A multi-billion dollar industry was created when most legitimate small business lending ended after the recession of 2008 transpired. The prime vehicle for small business lending was invented and delivered as the merchant cash advance, a high-interest loan that was not a loan, did not carry interest, and therefore has been generally unregulated for almost two decades.
While business funding in the form of "working capital" is important to small business owners, we argue that most small business owners are not aware of the dangers of taking on small business funding from so-called "direct lenders" and "brokers". These direct lenders and brokers can be highly predatory in their actions which in many cases leads to negative outcomes for the small business.
Often referred to "MCA loans," this article breaks down what merchant cash advances (MCAs) are, what they are not, and describes some of the implications for taking on such debt delivered by alternative lenders.
Thomas Tramaglini, Chief Operations Officer
Partner, Center for MCA Research
Supply and Demand: For many small business owners, an advance (MCA) is the only opportunity to secure funding for their business
For years we have attempted to describe the lack of affordable opportunities for small business owners to gain funding for their businesses.
For instance, we discussed the various affordable alternatives accessible to small enterprises.
The reality is that loans like SBA loans are quite uncommon. For example, in 2021, there were more than 32 million small businesses in the United States, yet only slightly over 12,000 SBA loans were granted in the same year. This equates to a funding rate of 0.00038% for small businesses. Essentially, this means that the likelihood of a small business receiving an SBA loan is approximately 1 in 37,000. These odds are not favorable for the average small business owner, unless you compare them to the chances of being struck by lightning (1/114,195) or dying in an airplane crash (1/205,552).
Because small businesses cannot access low-cost capital, alternative funding is the next option.
Because it is so difficult for small business owners to get a small business loan at a bank (see This Blog Post for Data), there are options that present a much easier route.
Alternative funding and specifically merchant cash advances offer things that defy what banks do not which opens the for funding:
Fast funding – Some MCA companies can fund small businesses in 90 minutes.
Most MCAs do not have UCC liens
MCAs are not usually reported on personal credit
Funds are unsecured
Payment frequency can be flexible at times
Most MCAs do not carry a personal guarantee
Easily refinance options which can cut costs
No early payback penalties
Small business owners can build a relationship with the lender ultimately securing better programing
Few required documents (including taxes) for funding
Picking your poison: The Merchant Cash Advance
For small business owners, a Merchant Cash Advance (MCA) is a convenient funding choice as it is unsecured, does not necessitate a strong credit history, typically does not require collateral, and involves minimal documentation, if any. An MCA application can often be processed within a day, usually based on a few months of business bank statements. Unlike a traditional loan, an MCA is an advancement on the business’s forthcoming receivables. Lenders determine the amount to advance by considering factors such as past credit card sales and revenue deposited into the business bank account.
To mitigate risk, lenders take into account variables like industry type, deposit frequency, and daily balances. Nevertheless, MCA lenders propose advancing a share of the small business's future sales, along with an agreement with the business owner regarding the portion of future sales sold to the lender.
MCA Loans are in no way Loans - The majority of small business owners believe that Merchant Cash Advances are loans but they are not.
Merchant Cash Advances, or MCAs, differ from traditional loans as they involve advances on future receivables that are repaid within a short timeframe. Since MCAs are not categorized as loans, they are able to bypass many of the regulations imposed on the banking and lending sectors.
According to NAV, MCAs are described as follows: “A merchant cash advance is not a loan but rather an advance based on your credit card sales. Repayment is made through a percentage of your daily credit card transactions. Approval is typically swift with minimal documentation required, although the convenience comes at the cost of higher interest rates.”
Interest and Terms
Merchant Cash Advances (MCAs) do not accrue interest. Instead, advances are subject to factor rates, also known as buy rates, which represent the portion of a small business's future sales that will be paid to the lender. Some advances may involve collecting repayment through a percentage of the business's daily credit card receipts until the agreed-upon future receivables are settled. The frequency of MCA repayments varies based on risk assessment and the business's bank account data. For example, if a borrower prefers monthly or weekly payments, the lender evaluates this based on the average daily balance in the business bank account. When daily balances fluctuate or are low, MCA lenders may mandate daily payments.
One of the main drawbacks of MCAs is their high cost. MCAs can be quite expensive, with payback rates reaching up to +50%. Additionally, most advances come with origination fees, which can amount to as much as 10% of the loan. The cost of money associated with MCAs is akin to the mechanism of credit card cash advances and, in some cases, even more expensive.
Because MCAs are not loans, few protections exist for small business owners.
Banks and lenders who provide loans to small business owners fall under governmental regulations, including reconciliation requirements. When a small business owner has difficulty paying their loan(s), the lender is required to follow protocols set by statutes which allow for small business owners to move forward in a palpable way.
Alternatively, cash advance companies do not follow such regulations and in turn only allow a few days to a couple of weeks for reconciliation. In many if not most cases, once a person/business has a hard time with their payback, the cash advance company will invoke harsh procedures such as UCC actions and lawsuits within days or a couple of weeks.
Most MCAs (if not all) come with a Personal Guarantee (PG)
One of the most important part of alternative funding, especially merchant cash advances are that most if not all providers include a clause that the owner(s) will personally guarantee payback.
