The Consequences of Defaulting on a Merchant Cash Advance Agreement

The Consequences of Defaulting on a Merchant Cash Advance AgreementTaking out a merchant cash advance can provide much-needed working capital for a small business. However, failing to repay the advance as agreed can result in serious consequences. This article examines what happens when a business defaults on a merchant cash advance agreement.

What is a Merchant Cash Advance?

A merchant cash advance (MCA) provides a lump sum payment to a business in exchange for an agreed upon percentage of future credit card sales. It is not technically a loan, so MCAs are not subject to the same regulations.

The advantages of an MCA include:

  • Quick access to capital with minimal paperwork
  • No collateral required
  • Payments tied to credit card revenue
  • Funds can be used for any business need

However, MCAs also come with risks, such as high repayment rates and strict default clauses.Consequences of DefaultingIf a business fails to meet the contracted repayment schedule, the MCA provider can declare the agreement in default and demand full and immediate repayment of the outstanding balance. Additionally, providers will charge fees, penalties, and default interest rates.Specific consequences include:Loss of Future Revenue

  • The MCA company can activate their confessed judgment clause. This allows them to seize business assets, freeze bank accounts, and garnish future revenue without court approval.
  • They can also use an ACH debit to automatically withdraw funds from bank accounts. This gives them first priority access ahead of other expenses.

Higher Repayment Costs

  • Default interest rates typically range from 20-35% APR compared to the original rate of 1.10-1.40 for every $1 received.
  • Some agreements impose a default fee equal to 20-30% of the funded amount.
  • Late fees often run 2-5% per month. With an outstanding balance of $50,000, such penalties can add over $1,000 per month.

Damage to Credit and Future Borrowing

  • Defaults are reported to business credit agencies and will devastate a company’s score. This restricts access to financing.
  • Personal guarantees mean the business owner’s personal credit also takes a hit. This impacts their ability to secure other loans or credit products.

Loss of Collateral

  • If repayment is secured by collateral such as property or equipment, the lender can seize those assets if the agreement defaults.
  • They can also place liens on collateral, restricting the ability to sell or borrow against the asset.

Potential Bankruptcy

  • Struggling with cash flow while facing rapidly compounding fees and interest makes it difficult for businesses to recover. Many end up having to file bankruptcy.
  • Business owners may also face personal bankruptcy if they signed a personal guarantee.

Other Legal Action

  • MCA providers can sue for breach of contract and win judgements ordering repayment, fees, charges, and legal costs.
  • If fraud is suspected, providers may file police reports or pursue criminal charges.

How to Avoid Defaulting on an MCACarefully evaluating the terms of an MCA agreement and maintaining open communication with the provider can help avoid the painful consequences of default. Consider the following tips:

  • Be conservative when projecting future revenue and setting repayment rates. Don’t overextend yourself.
  • Closely monitor cash flow and sales trends. Adjust repayment rates downward if needed before problems arise.
  • Communicate early if a slow season or emergency expense will temporarily impact repayment capacity. Many providers will work with businesses by adjusting rates or deferring payments for a short period.
  • If consistent struggles emerge, speak with the provider right away to discuss options before defaulting. This shows good faith and a willingness to eventually repay the full amount.
  • Seek help from a small business lawyer or financial advisor to negotiate alternative repayment terms or restructure the agreement.
  • Explore business loans through traditional lenders to refinance high-cost MCA debt.

While potentially useful, merchant cash advances do carry risk. Entering such an agreement requires careful consideration of the consequences of default. Monitoring cash flow trends, communicating with the provider, and seeking professional advice can help businesses avoid negative outcomes.What to Do If You Default on an MCAIf a business does end up defaulting on its merchant cash advance agreement, the situation may seem dire. But there are still steps that can be taken to resolve matters:Communicate with the MCA Provider

  • Be upfront about the difficulties you face making payments. Silence and avoidance will only anger them.
  • Demonstrate you still intend to eventually repay by proposing new terms or alternative arrangements.
  • If no compromise can be reached, clearly communicate if declaring bankruptcy becomes necessary. While certainly an undesirable outcome, honest dialog can lead to a more orderly process.

Seek Legal Counsel

  • Consult an attorney experienced with merchant cash advances. They can review your situation and agreement terms to identify any protections or exemption loopholes.
  • They can also formally communicate with the MCA provider on your behalf and negotiate alternative repayment arrangements.

Prioritize Revenue Generation

  • With future sales pledged to the MCA provider, focus intensely on driving more business through marketing initiatives or new revenue streams. Consider small business loans to help provide working capital.
  • If continuing operations is not viable, wind down in an orderly fashion through a liquidation sale or by selling business assets. Use these funds to repay outstanding debts.

Explore Debt Relief OptionsIf the MCA balance is unmanageable, consider:

  • Debt Settlement – The attorney negotiates with providers to accept a smaller lump-sum payment as satisfaction of the full balance. Typically settlements represent 20% to 50% of the outstanding amount.
  • Debt Consolidation Loan – Banks may approve business loans to repay an MCA under better rate and term conditions.
  • Bankruptcy Protection – As an absolute last resort, Chapter 7 or Chapter 11 bankruptcy allows for the elimination or restructuring of debts. However, this option comes with its own set of consequences.

While scary, defaulting on an MCA does not need to be the end of the road. Be proactive in communication and resolution efforts. Protect your business and personal assets through legal counsel. Remain determined, yet flexible, in re-establishing revenue streams. Consider all options, including debt relief or bankruptcy, to emerge with the best possible path forward for your business.

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