What Happens If I Default on a Merchant Cash Advance?
Taking out a merchant cash advance can seem like a quick fix when your business needs money fast. Unlike a traditional bank loan, merchant cash advances provide funding quickly without a lot of qualifications. However, they come at a steep price – merchant cash advances typically charge very high fees and interest rates. And if your business struggles to pay back the advance, you could end up defaulting.Defaulting on a merchant cash advance happens when you miss scheduled payments. This breaches your agreement with the lender. Defaulting comes with serious consequences that can hurt your business as well as your personal finances.In this article, we’ll explain:
- What is a merchant cash advance and how does it work?
- What happens when you default on payments?
- The consequences your business may face
- How defaulting affects your personal finances
- Strategies to avoid defaulting on an MCA
- What to do if you are behind on payments or anticipate default
What is a Merchant Cash Advance?
A merchant cash advance (MCA) provides a lump sum of cash to a business in exchange for a percentage of future credit card sales.With an MCA, a lender gives you an upfront sum of money. In exchange, you agree to pay back the advance through daily or weekly payments. These payments are taken automatically as a percentage of your credit card sales.For example, a lender may give your business $20,000 upfront. You would then pay back $500 per day, which is withdrawn from your credit card sales automatically. The payments continue until you’ve paid back the full $20,000 plus fees.MCAs are appealing because they provide fast access to capital. The application process is simple and funding can be received in as little as 24-48 hours. MCAs also use future sales as collateral rather than business assets. So they may be an option for businesses with bad credit or minimal assets.However, merchant cash advances come at a very high cost:
- Interest rates are sky-high – MCAs often have effective APRs of 60-200%, much higher than a bank loan.
- Short repayment terms – MCAs typically must be paid back within 6-12 months. This short timeframe makes the high payments challenging.
- Daily/weekly payments – MCA payments are taken daily or weekly, which can greatly impact cash flow for a small business.
As a result of the unfavorable terms, many businesses struggle to pay off their merchant cash advance. Missed payments can quickly spiral into a default situation.
What Happens When You Default on an MCA?
Defaulting on your merchant cash advance happens as soon as you miss a payment. Even a single missed payment puts your account into default.When you default, it triggers the lender’s rights to take action to recoup their money. Here are some consequences your business may face:
- Frozen bank accounts – MCA lenders can freeze your business bank accounts and seize any funds. This leaves you without access to operating capital.
- Lawsuits – The MCA lender will likely sue your business for breach of contract. If they win a judgment, they can seize your assets.
- Harassing calls – You’ll likely get frequent calls from collection agents demanding repayment. This distraction can impact your ability to run your business.
- Damaged business relationships – MCA lenders may contact your vendors and contractors, customers, and merchant processors. They may tell them not to do business with you due to the default.
- Higher payments – Your remaining balance may become due immediately. The lender can also increase your daily payment percentage. This makes the advance even harder to repay.
- Credit damage – Defaulting can seriously hurt your business credit score if the MCA lender reports it. This makes securing financing in the future more difficult.
- Personal liability – If you personally guaranteed the MCA, the lender can come after your personal assets as well in a lawsuit.
As you can see, the consequences of not paying your merchant cash advance can be severe. The impacts can last long after you’ve paid off the balance and hurt your business’ future prospects.
How Defaulting Affects Your Personal Finances
With an MCA, business owners are often required to personally guarantee the advance. This means if your business defaults, your personal finances are on the hook.Here are some ways defaulting on an MCA can impact your personal assets and credit:
- Wage garnishment – A successful lawsuit means the lender can garnish your wages to repay what’s owed. This leaves you short on take-home pay.
- Liens on personal property – The MCA lender can put liens on your home, vehicles, or other personal property. This prevents you from selling assets without paying off the MCA first.
- Levied bank accounts – Any personal bank accounts could be frozen and the funds used to repay the advance. This limits your access to cash.
- Credit damage – Like with business credit, defaulting can hurt your personal credit score if reported by the lender. Poor credit makes it hard to get loans, mortgages, credit cards, and more.
- Bankruptcy risk – If the MCA lender wins a large judgment against your personal assets, it could force you into personal bankruptcy. This impacts your finances for years.
- Stress and embarrassment – The weight of harassing calls, potential asset seizure, and credit damage takes a toll mentally and emotionally.
As you can see, defaulting on a merchant cash advance you’ve personally guaranteed puts both your business and personal finances at huge risk. It’s critical to avoid default if at all possible.
6 Strategies to Avoid Defaulting on an MCA
Defaulting on your merchant cash advance can be devastating for your business. Here are some proactive steps you can take to avoid missing payments:
1. Cut Discretionary Spending
Review your expenses and see where you may be able to cut back, even temporarily. Areas like marketing, subscriptions, office perks, and supplies can often be reduced to save cash. If you rent, see if you can renegotiate your lease.
2. Talk to the MCA Lender
Contact your MCA lender before you miss a payment. Explain that you are struggling to make the payments and see if they will let you pay a lower amount or defer a payment. While not guaranteed, it’s worth asking.
3. Try to Refinance
See if you can qualify to refinance your MCA balance with a business loan or line of credit. This allows you to pay off the MCA at lower interest rates. Just be sure the new monthly payments are affordable.
4. Use Business Credit Cards
Shift purchases to business credit cards temporarily. This preserves cash flow by delaying when expenses are paid. Just be sure to pay the cards off quickly to avoid high interest fees.
5. Bring in Investors
Consider bringing in investors or selling equity in your company. The influx of capital can help you pay off the MCA and avoid default.
6. Increase Sales
Brainstorm ways to increase sales through strategies like marketing campaigns, new products, or partnerships. More revenue makes it easier to afford the MCA payments.Avoiding default requires looking at both reducing expenses and increasing cash flow. The earlier you take action, the better your chances of working through an MCA without defaulting.
What to Do If You Are Behind on Payments
Sometimes despite your best efforts, you may fall behind on merchant cash advance payments. Here are some important steps to take if you anticipate defaulting:
- Contact the lender immediately – Let them know you may miss upcoming payments and try to negotiate alternate terms. Don’t wait until you’ve already defaulted.
- Prioritize MCA payments – As difficult as it may be, try to pay the MCA before other expenses like payroll or rent. Defaulting triggers the most consequences.
- Seek legal counsel – Consult a lawyer experienced with MCAs to understand your options and rights. An attorney can also negotiate with the lender on your behalf.
- Explore bankruptcy – Filing for business bankruptcy stops collections and lawsuits while a repayment plan is negotiated. Chapter 11 bankruptcy may allow you to restructure or discharge the debt.
- Close bank accounts – Temporarily close your main business bank account so the lender can’t freeze funds. Open a new account to use for critical operating expenses.
- Consider settlement – You may be able to settle your MCA balance for less than the full amount if you can pay a lump sum quickly.