Understanding MCA Payments: What Business Owners Need to Know

Quick Summary

If you’re considering taking out a merchant cash advance or already have one, it’s important to understand how they work. MCAs work differently from traditional bank loans in that they’re tied to your business sales and are often much more costly. Contract terms like personal guarantees and confessions of judgment create serious legal problems if you can’t pay.

What Is an MCA and How Is Repayment Structured?

A merchant cash advance (MCA) is a type of non-traditional business financing. It’s not a business loan. Instead, it’s a purchase of future receivables. When you take out an MCA, the lender buys a portion of your company’s future sales at a discount. Later on, you’ll repay the borrowed amount, along with a bit extra. 

Here are some of the key terms of an MCA:

• Advance amount: This is the upfront cash you’ll receive from your MCA provider. It could range from a few thousand dollars to hundreds of thousands of dollars.
• Factor rate: Instead of an interest rate, MCAs charge a factor rate, typically between 1.3 and 1.5. You multiply this number by your advance amount to determine how much you owe. For example, if you borrow $100,000 at a factor rate of 1.5, you’ll repay $150,000.
• Holdback percentage: The MCA company will take a portion of your daily or weekly sales, known as the holdback percentage, to repay your advance. For example, you might pay 10% per day of all sales, which the company will automatically pull from your business bank account.
• Estimated term: Most MCA agreements have an estimated repayment term, which is how long it will likely take you to pay back the advance based on your projected sales. Depending on your loan amount and your business revenue, it often ranges from six months to one year.

How Are MCA Payments Collected?

MCA payments are generally collected in one of three primary ways: ACH debits pulled directly from bank accounts, split withholding from credit and debit card sales, or lockbox arrangements with third-party accounts.

ACH debits

ACH debits pulled directly from bank accounts are the most common collection method for MCAs. Using this method, the MCA company gets authorization to debit your business bank account directly, usually on a daily basis. 

The fixed daily payment is based on your projected sales and your holdback percentage. For example, if your weekly estimated sales are $25,000 and your holdback rate is 20%, your daily payment will be about $1,000 ($25,000 x 20% ÷ 5 business days).

While they’re based on projected sales, the debits happen every day, regardless of your actual sales. If your revenue dips, you’ll still be on the hook for the same payment amount.

Split withholding

When your MCA company uses split withholding for your payments, they work with your credit card processors to withhold a percentage of every transaction before you even see the money. With a 20% holdback rate, as in the previous example, each $1,000 transaction would have $200 withheld for your MCA payments.

This traditional MCA collection method adjusts with your sales, meaning higher sales lead to faster repayment. On the other hand, the lower your sales, the lower your payments, and the longer it will take to repay your advance.

Cover the three main collection methods: split withholding from credit/debit card sales, ACH debits pulled directly from bank accounts (most common), and lockbox arrangements where a third party controls deposits. Emphasize that ACH debits happen daily regardless of actual sales.

Lockbox arrangements

The final MCA payment method is when your sales payments flow directly into a bank account that the MCA company controls or has access to. The lender takes its holdback percentage, then it releases the rest of the funds to you.

This repayment method offers you the least amount of flexibility. An MCA provider may be more likely to demand this method if they are concerned about repayment.

What Happens When Sales Drop or You Can’t Make Payments?

Any business owner understands that sales fluctuate throughout the year. Many owners, especially small business owners, turn to MCAs because they’re marketed as being more “flexible” than traditional bank financing, but that’s often not the case. 

Yes, an MCA with a true split-withholding arrangement will adjust your payments based on your actual credit card sales. But since many MCAs now use ACH debits with fixed payments, many business owners find themselves in a difficult situation.

If you’re a seasonal business or experience an unexpectedly slow period, you’ll end up with MCA payments that eat into a significant amount of your cash flow, and may even prevent you from meeting your other financial obligations. Unfortunately, this can easily lead to overdrawn accounts for small businesses. 

Some MCA agreements include reconciliation clauses (also known as “true-up” clauses, which allow businesses to request lower daily or weekly payments when their revenue drops. However, these are rare, and lenders don’t necessarily have to agree to such requests.

The True Cost of MCA Payments

MCAs are often marketed as a better alternative to traditional business loans. Not only are they often no more flexible than traditional financing, but they also end up being more expensive.

