A merchant cash advance provides a small business or startup with access to working capital. This alternative funding product is not considered a loan, but rather a purchase and sales agreement. The MCA provider advances the funds to the business in exchange for an agreed-upon percentage of its future credit card and debit card sales.
Because MCAs are not considered loans, these products are basically not regulated, and businesses have few legal protections in the event of default. By consulting with an experienced debt relief specialist, however, it may be possible to reconcile a merchant cash advance. Let’s take a look at the risks of a merchant cash advance.
Can a merchant cash advance help my business?
While an MCA gives you quick access to working capital to meet payroll, purchase supplies and equipment, or expand your business, there are a number of risks:
High Cost of Funding
Merchant cash advances are more expensive than traditional business loans. The cost of funding for an MCA is based on a factor rate, typically in the range of 1.2 to 1.5. The factor rate should not be confused with an interest rate or annual percentage rate (APR) that is the basis for traditional loan products. When the factor rate is converted into a corresponding APR, the figure could be in the triple digits.
Shorter Repayment Periods
A merchant cash advance is intended to be short-term funding, which involves daily deductions from sales over a term of 90 to 180 days. Funders often require repayment within 6 to 9 months, which is disadvantageous to a business seeking a longer repayment term.
Restrictions on Business Operations
Funders typically include provisions in an MCA agreement that restrict how the business can operate. For example, the business may be barred from (1) taking other business loans until the cash advance is repaid, (2) discouraging customers from using credit cards, or (3) offering incentives to customers who pay with cash (e.g. rebates, discounts).
Because an MCA agreement is a contract, the business owner is bound by its terms and a breach of contract may constitute an event of default. In this situation, the funder will rely on other terms of the agreement (e.g. Confession of Judgment, personal guarantee) to begin seizing the business and personal assets.
MCAs Are Not Regulated
Recently, states like California and New York have imposed stricter disclosure requirements on merchant cash advances. Moreover, the Federal Trade Commission has taken the position that MCAs fall under the purview of Section 5 of the FTC Act. Despite these initiatives, merchant cash advances are still not as strictly regulated as other consumer finance products. In the event of default, business owners have little, if any, legal protection.
Why This Matters
Despite the fact that MCAs are not regulated, the agreement should contain a reconciliation provision, which requires the funder to restructure the payment plan in case you experience a receivables shortfall. If the funder refuses to negotiate the payment term, you may have grounds for legal action based on breach of contract. If your business is at risk of defaulting on a merchant cash advance, the best way to protect your interests is to consult with the debt relief specialists at ReconcileMyMCA.com.