Welcome to Delancey Street. This article is about why an MCA funder might accept less than the full balance. If you owe a lender a substantial sum of money, say $200,000, and they take $100,000, it can feel like they made a mistake and you made off like a bandit. Unfortunately, that’s probably not the case. Settlement is not a charity, and it’s definitely not weakness on the part of the MCA lender. It’s a math equation they did.
At Delancey Street, we work on business debt every day, and we have noticed a consistent pattern. Funders settle when the discounted, risk-adjusted value of a lump sum payment beats the value of chasing the full amount that’s owed to them. Understanding that math is what lets a business owner negotiate from something other than fear. Our goal here is to help you get a successful outcome when you are in debt to an MCA funder and unable to keep up with those payments.
The balance is a claim, not money
Start with what a balance actually is. Now, it’s important to understand that the balance is a claim, not actual cash on hand that they can actually recover. When you took the MCA, it was an agreement for a purchase of your future receivables. The funder paid you a lump sum today and bought the right to a slice of your future revenue until a fixed dollar amount was delivered to them. That amount is known as the purchase amount or the right to receive. When you stop paying that amount, the unpaid portion becomes an unsecured claim against your business, and it’s usually secured by a UCC filing and a personal guarantee from you.
Now, a claim is not money. It is a right to try to get money from you. The gap between those two variables is where every settlement is derived from.
The funder’s internal team is asking themselves a question: How much are we going to actually be able to get from this borrower? They also ask questions like, what will it take to actually collect this money? How long will it take? And what will it cost to get us there?
What it costs to collect the full amount
Let’s run the numbers the way a collections team at the MCA lender is running them. Suppose the balance is $200,000. To collect it, they need to file a lawsuit, because easy tools are gone once you have no cash flow to recover from. Now, litigation will cost money: filing fees, attorney time, and of course staff hours. Any contested commercial litigation case can take months, if not years. Even after they get a judgment, enforcement is its own project. You need to get restraining notices, you need to file subpoenas, you need to involve sheriffs, and probably a lot more.
Risks the funder is taking
Now, let’s talk about the risks.
- Meanwhile, your business could close.
- Other funders that are ahead of them via the UCC filings may have stronger claims.
- In addition, you, the personal guarantor, may have no actual assets they can reach.
- Another thing to consider is whether you have defenses that have teeth with them.
Each risk is a probability haircut on that $200,000 that they’re trying to recover.
The value of a dollar collected today
In addition, money also has a value. A dollar that they collect in 18 months is worth less than a dollar collected today, and it’s worth much less to a funder whose entire business model depends on constantly deploying capital into new deals. Funders earn money by cycling their money, not by holding paper for long periods of time.
Remember, these funders are making 100 to 200% APR. So even if they take a 40% haircut on your money today, they can lend it back out on the streets for 200. 250% APR, no problem. Dead receivables sitting on the books are failing to earn the money, and in addition, it’s occupying capital that could be funding a new advance at a higher factor rate.
The internal math looks something like this. Say they get 70,000 today on 180,000. That’s better than possibly getting nothing in a year and a half while still having legal costs, enforcement costs, and so forth. Once you write out all of the risks that the funder is taking, the discount isn’t so generous anymore.
Legal risk is real leverage
Now, the second thing that MCA lenders are looking at nowadays is whether these MCA contracts are actually bulletproof. Legal risk is now real leverage that you have as a borrower. Courts have spent years asking whether these agreements are true purchases of receivables or actually loans in disguise. If they are loans, then state usury laws can apply, and in New York, a criminally usurious loan can be void.
The reconciliation provision
Courts have looked strongly at these MCA contracts, specifically at the reconciliation provision and whether MCA lenders are actually adhering to it. Now, remember, they bought a percent of your future receivables. The issue is if your revenue goes down, that percent is supposed to float and go down as well. Many MCA lenders are infamous for refusing to adhere to that reconciliation clause. If you ask for it, they might even say that you are now in default of the contract, which is not actually correct.
Finite term and non-recourse funding
Another factor that courts have been looking at is whether there’s a finite term on the MCA. Remember, this is supposed to be a percent of your receivables, and if your receivables go down, then the length is supposed to increase in order to make up for that stretching of the MCA.
Another thing that you may often hear is that MCAs are meant to be non-recourse sources of funding, which means that if your business goes out of commission and is no longer operating, then the MCA lender is taking all the risk. Now, the issue is, if the funder is truly bearing the risk, then the receivables never materialize, it is a purchase. But if you are personally guaranteeing it, then it’s not really a purchase of future receivables, it is a loan.
