Writer: Lucy Lazarony
Editor: Lillian Guevara-Castro
Reviewer: Adam West
Key Takeaways
- Merchant cash advances are becoming part of bankruptcy filings as small businesses have difficulty managing these expensive advances.
- Merchant cash advances have minimal underwriting, and it is easy for a cash-strapped business to qualify.
- Payments for merchant cash advances come straight out of a borrower’s business account on a weekly basis or on each business day.
Merchant cash advances, also called MCAs, are winding up in bankruptcy filings as small businesses fail to pay back these pricey cash advances.
Merchant cash advances are repaid using a portion of future business sales.
Ashley Morgan, a debt and bankruptcy lawyer in northern Virginia, has seen her share of merchant cash advances with small business bankruptcy clients. She said these advances are very common in businesses filing bankruptcies.
“MCAs tend to be a last-ditch effort by businesses to cover necessary expenses,” Morgan told us. “Too often businesses consider MCAs because they cannot qualify for other more traditional types of financing, like loans or lines of credit.”
High Costs of Merchant Cash Advances
The convenience of getting merchant cash advances when business liquidity is tight comes at a high price and with challenging terms.
“Most MCAs charge a high premium for their loans. Lenders also are often collecting weekly on the balances. With weekly collections, it basically can freeze the cash flow for the businesses and make it nearly impossible to continue to operate,” Morgan told us.
“As a result, businesses often have to consider bankruptcy to stop the hemorrhaging,” she said.
Morgan said merchant cash advances are like payday loans for businesses.
“They are the tool of last resort and are very costly,” Morgan said. “If lenders were more flexible about payment terms or allowing payments less frequently, it may help with borrowers.”
Impact on Small Businesses
Merchant cash advances are a small business problem, and these small companies take the biggest hits when they attempt to finance their businesses with multiple merchant cash advances.
“From my experience, it’s most common amongst small businesses versus large-sized businesses,” Leslie Tayne, a finance and debt expert and founder of Tayne Law Group, told us.
“It would be fair to say that most of the small business cases my firm tackles involve at least one MCA lender, but it’s also not rare to see cases with many stacked advances.”
Turning to Multiple Merchant Cash Advances
Unlike traditional loans, merchant cash advances have minimal underwriting making them easy to get. Businesses with limited credit history often apply for these cash advances when money gets tight. Many businesses use more than one to try to keep their businesses afloat.
“It’s also not uncommon to see businesses take out a MCA to cover the cost of a former MCA, stacking debt on top of debt that eventually becomes unsustainable,” Tayne told us.
Why Merchant Cash Advances Are So Expensive
Gerri Detweiler, author of “Finance Your Own Business: Get on The Financing Fast Track,” explains the high costs associated with merchant cash advances.
“Costs are usually expressed as a factor rate. If, for example, you are offered a $10,000 advance at a factor rate of 1.3 you’ll need to pay back $13,000. If your factor rate is 1.2, you’ll need to pay back $12,000. Multiply the factor rate by the amount of the advance,” Detweiler told us.
Paying back a merchant cash advance comes straight out of a borrower’s business accounts, and payments are due on a weekly basis or even each business day until the financing is repaid.
“This will affect your cash flow, and business owners don’t always account for that,” Detweiler said. “Sometimes that leads to cash flow problems that send them to get another cash advance and it becomes a spiral of debt.”
The Growth of Merchant Cash Advances
Merchant cash advances have exploded in popularity since the pandemic, and funders of these cash advances often advertise on social media that they offer fast cash without in-depth credit checks, Bloomberg Law reports.
According to Secured Finance Network, the merchant cash advance market is $12 billion to $15 billion and up to 19.7 billion annually. The market is projected to reach $35 billion in five years.
The Bottom Line
More merchant cash advances are turning up in bankruptcy filings as small businesses struggle to pay back these expensive cash advances. Merchant cash advances have minimal underwriting so a small business with little credit and in a tight spot for cash would be able to qualify.
Payment for merchant cash advances come directly out of business accounts, so cash flow is impacted immediately. Some businesses pay for one merchant cash advance with another — stacking up a pile of debt.
