Merchant cash advances, while easy to acquire, often come with high repayment costs and confusing terms, leading many owners to ask: Are MCA loans legal?
Merchant cash advances (MCAs) are increasingly popular among businesses that can’t secure traditional bank loans or need a quick infusion of capital. They’re easier to qualify for than traditional loans and don’t require collateral, but the trade-off can be high repayment costs and terms that are confusing at best and dangerous at worst. Many business owners discover too late that these advances may lead to financial strain, emotional stress and the very real possibility of shutting down operations altogether.
Below, we’ll explore what happens if you default on a merchant cash advance, how to get out of a merchant cash advance the safe way and the question many owners find themselves asking: Are MCA loans legal?
Understanding Merchant Cash Advances and Their Risks
A merchant cash advance is not a loan but an advance against future credit card sales. The MCA provider gives a business a lump sum in exchange for a percentage of its daily sales–plus fees. Payments are typically made via daily or weekly ACH withdrawals until the advance is repaid. While no collateral is required, borrowers often must personally guarantee the debt, putting their personal accounts and assets at risk in case of default.
Are MCA Loans Legal?
Reputable merchant cash advance companies provide a valuable service to business owners in sticky situations. Maybe your revenue is tied up in unpaid receivables. Or perhaps you need to purchase expensive new equipment but don’t have the liquid capital to do so. Any number of circumstances beyond your control can lead you to seek a quick cash infusion. In these cases, an MCA can feel like a saving grace.
The problem is that MCA agreements operate in a legal gray area. Unlike traditional loans, they aren’t subject to usury laws that prevent price gouging. This naturally invites some bad actors into the arena. Because MCA companies use a “factor rate” instead of an interest rate to calculate the payback amount, comparing apples to apples is impossible. This means borrowers often don’t realize their cash infusion comes with what translates to a 150-300% interest rate. To give you a frame of reference, usury laws cap traditional loans at an average of 36% APR.
Adding to the confusion, merchant cash advance regulations vary by state. California, New Jersey and New York, for example, have enacted laws to address transparency and abusive practices, such as requiring confessions of judgment (COJs) in the contract. But other states don’t have the same amount of oversight, allowing disreputable merchant cash advance providers to run amok.
So, even though MCA providers are technically legal, they may still employ predatory practices like price gouging with little recourse from regulatory boards. And if a borrower defaults, these same providers often use unscrupulous and aggressive collection tactics. This is why borrowers must do their due diligence in finding a reputable company and fully understand their contracts before signing.
What Happens if You Default on a Merchant Cash Advance?
Here’s what you may have in store if you default on your advance.
- Aggressive collection efforts: As stated above, MCA providers often use aggressive tactics to recover funds, including daily calls, harassment and even outright threats.
- Legal action: Providers can obtain judgments to seize your assets or garnish your accounts, especially when a personal guarantee is involved.
- Reputation damage: MCA providers can file liens on your business and even demand payments directly from your customers, which can irreparably harm your customer relationships.
It’s not all bad news, however. You have legal rights under certain provisions, so it’s imperative that you know what these are and when it’s time to pursue them.
How to Get Out of a Merchant Cash Advance
If you’re struggling with MCA payments or facing default, here are some steps you can take:
Renegotiate Payment Terms
If the daily or weekly repayment amount begins to exceed the percentage agreed upon in the contract, you can invoke the reconciliation clause. This clause stipulates that the repayment amount can be renegotiated if the monthly revenue the original calculations were based upon decreases.
Most owners don’t know they have a right to this or realize they must ask for a reconciliation–it doesn’t happen automatically. Furthermore, many MCA providers simply refuse to honor the provision even when business owners do ask.
Example:
MCA Provider X purchases $150,000 in future undetermined revenue for $100,000. The provider might review three months’ 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. But, if the MCA company refuses to honor the provision and continues collecting the same amount, the business could actually start operating in the red.
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.
Explore Merchant Cash Advance Consolidation Companies
While this may lower your daily payments, it’s not always feasible for businesses with poor credit or limited repayment capacity. It also does nothing to decrease the amount owed; it just extends the amount of time you have to pay it back, which may or may not be sufficient to lessen the burden on your business and help keep the doors open. It’s critical that you explore the pros and cons of MCA debt consolidation before following this course of action.
Fully Resolve Your Debt with the Help of a Professional
A UCC Article 9 reorganization provides a debt relief solution for merchant cash advance default. Second Wind Consultants are experts in employing Article 9 to help thousands of businesses like yours fully resolve their debt and go on to thrive.
Article 9 allows businesses in default to reorganize without liquidating their assets. This cooperative process benefits creditors, vendors, employees and business owners by preserving operations. While personal guarantees may remain, this strategy can help businesses regain stability and negotiate settlements on outstanding debts. Business owners can retain an employment engagement with the new entity, thereby resolving their personal guaranties without bankruptcy or litigation.
While MCAs can provide quick funding, their high costs, vague terms and weak regulation make them a potentially dangerous financing option. Understanding the risks of merchant cash advance default, knowing your rights under MCA regulations, and exploring solutions like Article 9 can help you navigate these challenges. If you’re struggling with MCA debt, schedule a consultation today to explore your options for financial relief.