MCAs Are Not an Advancement of Your Business’s Best Interest

Posted on: September 25th, 2023 by

Let’s run a hypothetical:

You own a small business in town. Finances are tight, particularly this month. You’ve made two sizable bulk product deliveries for which your customers haven’t paid, your roof started leaking again after that big storm this weekend, and the mortgage payment on your storefront is almost due. There’s no way you’re going to also make payroll if you can’t borrow some cash until those big client payments roll in.

Trouble is, neither of the banks in town will approve your loan application—not even the one with your home mortgage and the vice president you’ve known since you played high school basketball together. Time is running out, and so are your options.

But maybe there IS a lifeline. You saw that commercial last night for a company that promises fast funds for small businesses, and it sounds legitimate. Don’t lenders advertising on TV have to be regulated by the government? If you could borrow $100,000, that should cover your immediate expenses for the next few weeks…and by then maybe the clients will have paid you for those two deliveries, and maybe you’ll have your regular income from daily sales at the store to pay it back in full. Besides, this lender guarantees approval based only on your credit score, which is good enough.

Those “maybes” are doing a lot of heavy lifting—and if each of them doesn’t turn into a “definitely,” you could find yourself in far deeper debt.

The ABCs of MCAs

A merchant cash advance, or MCA, is a type of business financing that is not a traditional small-business loan. The MCA provider does not loan money secured by a business’s hard assets. Instead, it purchases a portion of future receivables. Since they’re not loans, MCAs are not federally regulated.

An MCA is most like a “payday loan,” and while an MCA is geared toward businesses instead of individuals, the business owner will be personally responsible for repayment if the business defaults.

MCA companies give you an upfront sum of cash right away, and require you pledge a certain amount of your future credit/debit card sales as repayment. If your income is not in daily card sales, fixed payments can come out of your bank account. The important part to note is repayment begins right away, and there is almost no flexibility to change or delay payments if your income runs short.

There is also typically an upfront fee, often 10%, which means if you need to borrow $100,000, you will receive only $90,000. And when we say repayment begins right away, it can be as soon as the same week or even the day you receive the funds—so your in-hand amount to spend from the needed $100,000 will likely be less than $90,000.

Unlike a credit card, MCAs do not charge a fixed annual percentage rate (APR). Instead they calculate fees on a “factor”—a factor of 1.25 is not unusual, which means if all goes well and you repay in time, you will be pledging $125,000 (or more, if you find you need to borrow more than $100,000 to actually receive $100,000) of your receivables.

More pitfalls

MCAs are designed for repayment within a short period of time, often a matter of months, and there is often no savings in paying it off before the due date. The only way a small-business owner might use an MCA without trouble is if they are very desperate for immediate cash, don’t mind the high fees, AND also know they will receive a large windfall shortly after borrowing the MCA.

Even then, there are more reputable vendor financing options which Ag & Business Legal Strategies can help you find and apply for. We serve many non-farm small-business clients in addition to farmers and farm owners, and at this time are advising at least five clients who borrowed MCA funds and are in need of legal representation.

Simply stated: An MCA is a bad route to take. They are not, strictly speaking, “loans” even when MCAs companies try to frame them that way—they bear none of the hallmarks of a government-regulated loan, such as a visible interest rate, clearly stated terms and length of repayment, or reasonable grace period to begin repayments.

There is also the loss of control. Payments are structured by the MCA provider on your income, but this doesn’t take cash-flow changes into account except possibly after the fact. If your annual business income is $1.2 million, the provider will treat it as $100,000 a month—if you pledge to paying 25% of weekly receivables, it will withdraw $6,250 each week from your sales or bank account. But what if your sales ebb and flow throughout the year, or month, and right now is low-income time? That’s probably why you’re tight on cash!

On paper, you’re supposed to be able to adjust these payment amounts…in practice, it’s difficult to reach someone with the MCA company to make the change in time and convince the company to honor the letter of its agreement.

If an MCA borrower defaults, many MCA agreements include a Confession of Judgment in the paperwork package. With this, you are agreeing to let a judge order the provider to seize your assets to satisfy the balance of what you owe if you miss even a single payment; you may not even be notified of the court date until the hearing is done. On top of this, the agreement may say you consent to a 30% attorney’s fee for the MCA on top of the balance and factor fees.

Stop and think before you apply

In addition to all the above, here are some things to consider if you’re still thinking of an MCA:

  • Know your profit margin. If your business is only making a 15% profit, don’t sign away 35% of your revenues to borrow funds—you’ll be losing money on every sale. If you don’t know your margin, don’t guess—if your “gut” and reality disagree on math, reality is going to win.
  • If you cannot get a local bank loan and are trying to compare rates at online banks, make sure you are dealing with a real bank and not another type of lender. You should be able to talk with a person on the phone and ask questions such as: Are you a federally regulated bank? Where are you located? What are the interest rate and repayment terms of this loan? What collateral is my business pledging?
  • If your bank or even a credit card will loan you funds but the interest rate seems high, notice that the MCAs don’t talk about interest—that’s because their effective interest rates are astronomically higher (e.g. 75+% APR).

If an MCA is your only option for operational business cash, that’s no option at all—it’s a financial crisis warning sign! It’s a sign that you need the kind of professional help an attorney can provide. At Ag & Business Legal Strategies, we can review your debts and advise on a reputable loan, or assist with debt restructuring or closing out your business without incurring additional personal debt to you. Hope springs eternal for farmers and other small business owners, but to paraphrase Kenny Rogers, while you got to know when to hold ‘em, you especially got to know when to fold ‘em, walk, and even run away.

At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy.

Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow.

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