What Happens if I Default on a Merchant Cash Advance?

As a small business owner, sometimes you need extra business funding to keep operating smoothly. Merchant cash advances (MCAs) have become a popular source of fast business financing. Unlike typical bank loans, MCAs are typically repaid with future sales from credit card sales.

Business consultation and analysis is always free. 973-662-4141

Unfortunately, they don’t have the same benefits and protections as a traditional small business loan. The high fees and tricky contracts associated with MCAs can threaten your business and finances if you aren’t careful. If you’re in danger of defaulting on a merchant cash advance, knowing how that could impact your business is important.

Read on to find out what happens if you default on an MCA, how to avoid it, and what to do if you’re already behind on payments.

How Merchant Cash Advances Work

Merchant cash advances provide businesses with a way to obtain immediate capital by selling a portion of their future sales at a discount to the lender. This type of funding is often used by businesses that need quick access to cash and have a high volume of credit card transactions or consistent sales revenue streams. It’s important to note that MCAs are not loans; they are advances based on the business’s future sales.

Here’s how they work: A business applies for an MCA, providing the funder with sales records and other required documentation. The MCA funder then evaluates the business’s sales history and cash flow to determine eligibility and the advance amount. If approved, the business receives a lump sum payment.

Repayment of an MCA is tied to the business’s sales volume, with the lender taking a percentage of daily or weekly sales. This percentage is known as the “holdback” rate. The frequency and amount of payments can fluctuate based on the volume of the business’s sales, meaning repayment is faster during periods of high sales and slower during periods of low sales. Additionally, instead of interest rates, MCAs use factor rates to calculate the cost of the advance. Factor rates are expressed as decimal figures rather than percentages, typically ranging from 1.1 to 1.5. The factor rate determines the total amount the business must repay.

Why Merchant Cash Advances Are Different

With other types of small business debt, it’s possible to work something out before the MCA funder files a lawsuit. However, merchant cash advances work a bit differently.

Many contracts from MCA providers include what’s called a confession of judgment. When you sign a contract that includes this clause, you’re effectively signing away your rights to defend yourself if there’s a breach of contract and the funder files a lawsuit to collect.

In other words, the funder can simply file the lawsuit and get a judgment to start seizing your business assets through UCC liens or other methods to recoup its money.

In many cases, merchant cash advance companies also require a personal guarantee. If your business can’t repay the debt, you can pay it back with your personal assets. So if the funder files a lawsuit, it could also impact your personal finances, not just your business.

Here’s an Example – fill out our FREE Analyses Intake form

A restaurant needs to renovate its kitchen urgently and decides to take a merchant cash advance to cover the cost. The lender approves an advance of $50,000 for the restaurant with a factor rate of 1.3.

• Advance Received: $50,000

• Factor Rate: 1.3

• Total Repayment Amount: $50,000 * 1.3 = $65,000

The agreement specifies that the lender will take 10% of the restaurant’s daily credit card sales until the $65,000 is fully repaid. If the restaurant averages $2,000 in daily credit card sales, the daily repayment amount would be $200 (10% of daily sales), and it would take approximately 325 days to repay the advance if sales remained consistent. However, the actual duration could vary with fluctuations in the restaurant’s sales.

Merchant cash advances offer a flexible financing option for businesses, especially those with strong sales but less favorable credit profiles. However, due to their high costs compared to traditional loans, businesses should be cautious about taking on this kind of financing.

Defaulting on a Merchant Cash Advance: What Happens Next?

If a borrower misses one or more MCA payments, the borrower is considered in default on their MCA agreement. Defaulting on a merchant cash advance is usually considered a breach of contract.

If you default on a merchant cash advance, there are several potential negative consequences:

1. Heightened collection efforts: MCA providers may aggressively pursue collection efforts to recover the owed amount. This can include hiring collection agencies or taking legal action to enforce the repayment.

1. Legal action: If the MCA provider decides to take legal action and wins, they may obtain a judgment against the business (and possibly the business owner, if there was a personal guarantee).

1. Personal financial risk: Many MCA agreements include a personal guarantee. This means that the business owner could be personally liable for the debt if the business defaults.

1. Credit score impact: Defaulting can still impact the business owner’s personal credit score and the business’s creditworthiness.

1. Reputation damage: Legal battles and financial struggles can harm a business’s reputation with customers, suppliers, and potential partners.

1. Renegotiation challenges: While some MCA providers might be willing to renegotiate the terms of repayment in cases of financial difficulty, not all are flexible.

What Is an MCA Lawsuit?

When an MCA company decides to sue a customer, they must first send a court summons and complaint notice. This will explain why you’re being sued and include the deadline for responding with a formal legal pleading. The exact timeline for responding depends on where you’re located. In New York, for example, you have 20 days if it was physically handed to you. You’d have 30 days if it was sent by some other means (like U.S. mail).

Steps You Can Take to Defend Yourself

While a confession of judgment doesn’t give you many options, it’s not ironclad. In some states, you may be able to fight it if you can prove any of the following:

• The confession of judgment doesn’t comply with state law or local rules.

• The confession of judgment is inaccurate regarding parties involved and the amount owed.

• Your MCA breach of contract doesn’t meet the stipulations to trigger the confession of judgment.

• The funder was negligent in clarifying what the confession of judgment meant when you signed the contract.

Tips to Avoid Defaulting on a Merchant Cash Advance

As you can see, defaulting on an MCA can seriously affect your business and finances. Below are a few steps you can take:

Look for Ways to Cut Costs

Since MCA payments are based on your receivables, they can take a big bite out of your cash flow. One way to make some more wiggle room is by cutting costs internally. Try hiring freelancers or contractors to save money on labor, or renting expensive equipment instead of buying it.

Try to Restructure the Debt

When you’re in danger of falling behind on your MCA payments, it’s a good idea to contact the MCA company ASAP. You might be able to negotiate a short forbearance period or adjust the payments if your business income falls.

Consider Debt Consolidation

Consolidating MCA debt involves taking out an installment loan and using the proceeds to pay off the MCA. This can help you manage your payments better.

Attempt to Settle the Debt

Negotiating with the lender for a lump sum payment that is less than the total owed can be another way out. It’s advisable to work with a debt settlement attorney for this process.

Get a Business Credit Card

If MCA debt has left you with slim margins and little cash flow, a business credit card could help by covering expenses when necessary.

Hire a Debt Relief Lawyer Team for Help

Whether you’re worried about falling behind on MCA payments, defaulting, or facing a lawsuit, hiring an MCA debt settlement legal team is important. We offer a free phone consultation and analysis to discuss how we can help you resolve your MCA debt. Call us today at 973-662-4141 or fill out our FREE Analyses Intake form. There’s no obligation, and we never share or sell your information.