MCAs typically carry alarmingly-high interest rates. What happens if you find yourself defaulting on a Merchant Cash Advance?
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 or hire more employees.
Then things changed. The 2008 financial crisis crippled home equity nationwide and tightened lending standards. Business owners in desperate need of short-term capital began flocking to alternative sources when their banks turned them away. Merchant Cash Advances (MCAs) emerged, 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 companies are paying interest rates over 100%. So what happens if you’re one of them, and now you find yourself defaulting on a Merchant Cash Advance?
First, it’s critical to understand what an MCA is. It is not a “loan;” it’s an asset-based type of funding where the lender is purchasing your future receivables. Business asset-based financing has been around a long time. Often lenders will purchase accounts receivable (known as factoring), or they buy your equipment and lease it back to you so you can have access to some cash. The MCA is unique because the funder is purchasing a portion of your future receivables. You take the money, 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 if your business goes through a seasonal slowdown or you can’t afford the daily rate because your cash flow is inconsistent?
Here are two scenarios you might find yourself in:
- Your business cash flow is too strained to survive, and you must close up shop.
- 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 funder 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 the end of your payment obligation. They cannot report this to a credit reporting agency (since they are technically not a lender) and they have no collateral to pursue. For most of our clients with MCAs, the funder makes no effort to collect once the business closes.
But beware, you can get into trouble if you do the following before closing your doors:
- Switch bank accounts
- Interfere with the MCA’s ability to take ACH payments
- Change merchant services processing companies
- Take cash or other types of payments to reduce revenue to your bank account
In the above scenarios, the MCA can accuse you of breaching your agreement and can try to pursue legal recourse. As long as you avoid these actions and wind up your business affairs in a clean manner, there’s nothing to worry about. If you need help in determining the best way to exit and close your company, Second Wind can offer you guidance.
Scenario 2 is a bit trickier. Let’s say, hypothetically, that business has slowed and you’ve obtained a $60,000 MCA to help fund operations. You’ve spent the funds to hire staff, advertise and buy inventory, but sales have not recovered. Now the payments of $6,500 per month have gotten too difficult to sustain, you are no longer taking a salary and you are racking up debts with your vendors. What can you do?
First, call your MCA funder and see if you can work out a modification or deferment. Make sure you have thoroughly analyzed your business debt situation, and you have created a detailed business debt schedule.
If you have made these efforts and still can’t pay, you have no choice but to stop the automatic withdrawals. As you now know, this action is a breach of the contract, and it exposes you, but it’s better than any other alternative you have. The MCA company has limited rights and no collateral. In most cases, these accounts can then get settled for a fraction of what is owed, even if the business remains open. Second Wind has had great success settling clients’ MCA debts for pennies on the dollar.
Make no mistake; this process isn’t easy and defaulting is a scary prospect. The collection calls and harassment from the MCA can be challenging to deal with, especially when you need to focus on rebuilding your company. Don’t go through it alone. Second Wind Consultants are experts at resolving these situations, and we can provide the peace of mind and successful resolution you seek.