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Are Merchant Cash Advance (MCA) companies taking more money than they should from your Business?
Merchant Cash Advances (MCAs) have become a popular financing option for small and mid-sized businesses needing quick access to capital, especially when traditional loans are challenging to secure.
While these merchant cash advances promise fast funding with minimal requirements, they often come with high costs and repayment structures that some business owners find problematic (ie- not being able to meet or afford the payments).
In recent years, questions have arisen about whether MCA companies are taking more money from businesses than they should, leading to concerns about transparency, fair practices, and financial risks.
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Merchant Cash Advances (MCAs) have become a popular financing option for small and mid-sized businesses needing quick access to capital, especially when traditional loans are challenging to secure.
Understanding Merchant Cash Advances (MCAs)
A Merchant Cash Advance (MCA) isn’t a loan in the traditional sense. Instead, it’s a business cash advance based on a business’s projected future sales, typically from credit card or debit card transactions as well as sales and revenue deposits.
The MCA provider offers a lump sum payment to the business, and in return, the business agrees to repay the advance plus a fee through a portion of its daily, weekly or monthly sales.
The key characteristics of MCAs include:
1. Speed and Accessibility: MCAs are often easier to secure than bank loans and are usually funded quickly, sometimes within days or even 24-hours
2. Repayment Based on Sales: Repayments are taken as a percentage of expected daily sales or revenue deposits which means that in times of low sales, businesses (SHOULD) pay less but often the payment is typically not adjusted properly.
3. High Costs and Factor Rates: MCA costs are typically calculated using a “factor rate,” not an interest rate. These rates range from 1.1 to 1.5 times the dollar amount advanced , meaning a business might end up repaying $1.50 (or more) for every $1.00 borrowed.
The High Cost of Merchant Cash Advances MCAs
While MCAs offer flexibility, they are among the most expensive types of financing available. Unlike traditional loans, MCAs do not have a set interest rate or an APR (Annual Percentage Rate). Instead, they operate on a factor rate, often leading to effective APRs that can exceed 100%, and even 200% in some instances!
For example, a $100,000 MCA with a factor rate of 1.3 requires a total repayment of $130,000 ($100,000 x 1.3). If the business repays this in six months, the effective APR is far higher than the factor rate would imply since the repayment is in less than 1-year.
This high cost has raised questions about whether MCA providers are profiting excessively from small businesses, especially those that may not fully understand the cost structure.
Lack of Transparency and Confusing Terms
One of the biggest criticisms of MCA companies is their lack of transparency. With traditional loans, lenders are required to disclose the APR and any fees, allowing borrowers to understand the total cost. In contrast, MCA providers typically do not provide an APR, which can obscure the true cost of the advance.
Common Transparency Issues Include:
• Opaque Factor Rates: The factor rate model can make it hard for businesses to understand the total cost compared to traditional financing options.
• No Disclosure of Effective APR: Many MCA providers avoid disclosing APR, which can make it hard for businesses to compare costs accurately.
• Confusing Contract Terms: MCA agreements often contain complex legal language that makes it difficult for business owners to understand their obligations fully.
This lack of clarity has led some business owners to find themselves paying more than they initially anticipated, raising concerns that MCA companies might be intentionally concealing costs to maximize profits.
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Daily Repayments and Cash Flow Strain
A key feature of MCAs is that they’re typically repaid daily or weekly as a fixed percentage of sales. While this seems flexible on the surface, daily payments can severely strain cash flow, especially for businesses with inconsistent or seasonal revenue and where a business receives client payments only once per month from AR collection.
Potential Cash Flow Challenges:
1. Variable Payment Amounts: If sales are slow, the daily percentage taken may seem manageable, but during high sales periods, the repayment amount can quickly escalate, creating significant cash flow challenges. Most MCA companies DO NOT adjust payments which conflicts against the contract language.
2. Longer-than-Expected Payoff Periods: Some MCA agreements lack a clear end date, meaning the repayment term is directly tied to sales volume. Businesses with fluctuating revenue might find themselves locked into longer repayment periods than anticipated.
3. Stacking MCAs: Some businesses end up “stacking” MCAs, taking multiple advances from different providers, which can result in a cycle of perpetual debt and deeper cash flow issues.
Business owners often realize too late that these daily deductions create a “cash flow trap” or NEGATIVE cash flow where their revenue is perpetually diverted to MCA payments, leaving them with minimal funds to cover other critical operating expenses and payments to other creditors. This can lead to serious disruption of business operations and put your business at serious risk of insolvency.
Are MCA Companies Taking More Than They Should Be?
The question of whether MCA companies are taking more money than they should is rooted in both the high cost structure and the practices used to collect payments.
Critics argue that MCA companies take advantage of business owners’ lack of understanding about factor rates and effective APRs, leading to higher repayments than what would be typical for other types of financing.
Have your business sales revenues declined, or even increased? In either scenario, an MCA company is suppose to adjust your “estimated” or “periodic” payment listed in the contract based on recent business revenues.
They are suppose to perform a reconcilation to determine if a payment should go up or down.
If they do not do this, they may be in violation of business usury laws in NY, CT or FL or whatever state or venue that their contract is located.
