In the years leading up to the 2008 financial crisis, small business owners had a consistent source of short term capital, their home equity. Rapidly rising house prices allowed them to borrow against their homes and put the money into their company to buy more inventory, fulfill a purchase order, hire more employees etc.
Then things changed. The 2008 financial crisis crippled home equity nationwide and tightened lending standards. Business owners in desperate need of short term capital were flocking to unconventional sources when their banks turned them away. They turned to Merchant Cash advance loans (“MCA”) which filled a funding gap for many small business owners all across the country. The rapid credit expansion in this sector is now a billion dollar industry, and hundreds of thousands of business owners are carrying debts owed to these lenders. In many cases, these businesses are paying interest rates over 100%. With these types of crazy interest rates, what happens if you find yourself defaulting on a merchant cash advance loan?
First, one must understand what these merchant cash advance loans actually are. They are not “loans” they are an asset based type of funding where the lender is actually purchasing your future receivables. Business asset based financing has been around a long time. Often lenders will purchase accounts receivable (factoring) or they buy your equipment and lease it back to you so you can have access to some cash. The MCA Loan is an interesting product where the funder is purchasing a portion of your future receivables. You take the cash and over the next 4-18 months, you repay the funder a daily or weekly amount equal to a percentage of your sales.
So what happens when your business goes through a seasonal slowdown or if you cannot afford the weekly rate because your cash flow is inconsistent?
Here are three scenarios you might find yourself in:
- Your business cash flow is too strained to survive and you must close the business.
- Your business is worth saving, but the payments to your MCA are too high to sustain.
In scenario 1, you should go ahead and close your business. In most cases the MCA will have no means of collecting on you. They purchased your ongoing receivables, but since you went out of business and have no further cash flow, that’s also the end of their payments. They cannot report this to a credit reporting agency (since they are technically NOT a lender) and they will have no collateral to pursue. For the most part, we have seen many clients who have taken on MCA loans where the funder makes no efforts to collect once the business is closed.
But beware, you can get in some trouble if you do the following before closing up shop:
- Switch bank accounts
- interfere with the MCA’s ability to take ACH payments
- switch merchant services processing companies
- taking cash or other payment terms in order to reduce revenue to your bank account
In the above scenarios, the MCA could accuse you of breaching your agreement and they could try and pursue you. Just wind up your business affairs in a clean manner and don’t be worried. If you need help in determining the best way to exit and close your company, get some guidance.
Scenario 2, is a bit more tricky. Let’s say this is the situation you find yourself in:
- Business has slowed, you borrow $60,000 in a MCA loan to help fund operations
- You spend the funds to hire staff and advertise and buy inventory, but sales have not recovered
- Payments of $6,500 per month are getting too difficult, you are no longer taking pay and you are racking up debts with vendors
First, try and call your MCA and work out a modification or deferment if the payments are getting too tough. Make sure you have thoroughly analyzed your business debt situation and you know how to create a detailed business debt schedule.
If you have made these efforts and you truly cannot pay, then you really have no choice but to stop the auto withdrawals. As you now know, it is a breach of the contract and it exposes you, but this is better than any other alternative you have right? The MCA still has limited right and limited collateral. In most cases, these accounts can then be settled for a fraction of what is owed, even if the business remains open. We have had great success getting these accounts settled for pennies on the dollar.
I will not say that this is easy and you will likely be full of fear when defaulting, so don’t go through it alone. Hire an expert and we will handle this for you. The collection calls and harassment will be bad enough from the MCAs and you need to stay focused on rebuilding your company. Give us a call and we can set you up for a free consultation where we will give you an honest assessment of your business debt situation.