According to Lending Tree, "A personal guarantee (sometimes spelled guaranty) is a provision a lender puts in a business loan agreement [or MCA] requiring owners to be personally responsible for their company’s debt in case of default. Lenders often ask for personal guarantees because they have concerns over the credit history, age or financial stability of your business. A personal guarantee can lessen a lender’s risk."
"The main danger is that if your business defaults on the business loan, you are liable for the loan. If a partner or family member co-signs, they could be impacted, too. It can also result in the following consequences:
Your personal credit declines if you can’t make the payments.
Your business credit declines if you can’t make the payments.
You could lose any collateral tied to the guarantee (e.g., equipment, home, car).
The lender can take your checking or savings balances (including retirement savings) if they were part of the collateral.
In other words, you could go under if your business goes under."
Signing away your rights: UCC
Along with personal guarantee (PG), alternative lenders can use the Uniform Commercial Code to address debt:
Lenders and MCA companies utilize UCC filings or liens to assert their rights to collateral, liens, or a secured interest. In the case of a Merchant Cash Advance, MCA companies secure your receivables as collateral through the Universal Commercial Code.
A UCC is essentially a legal document submitted to the state's Secretary of State (SOS) to declare that the lender or MCA provider holds a secured lien on the business. This enables the lender or MCA provider to take possession of and sell the collateral or funds if the small business owner defaults on their obligations.
If your business defaults on an advance or alternative loan, the "lender" will be able to freeze your bank accounts, credit card and ACH processors, payroll, vendors, client accounts receivable and more.
You do NOT want to have UCC actions going against you.
Signing away your rights: Legal
When you default on an advance (MCA) or alternative loan, most agreements have places where you give away rights or leeway in court. For instance, you may sign away your right to be served if you are sued, instead allowing service to be sent in the mail or via email. We have had many clients who receive a judgement against them and never know that they were sued. When we tell them, they said they never got an email - many of those messages are sent to SPAM folders.
The bottom line is that once you sign agreements that give away your rights, it will be an uphill battle for you legally.
Taxes and MCA – Be Careful
Small business owners should be aware that a Merchant Cash Advance (MCA) is not a loan, but rather an advance of future receivables. Despite this, many business owners mistakenly categorize MCAs as long-term liabilities on their balance sheets. It is uncommon to find MCAs not listed as such.
Given that MCAs are advances of future revenue and not loans, they should be considered as revenue rather than liabilities. For instance, if a business receives a $10K MCA, it should be recorded as a $10K revenue advance.
MCAs do not involve interest charges; instead, they entail a predetermined percentage of daily (or weekly) business sales to be repaid to the lender. Repayments should be deducted from the revenue, leading to a negative income line once the MCA is fully repaid, as the business owner has relinquished a portion of their future receivables to the lender.
You do not need to do it alone - How Beacon Client Solutions Helps You
The team at Beacon is here to help small business owners in a professional manner.
Who we work with:
Our team works with small business owners who are in default on their alternative loans or cash advances, have UCC actions against their company or personally, and those who are actively in litigation from alternative lenders.
Who we do not work with:
We do not work with people in good standing who have been paying their alternative debt requirements. If you are in an agreement with a lender or cash advance company and can pay, we recommend you continue to pay. We can help people generate plans for paying down debt, but we will not participate in interfering with commitments made by small business owners.
Defaulting on purpose is never a way to operate. Some companies may work with you, we will not.
What we do:
If you are in peril of going under, filing for bankruptcy, defaulting, or being sued, the team at Beacon Client Solutions do the following:
We will serve our clients by putting them first. We have many years of experience working with small business owners to generate solutions to problems. We will work with you every step of the way with your turnaround.
Our team of advisors, consultants, and attorneys will address the perils associated with your problems, from UCC liens to lawsuits.
We will hold bad players accountable, including brokers, bad MCA companies, their cronies, and those who want to put you and your business in a bad place.
Beacon will never scam clients by telling them they will save up to 80% on their obligations. From our experiences, some creditors will offer helpful ways to pay back your obligations, some will not. Savings are dependent on a host of factors including your behavior, payment history, the lender, and who you are working with.
References
(Rumore, 2021) https://businessdebtlawgroup.com/state-of-merchant-cash-advance-during-coronavirus-pandemic/ (Voigt & Campbell, 2017) https://www.nerdwallet.com/article/small-business/study-1-in-6-sba-small-business-administration-loans-fail
Contact Beacon Client Solutions to better understand your situation and how we can help you.
Dr. Thomas Tramaglini is the Director of Operations and Negotiation for Beacon Client Solutions, a company that supports small businesses on a host of fronts, especially MCA debt. Thomas has been a small business owner for many years, as well as held leadership positions in several organizations and companies. Thomas holds a B.A. in History, as well as Master’s and Doctorates in Organizational Leadership from Rutgers, The State University of New Jersey.
Disclaimer: Beacon Client Solutions is not an accounting firm or a law firm. We specialize in business consulting. Although we collaborate with exceptional lawyers and accountants, we are not authorized to offer legal or tax guidance. Our services are closely linked to professionals who hold the necessary legal certifications. With extensive experience in MCA resolution, Beacon Client Solutions comprehends the challenges faced by small business owners, particularly related to MCA. We cater to clients across all 50 states, Puerto Rico, Mexico, and Canada.
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