Setup a consultation call with us and we can direct you to trusted law firms that handle these scenarios and we can help you with your business and operational challenges while the lawyers handle the legal issues that may be present.
Factors Contributing to Potential Overcharging:
1. High Factor Rates: With factor rates between 1.3 and 1.5, MCAs often cost businesses 30% to 50% or more of the advance amount. In annual terms, this can translate to effective APRs well over 100%!
2. Aggressive Collection Practices: Some MCA providers employ aggressive tactics to ensure repayment, including legal action if payments fall behind. This can lead to additional fees, compounding the cost.
3. Ballooning Costs Due to Stacking: When businesses stack multiple MCAs, they pay high factor rates on each advance, potentially resulting in overall costs that far exceed the initial advance amount.
4. Confessions of Judgment: In some MCA contracts, businesses are required to sign a “confession of judgment,” which allows the MCA provider to obtain a court judgment against the business without a trial if they fall behind on payments. This can lead to additional fees and may put the business in a cycle of perpetual repayment.
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Regulatory Concerns and Legal Scrutiny
Merchant Cash Advance MCA companies operate in a largely unregulated environment, especially compared to traditional lenders. MCAs are classified as “advances” rather than loans, allowing them to sidestep many consumer protection laws that govern loans, including state usury laws that limit interest rates.
There are plenty of MCA companies that treat these “advances” as though they are loans by:
demanding a fixed payment that is “due”
not performing reconciliations when requested
arbitrarily adjusting payments down or up and not based on recent sales revenue (see contract)
alleging a personal guarantee on the contracts by the business owner that is actually a performance guarantee and not a full guarantee of the amount owed
threatening certain types of actions that they cannot take either legally or operationally
breaking their own contract as the contract writer
not underwriting the original contract properly
offering “renewal” funding that pays off the existing MCA and then “re-funds” the business with even more charges (exponential charges… ie- factor charges on top of factor charges)
using deception prior to funding through their “brokers” or agents of the MCA companies
promising a refinance and then it never happens
Regulatory Challenges and Legal Actions
1. Lack of Federal Oversight: Since MCAs are not legally defined as loans, they don’t fall under federal lending laws, allowing MCA providers to avoid interest rate caps and other borrower protections.
2. State-Level Regulation: A few states have attempted to regulate MCAs, but oversight remains inconsistent across the U.S. Some states have started to investigate and sue MCA companies for unfair or deceptive practices, but there is no uniform regulation.
3. Class-Action Lawsuits: Several lawsuits have been filed against MCA companies, alleging deceptive practices, failure to disclose effective APRs, and misuse of confession of judgment clauses. These cases highlight ongoing concerns about MCA companies’ ethics and transparency.
Alternatives to Merchant Cash Advances
Given the potential drawbacks of MCAs, it’s important for businesses to explore alternative financing options, especially those that offer more transparent terms and lower costs.
1. Traditional Bank Loans: Bank loans often have lower interest rates and structured repayment terms. Although they may take longer to secure and require a strong credit history, they’re generally less costly than MCAs.
2. Business Lines of Credit: A line of credit provides businesses with flexible access to funds and often comes with lower interest rates than MCAs. Businesses only pay interest on the funds they use, making it a cost-effective option.
3. SBA Loans: Loans backed by the Small Business Administration (SBA) offer favorable terms and low interest rates for small businesses. While they require a more rigorous application process, the savings can be substantial.
4. Invoice Financing: For businesses with outstanding invoices, invoice financing or factoring can provide immediate cash flow by advancing a percentage of unpaid invoices. This option is often more affordable than MCAs.
5. Equipment Financing: Businesses needing funds specifically for equipment purchases can use equipment financing, which allows them to pay for equipment over time while using it as collateral. This option typically has lower rates than MCAs.
6. Revenue-Based Financing: This option is similar to MCAs in that payments are based on a percentage of sales. However, reputable revenue-based financing providers often have lower costs and provide more transparency.
Tips for Evaluating MCA Offers
For businesses considering an MCA, careful evaluation can help avoid overpayment and potential financial strain. Here are some tips for assessing MCA offers:
1. Calculate the Effective APR: Use an online calculator to convert the factor rate into an estimated APR, which can help compare the MCA’s cost to traditional financing.
2. Analyze the Impact on Cash Flow: Assess how daily or weekly payments will affect cash flow, especially during low-revenue periods. Ensure that the business can comfortably meet these payments without sacrificing other financial obligations.
3. Request Full Disclosure of Terms: Ask for a clear breakdown of fees, repayment terms, and any additional charges. Avoid providers that refuse to disclose these details.
4. Avoid Stacking Advances: Resist the temptation to take multiple MCAs, as stacking can significantly increase costs and lead to debt cycles. Consider alternatives if additional funding is needed.
5. Read the Fine Print Carefully: Look for clauses that may affect the business, such as confessions of judgment or clauses allowing the provider to debit accounts. Consulting a legal or financial advisor can help identify potential pitfalls.
6. Consider the Long-Term Cost: Evaluate whether the MCA’s cost is justified by the expected return on investment (ROI) of the capital. If the funds won’t drive growth or revenue, the high cost may not be worth it.
Get Away from MCAs!
Speak to a Business Finance expert today.
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