Are Merchant Cash Advances Legal?

are merchant cash advances legal

As a business owner, the ability to borrow money is key to keeping your company running. Sometimes you need extra funds to buy inventory, pay employees, or simply remain cash flow positive. 

One form of financing that has become popular is the merchant cash advance. These often come with relaxed credit requirements and fast funding options. On the other hand, the fees are high and contracts often include tricky or deceptive language. So are merchant cash advances legal? Let’s take a look.

What Is a Merchant Cash Advance?

A merchant cash advance is a type of alternative financing for businesses. They don’t work the same as a traditional loans, which provides a lump-sum disbursement that you pay back in fixed installments over several years. 

Instead, an MCA is an advance on your future revenue. The MCA provider gives you a payment upfront in exchange for a cut of your revenue later. Typically, MCAs are designed for small business owners that do a bulk of sales via credit card and debit card sales (though just about any business can get one these days).

How a Merchant Cash Advance Works

There are two main ways an MCA gets repaid. The first is through a percentage of your daily sales. Each day, a portion of your receivables is deducted from your bank account, based on how much you earned. That means the daily payments can fluctuate up and down. 

The other option is to have regular, fixed withdrawals taken from your account. This is more common for businesses that don’t do a lot of credit card sales. The MCA company will withdraw money from your account on a daily or weekly basis, based on your estimated revenue for the month. 

Also, instead of a traditional interest rate that you would pay on a business loan, merchant cash advance providers charge a factor rate. This typically ranges between 1.1 and 1.5. To calculate the total cost of an MCA, you multiply the amount borrowed by the factor rate. So for example, if you borrowed $20,000 at a factor rate of 1.3, you’d repay a total of $23,000 ($20,000 advance plus $3,000 in fees). 

Usually, the repayment term for an MCA ranges from three to 12 months. Some lenders may allow more time to pay back the advance. But because the repayment term is so short, the cost is incredibly high when expressed as an annual percentage rate. In fact, the APR on an MCA can reach 300% and up. 

So back to our original question: Are merchant cash advances legal? The answer is yes, despite the fact that these financing options can be dangerous for business owners who aren’t able to fulfill the terms of their contracts.

There aren’t actually a ton of regulations around MCAs since they aren’t considered loans. That means that companies that provide MCAs don’t have to follow state usury laws, which protect borrowers from excessively high, predatory interest rates. They’re regulated by the Uniform Commercial Code instead. But this isn’t as comprehensive or strict as other federal laws. 

Some states have proposed laws to tighten restrictions around MCAs. In the future, we may see more regulation around this type of financing.

Frequently Asked Questions

Still have questions about the legality of merchant cash advances? Below are answers to some of the most common questions people have.

Yes, MCAs are legal in the state of California. However, in 2018, Governor Brown signed a bill into law that requires much more transparency when it comes to disclosures around fees. Merchant cash advance companies are required to provide information such as the total dollar cost of an MCA, the estimated term length, how many payments are required and at what frequency, prepayment policies, and the total cost of the financing expressed as an annualized rate. This law is designed to make it harder for merchant cash advance lenders to hide costs behind confusing factor rates. 

Are Merchant Cash Advances Predatory?

Merchant cash advances are sometimes considered predatory due to the lack of transparency in pricing and questionable clauses in contracts. For example, many MCA contracts include a confession of judgment clause; if a borrower falls behind on their payments, the MCA funders can file a lawsuit without notifying them, essentially taking away their ability to defend themselves in court. 

Similar to payday loans, the fees can also be quite high. This makes it easy for borrowers to get trapped in a cycle of debt, or lose their assets if they made a personal guarantee.

Are Merchant Cash Advances Tax Deductible?

With typical small business loans, the IRS allows you to write off the interest as a business expense. However, since an MCA is not a loan, you aren’t charged any interest. So there is no interest write-off available. The good news is that you might be able to deduct the fees. 

When you make payments toward your MCA, the portion that goes toward the factor rate might be deductible. The exact amount you can write-off — assuming you’re eligible for a deduction —  will depend on the terms of your contract. It’s a good idea to speak with a tax professional who can help you determine how much you can write-off in MCA fees. 

How Can I Get Help With a Merchant Cash Advance?

If you’re struggling to pay back your merchant cash advance, or are already behind on payments, know that there are solutions for you. Your first step should be to speak with an attorney who is experienced in dealing with business debts. A legal professional will be able to walk you through your options, whether that’s settling your MCA debt, filing for bankruptcy, or some other route. 

Tayne Law Group has been assisting clients with their MCA and other business debt for more than 20 years. Our law firm has relationships with creditors and their legal teams, so we know what steps need to be taken to resolve your debt. Plus, we can help even if you aren’t based in New York.

We offer a no-obligation consultation to learn about how we work and how we might be able to help. So if you need assistance dealing with an MCA debt, give us a call at (866) 890-7337 or fill out our short contact form. Conversations are confidential and we will never share your information.

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