What Happens if I Default on a Merchant Cash Advance?

So you took out a merchant cash advance to help your business through a rough patch – but now you’re struggling to make the daily or weekly payments. What happens if you can’t pay back your MCA and end up defaulting?

First, don’t panic. Defaulting on a merchant cash advance isn’t the end of the world. But it’s important to understand the potential consequences and your options for resolving the situation.

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What is a Merchant Cash Advance?

A merchant cash advance (MCA) is a type of short-term business financing where a company gives you an upfront sum of cash in exchange for a portion of your future credit card and debit card sales. Instead of fixed monthly payments, you typically pay back the advance through daily or weekly debits from your bank account, based on a percentage of your sales.

MCAs can be an attractive financing option for businesses that have poor credit or need quick access to funds, since the application process is usually fast and easy with minimal paperwork required. However, they also tend to have very high effective interest rates; sometimes exceeding 100% APR. This makes them an expensive way to borrow money.

What Constitutes Default on an MCA?

The specific conditions that trigger a default will be outlined in your MCA agreement. But in general, you may be considered in default if you:

Miss a payment
Make a payment that is returned or rejected due to insufficient funds
Close your business
File for bankruptcy
Commit fraud or violate other terms of the agreement

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Falling Behind on Payments

Since MCAs are paid back through daily or weekly debits, missing even a single payment can quickly snowball into a larger problem. Many MCA agreements have a provision that allows the funder to demand immediate repayment of the full outstanding balance if you default.

Some agreements may give you a short grace period to catch up on missed payments before declaring default. But don’t count on it – many funders will consider your account in default as soon as a payment is missed.

What Are the Consequences of Defaulting?

The consequences of defaulting on a merchant cash advance can be severe. Depending on the terms of your agreement and the actions of your funder, you may face:

1. Additional Fees and Penalties

Most MCA agreements include provisions for late fees, NSF fees, and default interest rates that can significantly increase the amount you owe. For example, you might be charged a $35 fee for each payment that is rejected due to insufficient funds, plus default interest of 5% per month on the outstanding balance.

These extra costs can add up quickly and make it even harder to catch up on your payments. So it’s important to communicate with your funder as soon as you realize you’re going to miss a payment, to see if you can work out an alternative arrangement.

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2. Legal Action

If you default on your merchant cash advance, the funder may decide to take legal action against you to recover the money they’re owed. This could involve filing a lawsuit and seeking a court judgment against your business.

If the funder obtains a judgment, they may be able to garnish your bank accounts, seize your business assets, or even come after your personal assets if you signed a personal guarantee. Legal action can be costly, time-consuming, and damaging to your business and personal credit.

3. UCC Liens

Many MCA agreements include a clause that grants the funder a UCC lien on your business assets until the advance is repaid. A UCC (Uniform Commercial Code) lien is a public record that gives the funder a security interest in your business property, such as equipment, inventory, and accounts receivable.

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If you default on the MCA, the funder can use their UCC lien to seize and sell your business assets to recoup their losses. They may also be able to intercept your receivables by sending notices to your customers instructing them to send payments directly to the funder.

4. Damaged Credit

Defaulting on a merchant cash advance can severely damage your business credit score, making it harder and more expensive to obtain financing in the future. MCA funders typically report payment activity to business credit bureaus. So missed payments, collections, and court judgments related to your MCA will show up on your credit report.

A low business credit score can impact your ability to lease property, obtain lines of credit, and work with vendors. It can also lead to higher insurance premiums and make you a target for predatory lenders.

What Are Your Options If You Can’t Pay?

If you’re struggling to make your MCA payments, the sooner you take action the better. Waiting until you’re already in default will only make the situation worse. Here are some options to consider:

1. Communicate with Your Funder

Many MCA funders would rather work out an alternative payment arrangement than deal with the hassle and expense of legal action. Reach out to your funder as soon as you realize you’re going to have trouble making a payment. Be honest about your situation and see if they’re willing to temporarily lower your payment amount or give you a short deferment.

You may need to provide updated financial statements or a detailed plan for getting back on track. But if you have a good history with the funder and they believe you’re acting in good faith, they may be willing to work with you.

2. Refinance the Debt

Another option is to seek refinancing to pay off the merchant cash advance with a longer-term, lower-rate loan. This could lower your monthly payments and give you more breathing room. Just be sure to carefully evaluate the terms of any new financing and watch out for predatory loans that could make your situation worse in the long run.

Qualifying for traditional bank financing can be tough if your business is already struggling. But there are alternative lenders that specialize in refinancing merchant cash advances and other high-risk business loans. You can also look into SBA loans, which may have more favorable rates and terms if you qualify.

3. Negotiate a Settlement

In some cases, it may be possible to negotiate a settlement with your MCA funder for less than the full amount owed. This is more likely if you’ve already defaulted and the funder is eager to recoup at least some of their money without a drawn-out court battle.

You can try to negotiate a settlement on your own, or hire an attorney or debt settlement company to help. If you reach an agreement, be sure to get the terms in writing. You may be able to pay the settlement in installments, but most funders will require a lump sum.

Keep in mind that settling an MCA for less than the full balance will still negatively impact your credit. The funder will likely report the account as “settled for less than full balance” on your credit report. But it can prevent more serious consequences like lawsuits and judgments.

Preventing MCA Default in the Future

If you’ve defaulted on a merchant cash advance, you’re not alone. MCAs are a risky form of financing and default rates are high. According to a 2018 study by the Federal Reserve Bank of New York, the average default rate for MCAs was 17.7% compared to just 2.8% for traditional bank loans.

To avoid defaulting on an MCA in the future, consider these tips:

Only borrow what you need and can realistically afford to pay back based on your sales projections. Don’t be tempted by easy approval for larger advance amounts.
Read your MCA agreement carefully before signing and make sure you understand the repayment terms, fees, and default provisions. If anything is unclear, ask the funder for clarification in writing.
Stay on top of your business finances and regularly review your cash flow. If you see trouble ahead, reach out to your funder proactively to discuss your options.
Consider alternative financing methods like traditional term loans, SBA loans, or business lines of credit. While these may have stricter qualification requirements, they often have more favorable rates and terms than MCAs.

The Bottom Line on MCA Defaults

Defaulting on a merchant cash advance can have serious consequences for your business, including extra fees, legal action, asset seizure, and damaged credit. If you’re struggling to make your MCA payments, the best thing to do is communicate with your funder as soon as possible to discuss your options.

Remember, an MCA should be a short-term financing solution, not a long-term burden. Borrow carefully and have a plan for paying the funds back on time. If you do find yourself facing default, know that you have options and resources available to help resolve the situation and get your business back on track.