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The Merchant Cash Advance Trap: How It Is Hurting Businesses and Using Banks

There is an old proverb about insanity having something to do with repeating the same mistakes over and over while expecting different results.

It’s been less than a decade since the housing crisis sent ripples across the banking community, crashing credit markets worldwide and sending the global economy into a tailspin. Irresponsible lending from creditors and irresponsible borrowing from homeowners combined to send us into the worst economic decline since the Great Depression.

And while the mortgage industry has been pulling itself out of the financial crash of 2008, we’re seeing an emerging trend in commercial finance that is figuring to do the same to the business community.

The issue is that “some” Merchant Cash Advance lenders offer predatory repayment agreements to cash-strapped businesses. These lenders aren’t worried about making risky loans or even working with businesses to ensure they have reasonable access to working capital — they simply offer easy money to anyone who will take it.

The private investors and even some big banks choosing to invest into these high return financial products are rolling the proverbial dice. Some are winning big but others late to the game will be left holding the empty bag. Remember all those empty lots that became worthless when the inflated bubble burst? Many banks and investors lost it all from the mortgage crash.

Sound familiar? It sure does to us.

Here come the stackers

Anytime good returns on investments are available, the chum in the water rapidly attracts the greedy sharks. Who cares how it harms anyone, if I can make my pockets burst at the seams with returns?

The responsible MCA lenders that play by financial underwriting rules fill the much-needed working capital needs of businesses that are not quite ready to be approved by banks or are not aware or a fit for factoring.

Say a business has a current 1st lien position financial product and is still struggling to maintain enough working capital to handle inventory or pay seasonal employees. At this point, a traditional commercial lender or a factor might be able to work with them if the ingredients are right. Sometimes a MCA can offer 2nd position advances if past sales are adequate to remedy the short term cash flow crunch.

Here come the stackers in the MCA community that are more than eager to offer a 3rd, 4th, 5th or infinity-and-beyond position advance. If a business is paying five separate lien holders each week — what are the odds that the business will ever cover all of these debts? Keep in mind: these advances are based off future sales, so a business’s future AR is already sold. Let sales dip and you are screwed because you are over-advanced. These companies are leveraged past the “point of no return,” will the business be permanently reliant on debt service to keep its doors open?

At this point, are MCAs really working with the business to provide them working capital to serve their customers, or are they simply taking advantage of them? The other question is why do business owners do this to themselves?

And get this — some MCA lenders do not even file a lien. MCAs have a loophole to essentially “cut” to the front of the line. This rather insidious workaround could present a serious risk to the banking community, which has worked hard to limit its risk in the post-crash world.

The ACH loophole

Taking a lien in the 4th or 5th position can be a bit of a downer, MCAs have worked out a system to “cut” to the front of the line when dealing with a heavily-leveraged business.

Say a business has four loans and it needs more capital. Rather than even filing a lien, an MCA instead sets a pre-arranged payment schedule that is directly deducted from the company’s bank account via ACH. This is a serious issue, in two ways:

  1. This gives the MCA an unearned first right to debt service from the business. If the business is responsibly paying on a loan in the first or second position, these deductions (sometimes done on a daily basis) can now harm the business’s ability to pay its other creditors.
  2. While banks, some MCA lenders and factors monitor new liens added to a business’s books, a regular ACH deduction is harder to notice. Now, banks that have responsibly vetted the businesses that they work with could be taking on a level of risk that they never agreed to or even noticed. Many MCA and factoring contracts forbid assets under a lien to be used as collateral as they are the ones that have rights to those assets. It is called being responsible and is looking out for the business owners.  

Before the business even has the chance to service the debt in the 1st or 2nd position, the MCA has already taken its share. Lenders, who have attempted to work responsibly with the business, are now assuming even greater risk.

How common is this? More common than we’d like to see.

Real life examples

Here are two real-world examples we’ve seen in the last few months:

  1. A well-established company with over $2.5 million in property approached us for factoring. They are currently working with a factor whose contract was expiring and were interested in shopping around. Here’s the problem: $600,000 on an outstanding business loan, a factoring account and two advances from 2 separate MCAs — one with a lien, the second no lien. They are paying $19,000 per week to these two MCA companies.

    Can we use their equity to help them? Can we refinance? No. They are past the “point of no return.” They asked the MCA companies for a few days relief from the daily payments because all their cash flow was being stripped from the daily ACH payments. One said yes, the other no and put them in default.
  2. We were approached by a 38-year-old company doing around $1.5 million in monthly receivables. At this point we should mention that you don’t stay in business for 38 years without being great at what you do. Still, this company approached us with two outstanding MCA loans, accounting for $25,000 in weekly deductions.

