Merchant cash advances: How to avoid default
How to avoid default on a merchant cash advance
- Read carefully before signing a Confession of Judgment to modify your cash advance agreement.
- If possible, find alternative financing through another MCA, an online loan or a traditional bank loan.
- Debt-consolidation companies may be able to restructure payment plans and help your business avoid bankruptcy.
Failing to repay a loan can have serious consequences, including property repossessions or wage garnishments. Business owners who have obtained a merchant cash advance, or MCA, face their own consequences if they default.
First, understand that MCAs are not loans — they are commercial transactions based on a business’s future revenue. MCA lenders do not report to credit bureaus, meaning a good repayment history cannot positively impact your personal or business credit scores. And MCAs are unsecured transactions, so lenders cannot seize property or other collateral as a means of recourse.
This does not mean MCAs are consequence-free transactions. Default rates are generally much higher for these transactions than for nonbank loans, with industry estimates ranging from 5 percent to 15 percent.
Here are some options for what you can do if default on your MCA has happened or seems imminent:
Adjust the payment
Some MCAs use a holdback percentage, whereby a percentage of your credit and debit card sales go to the lender. Because it’s a percentage-based payment, it typically fluctuates. If your business brings in more revenue, you pay more, but if you bring in less, you pay less.
However, most cash advances today are structured through an Automated Clearing House, and are repaid in fixed amounts taken directly from a business owner’s bank account. If the daily or weekly repayment burdens of an MCA are pushing your business expenses too high, it’s possible to receive modifications by contacting your lender.
Be aware that a lender may agree to lower your payment or extend your repayment period if you sign a Confession of Judgment. This is a risky agreement for a borrower because it essentially states an admission of fault. The lender can seek recourse without filing a lawsuit and may receive a court judgment without notifying the borrower. They can then use this judgment to garnish wages and other sources of income.
Find alternate funds
MCAs use a factor rate, rather than an annual percentage rate (APR) to calculate the cost of borrowing, including interest and fees. A factor rate may be a bit confusing, but it’s not uncommon for a cash advance to have an equivalent APR of 100 percent or higher. If you have a high-cost cash advance that you can’t keep pace with, it may be tempting to pay off the balance using a second MCA with a more favorable rate.
This can be a successful strategy if you avoid the cycle of loan stacking. In these circumstances, a borrower has two or more cash advances on their books. Because MCAs are public records available through each state’s Uniform Commercial Code (UCC), some loan providers solicit business owners with existing debt and attempt to “stack” more on top. It’s advisable to take out a second MCA only if the proceeds completely pay off the balance of a first-position MCA. Also, watch out for the practice of “double dipping,” in which a lender essentially charges interest twice, diminishing the effectiveness of a new cash advance.
Other alternate funding sources may include an online loan or traditional bank loan. Online business loans usually have better repayment terms and rates. Many lenders have APRs ranging between 10 and 25 percent. Bank loans often have the best terms and rates, but they can be difficult to qualify for. Many business owners turned to a cash advance because they were ineligible for a bank loan.
Get legal help
If your business is drowning in debt due to an MCA and associated late fees or collection costs, there are companies that specialize in business-debt consolidation and refinancing, helping the entrepreneur avoid bankruptcy or a lawsuit. These companies may be able to renegotiate cash-advance repayments to make them affordable.
Bankruptcy proceedings may be a last-ditch way to find debt relief. Sole proprietors may file for Chapter 7 bankruptcy, allowing them to discharge personal and business-related debts while keeping the business open. However, businesses that are jointly operated or have employees may not wipe out their debt obligations through Chapter 7. These businesses must be shut down and their assets sold. Business owners can avoid personal liability through this process, however.