They need cash now. The vetting process at a bank can drag on. An MCA can fund you fast. That’s its appeal.

Under the law, a business can sell future revenue, invoices and receivables to a funder at a discount, and that sale is not a loan.

If there’s no loan and there’s no interest, usury can’t apply. At least that’s the theory.

An MCA is presumed to be legal, as long as the funder abides by the contract. If they breach it or treat the deal like a loan, then a court may rule it an unlawful loan. The point here is that while an MCA is afforded protection as a contract, the funder itself can behave in a way that ends up causing it to lose that protection.

Usury law can come into play when the funder behaves like it’s a loan, won’t reduce payments when sales are down, or fixes the contract’s terms.

In New York, interest on a loan above 16% is usurious. Above 25% is criminally usurious.

What New York’s Criminal Usury Law Says

What New York’s criminal usury law says

If the loan charges an annual interest rate of more than 25%, it’s void. That’s as if it doesn’t even exist. It has no legal effect.

The statute says you commit criminal usury in the second degree if you knowingly charge or receive more than 25% a year on a loan or forbearance without legal authority. Equivalent rates over other periods are also crimes. The bottom line is that the funder has to know it’s charging that rate, and an interest rate that works out to more than 25% when stretched to a year counts.

Most banks don’t offer MCAs.

There are no rules for who can be a funder, so anyone can. If you work with a funder you can’t check out, you are opening yourself to danger.

A loan has to be repaid no matter what. That’s what makes a loan a loan. That’s not the way MCAs are supposed to work. They are supposed to depend on whether the business is making money.

The Purchased Amount is the total amount that the business owes the funder.

The Purchase Price is the amount of cash that the funder actually gives the business up front.

The Factor Rate is the Purchased Amount (the total amount owed) divided by the Purchase Price (the amount paid to the business). The riskier the funder thinks the business is, the higher the rate.

The Specified Percentage is either the percentage of the revenue stream the funder bought, or, if the funder bought a fixed amount, the percentage of daily or weekly revenue it collects.

The periodic payment, what funders sometimes call the “Remittance,” is what the funder takes from your bank account each day or week by ACH.

The payment each day or week should be the Specified Percentage multiplied by the business’s revenue for the day or week. That’s the formula.

Funders can charge you an origination fee, and it’s usually taken right out of the money you receive. Sometimes it’s paid to an outside broker for the referral, sometimes the funder just keeps it to pad its return.

A broker is the middleman. They connect the borrower and the funder. They are usually paid through the origination fee that funders take out of the Purchase Price. They don’t need a license.

The ACH fee is usually taken right out of the money delivered. And the contract might call ACH non-automatic and labor intensive. This is true even though ACH actually stands for Automatic Clearing House. Go figure.

The reconciliation provision, sometimes called a true up, makes the funder refund whatever it over-collected when business slowed down.

An Adjustment, sometimes also called a Reconciliation, makes the funder lower the periodic payment during a slump to match the lower sales.

Stacking is what funders call taking several MCAs at once. MCAs are so expensive that a lot of businesses stack to keep making payments. The cost of one MCA drives the business into the next. If you default because of stacking, funders usually add a money penalty.

An event of default is something you do that puts the funder in a foul mood. Any of these moves can default your MCA: blocking the funder’s ACH, too many NSF bounces, changing or closing a business bank account without telling the funder, opening or using a new business bank account without telling the funder. These are moves you might have to make in the course of business.

The best MCA is none at all. If you’re desperate, then shop for a low cost, a solid reconciliation clause and a funder willing to work with you. If the payment doesn’t come down when business slows, you’ll be hard pressed to make it.

A funder has remedies. It can file or enforce a UCC lien on business assets including your customers without having to go to court. It can sue you in state or federal court for breach of contract and enforce the owner’s guarantee. It can do both at once.

There are three ways a funder can start a collection. One, your customers may get letters telling them to pay them, not you. Two, you may get a Summons and Complaint in the mail. Or three, you may not get papers. The funder may just freeze your bank account.

How long does a judgment last? Twenty years.

The Downsides of an MCA

The downsides of an MCA: the very high cost, the heavy fees, the short terms and the huge daily or weekly payments. An MCA alone can sink a business.

Worst of all, some MCAs are scams outright. And the industry has more than one.

• Some funders don’t lower the periodic payments when your sales go down or reconcile the account when you’re in a slump.
• The Carrot: funder dangles a bigger second advance in front of you if you pay off this one early, or bigger regular loan down the road that never materializes. It will keep you paying even if your sales dip.
• Some funders double, even triple and quadruple dip and go back more than once.
• A funder who over-collects the Purchased Amount, meaning it takes more than the Purchased Amount, is taking money it wasn’t due.
• Sometimes a funder keeps charging a monthly fee after you’ve paid the entire Purchased Amount.
• If a funder freezes your accounts or assets that aren’t even in the courts’ jurisdiction, it’s frozen out of reach.

New York’s Department of Financial Services issued its final rule under NY Commercial Financing Disclosure Law Aug 1, 2023. It covers any non-bank commercial lender or financier who extends a commercial or business financing offer up to $2.5 million. Certain providers who make a specific offer must give written disclosures in the style of Truth-in-Lending at the time of the offer.

California, Utah and Virginia have similar rules on the books.

California’s SB 1235 only applies to certain commercial financiers and MCA funders. It requires specific disclosures to merchants, much like New York’s rules.

Utah has passed rules to regulate the Merchant Cash Advance business. Lenders and brokers are regulated by the Dept of Financial Institutions. They are required to register as a Merchant Cash Advance Provider.

In Virginia, HB 1027, which took effect July 1, 2022, governs Merchant Cash Advance funders and brokers. They are required to register with the State Corporation Commission and give specific disclosures before funding. Confessions of judgment are banned.

The big funders are Amazon, Intuit, Shopify, Stripe, Square, Paypal Working Capital. OnDeck Capital, Rapid Finance, Kapitus are mid-size. National Funding, Credibly, Fundbox and Fox Funding are small.

If You Are Having Trouble Making the Payments

If you are having trouble making the payments, ask the funder for a reconciliation and an adjustment. Make it clear that the business is in trouble and give them proof if you have it.

If the business failed or shut down, or if the receivables dried up, the deal should be done. If the funder breached or committed fraud, that could excuse payment. These are not guaranties; just possible reasons for non-payment.

MCA debt can be settled, but get a lawyer who will put your interests first. If you negotiate for yourself, the funder will be dictating the terms and you will not know what to ask for. Settling on your own is a big mistake. A good lawyer knows what to ask for and isn’t taking orders from the funder.

Watch the settlement papers carefully. Most funders require you to agree they can enter judgment against you in the event you breach the settlement. Their only obligation is that a lawsuit has been filed prior to your signing. That’s it. They don’t have to give you any prior notice of default or of the judgment.

Forum shopping is when a funder files a case in a place that has friendlier rules and procedures even though it has no real tie to the place.

If the funder asks, you must provide receivables reports or invoices. If it doesn’t ask, you’re generally not required to keep sending them.

If the merchant cash advance funder has sued you, hire a competent lawyer in the state where the case was filed.

Don’t ignore it. If you don’t respond to a MCA lawsuit, the court can issue a default judgment against you and the business. And, because you signed a personal guaranty, you may be stuck with it.