    This company, which has served its community for the better part of four decades, is now dealing with insufficient funds issues. The amazing part: One of the biggest banks on the planet has a $1.2 million loan outstanding with this company, and we can assure you they were unaware of these 2 MCA advances that were drawing these funds daily out of the bank account.

In both cases, we’re seeing well-meaning and desperate businesses being taken advantage of by irresponsible lenders. Yes, these business owners are responsible for taking on these advances but it has all of the same hallmarks of the credit crash after the housing crisis, with the potential to ripple across businesses, banks and the community as whole.

We’re doing the same thing all over again, and we’re expecting a different result. It’s insanity.

Bringing community back to commercial finance

Why are we writing this? Why speak up? It’s because the cookie is crumbling and not enough people are listening. Many banks are not aware and business owners are not familiar with what all these offers for fast money really mean. Just like the stated income mortgages prior to 2008, the allure of fast cash is too great, and it’s leading businesses into a situations they can’t recover from.

If this continues to happen at a large scale, it has the potential to send shockwaves across our entire economy.

There is a lot at stake. Having seen trends come and go over the last two decades, this is one that has us worried. Our goal is bringing community back to commercial finance by bringing value to the marketplace and offering real solutions rather than existing to profit off the backs of business owners, we work with all of our clients as partners. We succeed together.

If you’ve dealt with Merchant Cash Advance lenders who have an unfavorable lien or no lien you have found yourself sucked into a spiraling decline where a cash flow solution has become a cash flow drainer, and it is starting to become too much, we’d love to work with you. We are working with companies that may be able pull you out from these situations and develop sustainable working capital solutions by doing things the right way.

We are also looking for confidential conversations from business owners that are facing dire situations due to this stacking nightmare. We need to bring this stuff to light so others can be forewarned.

We look forward to the opportunity to serve your company.

  1. I feel compelled to respond to this article because this describes my situation perfectly. I have been in business (dentist) for ten years. Dentistry is a very expensive business to be in with very high overhead. Millenials are coming out of school with expectations of high pay and regular pay raises. Dental supply companies never reduce or adjust their prices for a company dependent on insurance receivables. Add property taxes, tangible personal property taxes, school loans, business startup loan, home mortgage, kid’s school,and on and on and cash flow is strangled. I was always able to manage it until last year when we had to overhaul our entire office computer hardware and software system costing $12000. I couldn’t get a bank loan for this due to my existing liabilities, so a MCA loan was my only conceivable option. In less than a day I had the funds I needed to pay for the new computers and software. I was floating on cloud nine until the daily payments started and began to strangle the cash flow. I started receiving insufficient funds emails….and this has never happened before. In a panic, I applied for a second MCA loan to increase working capital to keep up with payroll and other liabilities. Uh-oh…now I have even more daily payments strangling my business. I quickly realized this fact: I increased my working capital but I also increased my liabilities with no change in revenue. All I’ve done is buy more time until the increased debt to revenue ratio puts me back in the same situation I started in. Unless revenues increase or I use the MCAs to pay off other debts, all I’m doing is delaying the inevitable, not really solving anything. So this is where I am at now. I got to the point where I seriously feared bankruptcy. I looked at my three kids and wife sleeping in the morning terrified that their life was about to be turned upside down. That sinking feeling came over me and I cried driving to work. I realized no one can help. If only there was a wealthy person who could solve my problem without breaking a sweat. Believe it or not, I emailed Bill Gates, Richard Branson, Oprah and others to no avail. They don’t give a shit about me. In my mind the only way out (short of bankruptcy) is to find a funding company willing to get me out of debt and structure a long term repayment schedule that is proportional to cash flow. Other than that, no one is altruistic enough to really help without helping themselves first.

    • Richard;

      I am truly sorry for the circumstances you find yourself in. Unfortunately more and more businesses are getting into this same situation and it is taking its toll.

      We specialize in B to B funding and see the fallout daily, we are out to bring awareness and hopefully provide value to business owners so they can make better-informed decisions and avoid what you are facing.

      I wish you all the best and hope you are able to find a solution to improve your circumstances.

      Thank you for sharing your story.

      All my best;

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Diversified Funding Services was founded in 1998 by Mark Little with the mission to provide businesses the opportunity to obtain critically needed cash flow for their companies with Account Receivables financing, traditionally known as Factoring.

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Diversified Funding Services, Inc
125 Habersham Drive / Suite C
Fayetteville, GA 30214
Toll Free: (888) 603-0055
Phone: (770) 603-0055
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