Are MCA Loans Predatory?
Merchant cash advances (MCAs) have become an increasingly popular form of financing for small businesses in recent years. But are these loans actually predatory, taking advantage of business owners in need? There are arguments on both sides.
What is an MCA Loan?
A merchant cash advance is a form of financing where a company provides a business with an upfront sum of cash in exchange for a percentage of future credit card and/or debit card sales. There are usually no set monthly payments or fixed repayment terms. Instead, the MCA provider takes a fixed percentage of daily credit card sales from the business until the full amount plus fees and interest is repaid.MCAs are often appealing to small business owners because they are quick and easy to obtain compared to traditional bank loans. Approval decisions can happen in as little as 24 hours and require minimal paperwork. The funds can provide much-needed working capital for marketing, inventory, payroll, expansion costs and more.However, default rates are high and critics argue that merchants are often misled about the true costs of these loans and can end up in difficult financial situations as a result.So let‘s take a closer look at some of the arguments around whether MCAs are predatory or simply a financing option like any other.
High Interest Rates and Fees
One of the main criticisms of MCA loans is that they come with exceptionally high interest rates, which are often obscured or hidden in fine print. Rates can routinely exceed 50% or even 100% APR when all origination and servicing fees are factored in. This is radically higher than rates for traditional bank loans and credit cards.Of course, MCA providers argue that these loans are inherently riskier than traditional loans because they are essentially making an investment in a business‘s future revenue stream. So higher rates help account for the increased chance of default.However, small business owners are often caught off guard by just how much the fees, rates and repayment structure ends up costing them in the long run. By the time all is said and done, they may have repaid double or even triple the original loan amount.
Aggressive Daily Repayment Structures
Another aspect of MCA loans that critics view as predatory is their daily repayment structure. MCA providers have direct access to a percentage of a business‘s daily credit card sales revenue until the loan is repaid. This means that repayment happens automatically every day regardless of how the business is actually performing.This can become an immense financial burden during slow periods or seasonal dips in revenue. Or if the business suffers any other hardship like supply chain disruptions, loss of a major customer, etc. Suddenly the business finds itself struggling to cover daily operating expenses because so much revenue is being diverted to the MCA provider.Of course, this aspect also benefits the MCA provider by minimizing default risk on their end. But it passes that risk onto the small business itself.
Opaque Terms and Conditions
Critics also take issue with the fact that MCA contracts often have opaque terms and conditions that merchants don’t fully understand. Key details about rates, fees and the repayment process are buried in fine print or technical jargon.Business owners see the lump sum they’ll receive upfront but may not grasp how much they’ll end up repaying overall. The actual annualized cost of capital can be obscured. And they may not realize that the MCA provider will gain access to their daily credit card sales revenue.Merchants are often desperate for quick financing and trust the assurances of MCA sales reps. But later come to regret the decision when the less favorable terms come to light during the repayment process.
Limited Underwriting and Oversight
Unlike banks and traditional lenders, critics argue that MCA providers do limited financial underwriting and risk evaluation before approving loans. Approval decisions are made very quickly, often within 24 hours of an application.MCA providers argue that this is one of the major benefits they offer to small businesses—rapid access to financing without onerous paperwork. However, critics counter that it also enables loans to be made to merchants that realistically may not have the financial capacity to handle the repayment terms.
If a business fails soon after taking an MCA loan, the provider is at risk of not fully recouping their investment. But the business owner can be left in financial ruin with few options. The rapid approval process enables loans to high risk merchants that traditional prudent lenders would not approve.
Difficulties Getting Out of MCA Agreements
Perhaps the most challenging issue for small businesses is that MCA agreements can be very difficult to get out of once signed. Even if a merchant‘s financial situation deteriorates significantly, MCA providers have several avenues to continue extracting repayments, such as:
- Gaining access to the merchant’s credit card processing accounts
- Filing confessions of judgement that allow them to seize business assets without a court proceeding
- Imposing high prepayment penalties if a merchant tries to refinance the loan
- Charging steep termination fees
Merchants often feel trapped and unable to take control of the situation once daily payments start getting debited from their accounts. While contracts allow this, critics argue that MCA providers take full legal advantage of struggling businesses.
Arguments Against the “Predatory” Label
However, not everyone views merchant cash advances as inherently predatory. Proponents argue they are simply an alternative financing option that helps provide funding to businesses ill-served by traditional banks. When used judiciously, MCAs can benefit both the lender and borrower.
High interest rates account for default risks – Small businesses are risky borrowers. MCA interest rates simply account for that risk and allow financing to still flow to those businesses.
Merchants go into agreements willingly – Providers point out that terms and conditions are fully disclosed, and business owners opt into the loans willingly. Merchants must take responsibility for not comprehending the full costs.
An alternative to high credit card debt – For some businesses, an MCA agreement can actually be cheaper than relying on credit cards to finance operations. Credit card interest rates can exceed 25%, while MCA rates are at least tax deductible.
Fast access to working capital – When used prudently, MCA loans provide rapid access to growth capital that struggling businesses literally can’t find elsewhere. This capital can be used to turn around a failing business.
Helps fund underserved markets – By approving merchants that banks deem too risky, MCAs help provide financing for underserved communities that have historically lacked access to capital for small businesses. This can enable business growth and job creation in low-income and minority neighborhoods.
Best Practices for Merchants
If you are considering an MCA, be sure to follow best practices to ensure it is the right financing option for your business:
- Carefully vet MCA providers and compare options to find reputable ones with reasonable terms.
- Read all contracts closely and make sure you fully understand all fees, rates, repayment structures and penalties involved. Don’t let sales reps gloss over key details. Ask questions if anything is unclear!
- Be conservative with the amount you borrow and closely model cashflow needs. Borrow only what you reasonably expect to afford repaying.
- Have an attorney review any MCA contract before signing. Negotiate terms if possible.
- Explore all other business financing options first, including traditional bank loans, credit cards, SBA loans, etc. Only use MCAs as a last resort.
- Have a clear plan to repay the MCA quickly and transition to more affordable longer-term financing options.