Consider the factor rate that’s commonly used for MCAs. Unlike the interest rates that many loans charge, factor rates are more obscure. When you see that an advance has a factor rate of 1.5, that doesn’t immediately set off alarm bells. But when you turn that into a number you can more easily understand, MCAs often have APRs ranging from 50% to 150%, far higher than any normal business loan.

MCAs also become dangerous as they lead to a cycle of renewals and stacking. Many MCA companies will give you the “opportunity” to renew your advance. But that just means you end up paying more in fees without actually getting more benefits.

Additionally, many people end up stacking MCAs to help them cover their expenses, often as a result of the high fees from their original MCA. Suddenly, you have multiple MCA payments coming out of your bank account every day, making it difficult to pay your other bills.

These traps often lead to years of debt that’s difficult to escape from, similar to a cycle of payday lending that an individual consumer might fall into when they’re facing financial hardship.

Dangerous Contract Terms That Affect Your Payments

MCA agreements can be complex, and many borrowers don’t understand the dangerous provisions that often lie within them. Here are some terms you should understand before you agree to take out an MCA:

• Personal guarantee: Many MCAs require personal guarantees, which hold you, as the business owner, personally liable for the debt if the business can’t repay it. Not only is your business at risk, but you’ve also put your personal assets and credit score at risk.
• Confession of judgment (COJ): A COJ, possibly the most dangerous term in MCA agreements, allows MCA companies to get default judgments against you without having to go through the traditional lawsuit process. You could face orders for wage garnishment or bank account levies without even having the chance to defend yourself.
• Default triggers: MCA agreements include certain events that automatically constitute default, giving the company grounds to accelerate the remaining balance and begin aggressive collection tactics. These triggers include missed payments, taking out additional advances without permission, and seeing a drop in your business revenue.
• Aggressive collection remedies: MCA companies may use tactics such as accelerating repayment (demanding the full balance immediately), daily compounding penalties, UCC liens, and more.

These terms give MCA companies leverage over you, even when they are questionable or outright unethical. The terms might not even hold up in a court of law, but many borrowers don’t understand their rights, and they feel like they have no options.

Next Steps

If you’ve already taken out an MCA, it can feel disheartening to learn more about these predatory terms and feel like there’s no way out. But that doesn’t have to be the case. An experienced MCA attorney can help assess your situation and advise you on possible solutions, including negotiating a better outcome.

Tayne Law Group’s attorneys focus on helping business owners like you navigate MCAs and other business financing issues. We can discuss your case and help you explore your options. To learn more about a free phone consultation, contact us today by calling (866) 890-7337 or filling out our short contact form to set up a consultation. We never share or sell your information, and all conversations are confidential.

FAQ

What is a factor rate, and how does it affect my total payback?

A factor rate is the fee structure MCAs use. The factor rate serves as a multiplier of your advance amount. Multiply your factor rate (typically 1.3 to 1.5) by your advance amount to find your total payback amount. For example, a $100,000 advance with a 1.5 factor rate will have a total payback amount of $150,000.

Can MCA payments adjust if my sales go down?

Whether your MCA payments can be adjusted if your sales go down depends on your agreement’s collection structure. If you have split withholding, then your payments will automatically adjust based on your sales. But with ACH debits, you’ll pay the same amount regardless of your sales.

It’s worth reviewing your MCA contract to see if it includes a reconciliation clause that allows you to request an adjusted payment based on changes in your business’s revenue.

What happens if I miss an MCA payment or my account is overdrawn?

If you miss an MCA payment or have insufficient funds in your bank account, your MCA may go into default. At that point, your MCA provider may accelerate your repayment, meaning you’ll have to repay the full balance right away. They may also resort to aggressive collection tactics, including obtaining a wage garnishment order, freezing your bank account, or placing a lien on your business or personal assets.

Are personal guarantees enforceable on MCA agreements?

Yes, personal guarantees are enforceable on MCA agreements. These guarantees hold you personally liable when your business can’t repay its debts. Unfortunately, your lender can personally sue you and come after your assets, including your home equity, vehicles, and bank accounts. You will also likely see your personal credit score drop if you fall behind on payments.

Can I negotiate lower MCA payments or settle for less?

Yes, it’s possible to negotiate with your MCA provider. Some companies may be willing to negotiate lower payments to ensure you actually repay the full loan amount. Additionally, some lenders may be willing to accept a settlement for less than your full debt amount, but it’s more difficult to negotiate these deals. It’s best to have an experienced MCA attorney negotiate on your behalf to give you the best chance of success.