Merchant Cash Advance: Sound Fast Financing or Recipe for Disaster?

by Jeremiah Foster

The merchant cash advance (MCA) is a financing option that typically ends in a death spiral for most small businesses. In fact, more than 60% of the receiverships assigned to Scottdale-based business advisory firm Resolute Commercial Services involve at least one, if not more, merchant cash advances.

That’s because once a business enters into an MCA agreement, it is nearly impossible to repay it without securing additional financing from other merchant cash advance providers.

What Is a Merchant Cash Advance?

Merchant cash advance companies provide small and medium-sized businesses with a lump sum cash advance in exchange for a portion of future credit or debit card sales.

Retail and restaurant operations that have strong credit card sales are most likely to fall prey to this type of cash-raising option.

Typically, merchant cash advance companies will recoup their advance by making daily withdrawals, of either a fixed amount or a percentage of daily sales, directly from the customer’s bank account.

What’s in a Name?

Currently, MCA companies are charging rates of up to 400% annualized interest. In many states, interest rates that exceed 20% are illegal under usury laws.

However, merchant cash advance businesses have long maintained they are not providing loans but are merely purchasing a business’s future credit card sales or future accounts receivable.

This is an important distinction, and it’s how most MCA companies are able to avoid complying with usury laws.

Beware of the Downside

Merchant cash advance companies use an obscure legal strategy called a confession of judgment to ensure they will be able to collect.

In order to receive an advance, the cash-strapped business owner is often required to sign these confessions and agrees that the business is liable for any future legal disputes, while waiving the right to action in court — before a dispute even occurs.

Effectively, the signer admits to breaching the contract with the merchant cash advance company in advance, before a breach ever takes place.

Many business owners who use MCAs are not aware that a confession of judgment is part of the application and sign unwittingly. With the confession of judgment signed, all it takes is one missed payment — or for the merchant cash advance company to allege a payment was missed — for funds to be seized from the business.

Because the MCA provider already has direct access to the business owner’s bank accounts, the merchant cash advance company can start withdrawing funds from the account without warning.

Court clerks and financial institutions have no option but to comply with the looting of the business owner’s accounts. In the wake of a breach, bank accounts are often swiftly drained of funds, and the business owners find themselves destitute.

The business owner has no recourse in this situation, having already agreed to lose any legal dispute against the MCA company.

When to Use a Merchant Cash Advance

As a general rule, it is best to avoid merchant cash advances.

However, an advance could provide an interim solution, only if guaranteed financing is on its way.

Any business owner who pursues an MCA should never agree to sign a confession of judgment and should have an attorney review all contracts before signing.

 Fighting Back against Merchant Cash Advances

If merchant cash advances are determined to be loans, then state usury laws prohibiting lenders from charging excessively high interest rates may apply to these transactions.

A recent landmark decision by the District of Montana U.S. Bankruptcy Court did just that. The ruling could severely impact the ability of merchant cash advance companies across the country to continue practices with questionable ethics.

The ruling, issued by Chief Judge Whitman L. Holt of the Eastern District of Washington in September, determined that New York-based merchant cash advance company CapCall, LLC provided a loan, rather than purchased future accounts receivable, to a struggling restaurant group known as Shoot the Moon.

Resolute pursued the case as trustee of the Shoot the Moon Liquidating Trust. CapCall is now required to return more than $2.7 million in interest, preferential payments and attorneys’ fees to the Shoot the Moon Liquidating Trust for distribution to Shoot the Moon’s creditors.

The ruling could set legal precedent for future bankruptcy proceedings involving merchant cash advance companies, resulting in larger recoveries for creditors during the bankruptcy process.

However, winning court battles in individual states is not enough. Legislative regulation of this industry is needed to ensure fair business practices that no longer prey on struggling businesses.

As president of Resolute Commercial Services, company founder Jeremiah (Jerry) Foster leads the firm’s team of industry experts in advising creditors, equity holders and enterprises as they navigate the many phases of a turnaround, restructure or crisis management plan.

Foster has been appointed as a chief revenue officer, interim chief executive officer, trustee, receiver, special master, or liquidating trustee for more than 100 different enterprises.

Did You Know: Merchant cash advance companies (MCAs) are able to charge borrowers up to 400% annualized interest by claiming they are not providing loans and are therefore not subject to usury laws. 

Speak Your Mind

In Business Dailies

Sign up for a complimentary year of In Business Dailies with a bonus Digital Subscription of In Business Magazine delivered to your inbox each month!

  • Get the day’s Top Stories
  • Relevant In-depth Articles
  • Daily Offers
  • Coming Events