That test matters because contract language varies from one MCA lender to the next. But if your reconciliation clause says that the funder may, in its sole discretion, adjust payments, it’s very different from one that says the funder shall adjust upon documented request. Federal courts in New York have let claims proceed on the theory that an MCA agreement was essentially a void loan. Now, that’s not a guarantee that the contract you signed will fail when tested by courts, but it’s a documented risk that a funder has to price if they do try to collect the full amount from you.
Regulators have added pressure
In addition, regulators have added pressure. For example, the FTC recently settled with Yellowstone Capital for over $9 million due to unauthorized withdrawals and misrepresented funding amounts, and consequently sent refund checks to thousands of small businesses. In addition, New York now requires standardized disclosures, including an estimated APR on sales-based financing offers under a set threshold.
Now, none of that erases your debt. But if you signed a messy contract, it means the funder has incentive to close this quietly rather than litigate it publicly, because now that can be used as part of a criminal investigation against them.
Collection tools have gotten weaker
In addition, collection tools have gotten weaker. For years, the industry ran on confession of judgments. You signed one when you took the funding, and then the funder would file it in a New York County Clerk’s office when you defaulted, and a judgment would exist before you even knew there was a case. That single change now, where New York in 2019 banned it against out-of-state debtors, has changed the economics of it.
Funders used to be able to convert a default into a judgment in days, but now they have to file a real lawsuit, serve you, and actually have a strategy, legally speaking. While contracts still push for New York forum selection and expedited procedures, confessions only remain available to them against in-state borrowers under much stricter rules.
What that really means for you is slower collection means a higher discount rate applied to the balance, which means a bigger settlement discount.
Bankruptcy is the least favorable outcome for them
Another thing that lenders are going to be wary of is the fact that you can file bankruptcy, and it’s the least favorable outcome for them. In bankruptcy, an unsecured MCA claim often gets very little, and courts may attempt to recharacterize the agreement as a loan when examining factors we spoke about previously.
For example, subchapter 5 of chapter 11 is a streamlined small business path to get out of debt. Its debt limit is approximately $3 million, and though eligibility depends on your total debt, it is a viable way out of MCA debt. Now, you should never bluff a filing you would not make, but if your business numbers genuinely point towards you having an insolvent business. Then it is worth bringing up.
What actually moves the numbers in your favor
Now, what actually moves the numbers towards a possible settlement in your favor? Typically speaking, facts drive outcomes more than tonality.
- For example, if your deposit history and current revenue are downtrending, then funders are more likely to settle because they see the writing on the wall.
- If you have multiple stacked advances, then a fourth position lender will know that they have a least likely chance to collect versus a first position lender.
- In addition, the strength of the contract language matters as well. If there are legal issues in how the contract was drafted, or if the lender refused to honor the reconciliation clause, this could provide incentive for them to settle for less.
Trade-offs and costs of settling
Now, it’s worth mentioning that there are trade-offs for settling. Settling does come with costs. For example, one of the first things you have to be in is a position of default when attempting to settle.
- Typically, though, that does come with UCC liens, merchant processor holds, damaged relationships with your lender, and lawsuits filed before any deal closes.
- In addition, forgiven debt can create taxable cancellation of income.
- In addition, your personal guarantee may survive unless the release you sign covers you by name.
- In addition to all of this, most lenders will have anti-stacking and cross-default clauses which can trigger if you do default.
This is why before you default, it’s important to know exactly what it is you have signed up for and to have eyes wide open going into this process.
Invoking a written reconciliation right
The first thing we typically recommend is invoking a written reconciliation right with real bank records, processor statements, and so forth. Because this is a contract remedy rather than a breach. It doesn’t always work, and funders will try to resist it. But it makes it so that if the funder refuses to honor it, they are in default of the agreement, not you.
Money in hand today
Where does this all leave you? Funders may take less because it is better to get money in hand today than try to speculate on the potential value of a claim one to two years out when they may get cash back. They’re in the business of redeploying cash as quickly as possible, and any cash you give them is better than no cash at all. Your job is to make the speculative side that they could collect the full amount look unattractive based on real financials and real defenses from your actual contract.
If you are struggling with business debt, we encourage you to reach out to us today to get a risk-free consultation so we can show you your different pathways.
