What Happens If I Default on a Merchant Cash Advance?
Taking out a merchant cash advance can provide much-needed working capital for a small business. However, failing to repay the advance as agreed can have serious consequences. Here’s an overview of what happens if you default on a merchant cash advance.
Understanding Merchant Cash Advances
A merchant cash advance (MCA) provides a lump sum of capital to a business in exchange for a percentage of future credit card sales. It is not technically a loan, so MCAs are not subject to the same regulations.With an MCA, a business receives funding upfront, which it repays by allowing the MCA provider to withdraw a fixed percentage of daily credit card receipts. There is no set repayment schedule – the business repays the advance as a percentage of daily sales until the full amount plus fees is repaid.
What Qualifies as Default on an MCA?
You will be considered in default of your MCA agreement if:
- You close the business bank account linked to the MCA
- You stop processing credit card transactions through the account linked to the MCA
- You file for bankruptcy
- You fail to achieve the minimum amount of daily card processing volume agreed to
- You fail to repay the full MCA amount within the maximum repayment period
Defaulting on an MCA should be avoided because it usually triggers steep penalties and can harm your business’ credit.
Penalties for Defaulting on an MCA
The consequences for defaulting on an MCA can include:
Higher Interest Rates and Fees
- If you default, the MCA provider may hit you with much higher fees and interest rates. Rates may rise from the typical 1.1-1.5 times the advance amount to 2-3 times.
- Late fees around 5-10% of the outstanding amount could be charged monthly. Legal fees also often apply.
- In total, your small business could end up paying 3-4 times the original MCA amount.
Harm to Your Business Credit Score
- Defaulting constitutes a serious negative item on your business credit reports. This damages your credit score.
- A low business credit score makes it much harder to secure financing in the future. Interest rates for any credit product also rise substantially.
Debt Collection Harassment
- The MCA provider has the right to aggressively pursue repayment. A debt collector will likely be hired.
- You can expect frequent calls from collectors demanding payment. Any linked bank accounts may be levied.
Potential Lawsuit & Court Judgement
- If informal collection efforts fail, the MCA provider can sue your business for the balance owed plus interest and legal fees.
- If they win a court judgement, your business assets may be seized and sold to pay off the debt. Bank accounts can be frozen too.
As you can see, the consequences for defaulting on merchant cash advances can jeopardize your entire business. It’s critical to understand the risks before taking an MCA and to carefully manage repayment.
Strategies to Avoid MCA Default
Defaulting usually happens because of insufficient sales volume or poor cash flow management. Here are some tips to avoid this outcome:
Be Realistic About Sales Projections
- When applying for an MCA, you submit sales projections to determine the repayment percentage.
- Set realistic projections to avoid agreeing to too high a percentage. Remember to account for seasonal fluctuations.
Structure the MCA Appropriately
- Negotiate enough time to repay – often MCAs allow 12-18 months.
- Lock in a reasonable fixed repayment percentage. Rates above 12-15% become unmanageable.
- Get flexible repayment terms that lower daily payments if you have a bad sales month.
Closely Monitor Cash Flow
- Once you get the lump sum, be careful not to overspend it. Consider it a loan that must be repaid from future sales.
- Check your credit card batch payments regularly to ensure the MCA withdrawal amounts match projections.
- Cut overhead costs if sales volumes fall to remain cash flow positive.
Being strategic with how you use merchant cash advance funding and managing your repayment responsibility will help avoid disastrous defaults. That being said, running a small business is tough and defaults do happen.
What to Do If You Default on an MCA
If you do end up defaulting, stay calm and take these steps:
- Communicate – Contact the MCA provider explaining why you defaulted and discuss options. Maybe interest can be waived and a payment plan arranged.
- Seek Legal Counsel – Consult a lawyer to understand your rights and timeline for any legal action the MCA company may take.
- Explore Alternatives – Ask the lawyer about bankruptcy or debt settlement to resolve what you owe at a discount.
- Prioritize – Treat repaying the MCA as essential to saving your business rather than other obligations. Redirect sales revenue to paying it before anything else.
While defaulting on an MCA can damage your business, being proactive gives you the best chance to resolve the situation. With legal help, many small business owners reach settlements with MCA providers and move forward.
Could Debt Settlement Help My Business If I Default on an MCA?
If communicating with your MCA provider fails to bring reasonable solutions, debt settlement may be a viable approach.Debt settlement involves negotiating with creditors to agree on paying a lump sum that is less than what you owe in exchange for wiping out the debt. Settlements typically range from 40 to 60% of the total owed.Here are some pros and cons to consider regarding debt settlement for defaulted MCAs:
Potential Benefits
- Settling could relieve your business of the full defaulted MCA balance and fees owed at a discount
- Monthly payments through a debt settlement program may be less than the high MCA repayment percentage
- Settling could allow you to avoid court judgements or bankruptcy
Drawbacks
- Your credit score will still take a hit and show a negative settlement was reached
- The MCA company may balk at settling or demand a larger amount
- Any savings from settling may be taxed as income
Over 1 million small businesses have resolved credit disputes through settlement, so it’s definitely a strategy to discuss with financial and legal experts if you default on an MCA. They can advise if it’s right for you.
Summing Up the Risks of Defaulting on Merchant Cash Advances
While merchant cash advances provide critical funding, they come with serious repayment obligations. Defaulting leads to legal action, extreme fees, harm to your business credit, and revenue garnishment.Avoid finding yourself in this situation by only taking what you can manage, monitoring cash flow diligently, and cutting costs if sales drop.If you do default in spite of best efforts, act quickly to communicate with the MCA provider, get legal advice, and look into alternatives like settlement that could resolve the debt.Most importantly, know there are resources like Delancey Street that understand these issues and have experts who can help you create healthy money habits and relationships with creditors. Don’t hesitate to reach out.
