Merchant cash advances (MCAs) have become a popular financing option for businesses that, due to a variety of reasons, don’t qualify for a traditional bank loan. Because they don’t require collateral, an MCA can seem like an enticing option to acquire cash quickly. But as with anything that seems too good to be true, business owners should proceed cautiously. The terms, fees and regulatory compliance of MCAs raise numerous questions and lead many business owners to ask: Are MCAs legal?
Here is everything you need to know about MCA regulations, what happens if you default on a merchant cash advance, and how to get out of an MCA safely.
What is a Merchant Cash Advance
An MCA is not technically a loan. Instead, it is an advance based on a business’s future credit card sales. Typically, an MCA provider advances a sum of money to a business in exchange for a percentage of future credit card sales, plus fees. The company agrees to pay back the advance via daily or weekly ACH withdrawals from their bank accounts until the full amount is paid back.
Although no collateral is required for these types of advances, business owners must usually personally guarantee the repayment. This means if your business can’t repay the debt, you will pay it back with your personal assets. So, if you default, the fallout will impact not only your business but also your personal finances and even your home.
Are MCA Loans Legal?
MCAs are widely utilized, but they are not subject to the same usury laws as regular loans. Usury laws exist to protect borrowers from paying exorbitant interest rates, which are reflected in the APR. These laws vary from state to state, but the average interest rate cap is about 36%.
Merchant cash advances use something called a factor rate to determine what fees will be added to the amount of capital borrowed. Few consumers have any idea what a factor rate is or how it compares to an APR, making it virtually impossible to compare apples to apples when researching loan providers. Because of the short-term nature of the payback period and the confusing math, business owners are often completely unaware they’ve just agreed to an MCA with a factor rate that translates to 150-300% APR!
Given that MCA regulations differ depending on where the MCA provider is located and because they are not subject to usury laws, the industry is a bit like the Wild West. Good MCA companies provide a much-needed service to cash-strapped businesses. However, disreputable MCA providers can cause damage that may lead a company to close its doors.
Some states are starting to enforce MCA regulations on their own. In California, New Jersey and New York, policies are cracking down on things like lack of transparency in terms, pricing and the use of confessions of judgment (COJs). But if you’re not located in those states, you’ll have to fend for yourself.
If you have taken out a merchant cash advance, there’s a very real possibility that you are paying an interest rate far in excess of your state’s interest rate cap. And it’s always important to remember that just because an MCA may technically be legal, that doesn’t mean the lenders aren’t engaging in predatory or illegal practices.
What Happens if You Default on a Merchant Cash Advance?
There are several methods you can try to avoid defaulting on your merchant cash advance in the first place. You can cut costs internally, swap contractors for full-time employees or renegotiate terms with vendors and suppliers.
If none of these methods proves effective, you might think it’s wise to consolidate the debt, which involves taking out an installment loan and using the proceeds to pay off the MCA. This has the potential to swap your daily, high-interest payment for a monthly, lower-interest payment over a much longer time period. However, this option is generally only available to people with good credit or those with less than 50% of their advance left to repay. More often than not, trading debt for debt is a bad idea.
If your MCA debt has become unsupportable, you may invoke the reconciliation provision written into most, if not all, MCA contracts. Reconciliation means the provider will adjust the daily payments to reflect a percentage of revenue instead of the fixed daily payment amount—which protects the business during months with depressed revenue.
Here’s an example of what that looks like:
MCA Provider X purchases $150,000 in future undetermined revenue for $100,000. The provider might review three months’ worth of bank statements and determine that, on average, the business brings in $8,000 a day, and a daily repayment of $800 (or 10%) will suffice until they have collected the full $150,000.
If the borrower’s revenue drops, it would logically become necessary to recalculate their 10% based on the reduced revenue. If the company is now bringing in an average $4000 a day, the daily repayment should drop to $400.
Unfortunately, most owners don’t know they have a right to this or that the onus falls on them to request it. Also, it’s extremely common for MCA providers to refuse to do it, even if you do request it. This can be a death knell for a struggling business.
If you find yourself in default, several things may happen:
Increased Collection Efforts
MCA providers will likely pursue collection efforts to recover the owed amount, which can often become quite aggressive.
Legal Action
If the MCA provider pursues legal action and wins, they can obtain a judgment against your business–and yourself if there was a personal guarantee–leading to bank account levies or asset seizure.
Reputation Damage
Your business’s reputation with customers, suppliers and potential partners may be negatively impacted, especially since your MCA provider can go to your clients directly and demand that they pay them instead of you.
What Are Your Legal Rights if You Default on a Merchant Cash Advance?
Because things can turn dire quickly, you should ask for help immediately if you can’t make your payments on time, especially if MCA lenders or their collectors refuse to honor the reconciliation terms or if they begin harassing you. Here are your rights if you are in merchant cash advance default.
You may qualify for and be entitled to a UCC Article 9 “reorganization.”
An Article 9 is a cooperative process with your first-position lender (to whom you are in default because of the MCA) that yields a clean new balance sheet. Business debt relief under UCC Article 9 can be understood as an alternative to bankruptcy that benefits all parties involved.
In short, with consent from the business owner, the bank can elect not to liquidate at auction (always a bleak prospect) and instead “sell” the assets into a new operating entity. In the process, all other debt is removed from the business operation, and only the business assets and operations are transferred to the new entity.
When assets are liquidated at auction, the business is ended, but when they are sold into a new operating entity, the business is preserved. Personally guaranteed debts may still remain in the old operating entity, along with other unsecured debts, vendor debts, etc.
However, by preserving the guarantor’s business and their ability to earn from it, creditors can recover more through reasonable settlements than they would if the business were liquidated, and vendors can preserve their relationships with the business. Best yet, employees of the previously insolvent business get to keep their jobs, and the business operator can continue to earn in order to make good on their personal guarantees. In short, an Article 9 reorganization is the only solution that provides wins for all parties involved.
So, while MCAs can provide swift access to capital, businesses should approach them cautiously, ensuring a comprehensive understanding of the terms and potential legal implications before signing on the dotted line.
If you are in default on a merchant cash advance, a debt relief strategy might be the solution you need. If you’re interested in learning more about whether Article 9 debt relief is right for your business, schedule your complimentary consultation today.
