If you are reading this article then you are probably one of the many that have stopped paying because the payments are unaffordable and consuming all of your cash flow. Or maybe you have only missed a payment or two and are wondering what comes next. The answer is complicated because it depends on how your contract is written and which state you’re in. For most owners, though, the story starts the same way. The funder starts collecting a large chunk of your cash flow every business day, making it hard to pay staff and other bills. Eventually you reach the point where you can no longer meet the daily or weekly payments.
The Contract You Signed
To see what comes after that, start with what you signed. However, in the case of a MCA, the contract you signed does not state that you are taking a loan. Essentially, the contract states that you are entering into a purchase of a percentage of your future credit card receivables. So instead of getting a loan, your business receives a lump sum with the requirement to pay back that amount in trade for a portion of your business’ incoming revenue. The provider adds its fees and pulls payments by daily or weekly ACH withdrawals from your bank account until the full amount is paid back. No collateral is required, which is part of the appeal, but owners almost always sign a personal guarantee. If you don’t pay the MCA back, the owner will. When a business defaults, the fallout reaches your personal finances and even your home.
The cost is the other problem. Few owners have any idea what a factor rate is or how it compares to an APR, and they certainly don’t know how to calculate their cost. Because the payback period is so short, an advance can work out to an APR of 150 to 300 percent. This is far more than a small business can afford. On a regular loan, state usury laws would cap the rate at about 36 percent on average. Since it is not a loan, the provider can charge far more and not have to worry about state lending laws. Some states are starting to push back: California, New Jersey and New York are cracking down on unclear terms and pricing and on the use of confessions of judgment. If your business is located anywhere else, current state laws aren’t doing you any favors. This leaves small businesses with very few protections when it comes to their contracts.
Collection Efforts
So what actually happens if you stop paying? First come the collection efforts, and they come down hard. The provider can even go to your clients and demand that they pay the MCA provider directly instead of you, which can do real damage to your reputation with customers, suppliers and potential partners. The second step might be a lawsuit. The provider would sue you to get judgment, either against your business or the business owner personally. Once the provider wins, it can attach to your bank account or levy against your assets, putting them directly into its pocket. If there is a personal guarantee on the contract, they can go after your personal assets too.
Options Available Before You Get to That Point
If you are thinking about stopping payments on an MCA, there are options available before you get to that point. You can always look at cutting costs inside your business. Maybe you can exchange contractors for full-time employees; you might be able to renegotiate terms with your suppliers or vendors. All of that helps, but if that isn’t enough or you can’t do it fast enough then it’s not a real solution. Debt consolidation means obtaining an installment loan in order to pay off the Merchant Cash Advance. This swaps a daily high-interest payment for a monthly lower-interest payment over a longer period of time. This is usually only an option if you have good credit or less than 50% of the advance left to repay. While this may appear to be a great solution to your problems, it can create more problems. Usually trading debt for debt is a bad idea.
The better tool may already be in your contract: most, if not all, MCA agreements include a reconciliation provision, which means the provider adjusts your daily payment to reflect a percentage of your actual revenue instead of a fixed amount. So, the first step would be to look at the contract you signed to see whether there is a reconciliation provision.
Here is an example. Say a provider buys $150,000 of your future revenue for $100,000. It looks at three months of bank statements, sees that you bring in about $8,000 a day, and sets your daily payment at $800, or 10 percent, until it has collected the full $150,000. Now if the business slows down and only makes $4,000 a day, the daily payments drop to $400. That keeps the business alive through the months when revenue is down. Unfortunately, most owners don’t know they have this right, or that it is up to them to ask for it, and it is extremely common for providers to refuse even when they do. For a struggling business, that refusal can be a death knell.
If you’re finding it hard to make payments on a merchant cash advance, and your funder won’t honor the reconciliation terms or is sending collectors after you, now is the time to get help fast. You may qualify for a reorganization of your debt under UCC Article 9. It’s a cooperative process with your first position lender, and it can give you a clean new balance sheet to work from. It is an alternative to bankruptcy, and it can benefit all parties involved.
The logic is simple: if you liquidate the assets and sell them at auction, you’re done as a business. If you’re selling the assets, consider selling them into a new business you’re starting and keep the company running. The personally guaranteed debts may remain in the old entity and be lumped in with the other unsecured and vendor debts. But because the business survives, creditors can recover more through reasonable settlements than if you liquidated the assets, your vendors will keep the relationship, the employees will keep their jobs, and you’ll keep earning and be able to make good on your personal guarantees.
If you stop paying, the debt doesn’t disappear. Instead, it will result in collections, then possibly a lawsuit, a judgment, and a claim on your personal assets if you signed a guarantee. Merchant cash advances were created to give businesses fast access to cash. They need to be dealt with carefully. Understand the terms and what’s at risk before you sign anything. If you are already in trouble, don’t go silent; reach out and start asking for help early.
