SMBs (small and medium-sized businesses) depend on a consistent flow of funding to operate. Seasonal variations or unforeseen costs can break that flow, leaving you searching for answers.
Merchant cash advances (MCAs) can be an alluring choice for filling temporary funding gaps in your business.
However, failing to make an MCA payment may have serious repercussions. Disclosures of available financial accounts at IOU Financial show that over 8% of loan portfolios may be impaired or past due.
Furthermore, a default might have a cascading impact that affects the MCA company as well as the merchant, financially. This might result in severe long-lasting issues and the MCA company might decide not to fund similar businesses.
Considering that the default rates have been found to vary over time from 4% to 13%, this blog post will discuss what happens if you miss payments on a merchant cash advance and the ways you can get ahead.
Understanding Merchant Cash Advances (MCAs)
Before diving into defaults, let’s revisit how MCAs work. Unlike traditional loans, MCAs are not a lump sum of cash. Instead, they are a purchase of a part of your future sales.
The MCA provider gives you a cash advance based on a percentage of your daily debit and credit card sales. Repayment is then automatically deducted from your sales receipts at a predetermined factor rate, a fixed fee on top of the advanced amount.
Consequences of Defaulting on an MCA
Missing an MCA payment is considered a default. The specific consequences will vary depending on your MCA agreement and state laws.
However, some familiar repercussions include:
- Late fees and penalties: Most MCA agreements include hefty late fees for missed payments. These can add up, further straining your cash flow.
- Increased factor rate: If you default, your MCA provider may increase your factor rate, making repayment even more expensive.
- Collections activity: MCA providers will likely employ aggressive collection tactics, including phone calls, emails, and letters. They could also involve collection agents who could pay you a visit and ask you to make the payment.
- Legal action: In severe cases, the MCA provider may take legal action to recover the balance amount. This could result in a court judgment, wage garnishment, or asset seizure.
- Damaged credit score: Defaults are reported to credit bureaus, negatively impacting your personal and business credit scores. This can make it difficult to secure future financing.
Mitigating the Impact of a Missed MCA Payment
While defaulting on an MCA is a severe situation, there are steps you can take to minimize the damage and potentially recover:
- Gather Documentation: Collect all your MCA paperwork, including the original agreement, payment history, and communication records with the provider. This will be crucial for any future discussions or negotiations.
- Focus on Communication: Maintain open communication with your MCA provider. Explain your circumstances and be honest about your financial situation. The more information you provide, the better they can understand your challenges.
- Negotiate a Solution: Express your willingness to work towards a solution. Be prepared to propose alternative repayment options, such as extending the repayment term or increasing the amount of your future payments.
- Explore Debt Consolidation: If you have other debts with high-interest, consider consolidating them with a lower-interest loan. By doing this, you can clear up cash flow and concentrate on repaying your MCA.
Understanding the MCA Collections Process
If you default on your MCA, the provider will likely initiate collections activity. This may involve:
- Phone Calls and Emails: The MCA provider’s collections department will attempt to contact you frequently. Be polite and professional, but reiterate your desire to work out a solution.
- Collection Fees: Some MCA agreements include additional collection fees in addition to late payments, which can increase the total outstanding balance.
- Legal Action: As a last resort, the MCA provider may file a lawsuit to recover the funds. This can result in a court judgment, which can lead to wage garnishment or your asset seizure.
How to Recover from an MCA Default?
Recovering from an MCA default takes time and effort. Here’s what you can do:
- Focus on Repayment: Prioritizing repaying the MCA as quickly as possible will help minimize the total cost, including late fees and potential legal fees. Remember, if the cost factor of an MCA deal is around 1.30, meaning you would need to pay back $1.30 for every dollar received.
- Rebuild Your Credit Score: A default will negatively impact your credit score. However, consistent on-time payments for other loans and credit cards can gradually improve your score over time. It’s important to note that MCA default rates have significantly decreased from 12-13% in 2009 to around 4-5% today, reflecting the industry’s risk management improvements.
- Seek Professional Help: If you’re struggling to manage your finances, consider seeking help from a credit counselor or financial advisor. They can guide budgeting, debt management, and rebuilding your credit.
Remember: Defaulting on an MCA is not the end of the road. By taking proactive steps, communicating openly, and prioritizing repayment, you can overcome this challenge and get your business back on track.
Financial Considerations When Choosing an MCA
While MCAs offer quick access to capital, they come with higher costs compared to traditional loans. Before choosing an MCA, consider the following:
- Factor rate: This is the critical cost metric for MCAs. Compare rates from different providers to ensure you’re getting a competitive offer.
- Repayment terms: Understand the repayment schedule and any prepayment penalties.
- Early termination clause: See if the agreement allows early termination with a settlement fee.
Conclusion
Merchant cash advances can be a valuable tool for small businesses, but it’s crucial to understand the risks involved. Missing an MCA payment can lead to a cascade of negative consequences.
If you’re considering an MCA, carefully evaluate your financial situation and choose a reputable provider with transparent terms. Remember, open communication and proactive planning are essential to avoid default and ensure a successful MCA experience.
FAQs
What happens if I can’t pay my MCA on time?
Missing an MCA payment is considered a default and can result in late fees, increased factor rates, aggressive collections activity, legal action, and a damaged credit score.
Are there options for repaying a missed MCA payment?
Yes. Contact your MCA provider immediately and discuss your situation. You can renegotiate your payment plan, enroll in a hardship program, or secure alternative financing to pay off the MCA.
How can I avoid defaulting on my MCA?
Careful financial planning is crucial. Before getting an MCA, thoroughly assess your cash flow and ensure you can comfortably afford the repayments.