Merchant Cash Advance Legal Issues Explained

Merchant cash advances allow business owners to get their hands on the funds they need quickly. But there’s a dark side to merchant cash advances that has led to a rising number of legal issues. We explore merchant cash advance legal issues below.

Key Points:

• Merchant cash advances are contractual arrangements in which the business owner sells a percentage of their future sales in exchange for a cash advance that must be repaid. 
• The high cost of these advances often leads to repayment issues. From there, legal issues can enter the scene. 
• Understanding the merchant cash advance legal issues out there can help you make an informed choice before getting into a merchant cash advance or help you navigate your existing MCA.

What Are the Legal Issues with Merchant Cash Advances?

Merchant cash advance funding can solve short-term cash flow issues. But the nature of this expensive contractual agreement can lead to legal issues. Here’s why:

• Merchant cash advances aren’t technically loans. Instead, the advance is a purchase of a percentage of future sales. 
• Since it isn’t a loan, merchant cash advance regulations are sparse. MCA companies don’t have to follow state usury laws. Plus, there are no federal laws on the books about merchant cash advances. 
• The lack of legal oversight means these funding sources are often significantly more expensive than other financing solutions. 
• In recent years, the merchant cash advance system has drawn scrutiny based on the high costs and minimal qualification requirements. 

How Does a Merchant Cash Advance Work?

As mentioned, a merchant cash advance isn’t a loan. Here’s how it works:

• Apply: The MCA company will look at your credit card sales to determine the size of the advance.
• Accept: If you agree to the advance, you’ll sign a contractual agreement in which you sell a percentage of their future credit card sales. 
• Use the funds: You’ll receive the funds quickly after the paperwork is signed. Sometimes you’ll get the funds that day! You can use the funds as you see fit. 
• Make daily repayments: The advance company will work with your credit card processor to take an agreed-upon percentage of your daily or weekly sales automatically. Generally, this daily percentage is somewhere between 10% and 20%.  

How Do Merchant Cash Advances Differ from Other Types of Business Financing?

Merchant cash advances are a unique funding opportunity. Here are the differences to consider:

• Not a loan: Importantly, a merchant cash advance is not a loan. Although you receive upfront funds that you must repay, it’s not a loan based on the contract, which specifies a purchase of future sales. 
• Expensive: MCAs don’t have to follow regular lending rules. With that, most are more expensive than your other options. 
• No set repayment term: You’ll repay the loan based on your daily sales. So, there’s no specific monthly payment due. However, there is a cap on your repayment timeline. In most cases, you’ll have between three to 18 months to repay the entire loan. 

How Are Rates Calculated on a Merchant Cash Advance?

Merchant cash advances have different rates than a regular loan.

• Factor rate: MCAs have factor rates attached to the loan. A factor rate lets you know how much the loan will cost without any regard to repayment timelines. 
• Factor rates vs. interest rates: Interest rates represent a percentage of the principal the lender charges to borrow the funds. The factor rate is multiplied by the advance amount to determine the total repayment cost. 
• Example: Let’s say you are borrowing $10,000 with a factor rate of 1.25. In this case, you’d pay back $12,500. 

What Are the Potential Dangers of a Merchant Cash Advance?

All types of business funding come with risk. But merchant cash advances come with added potential dangers:

• Expensive factor rates: On the surface, factor rates seem small. But in reality, many factor rates translate into triple-digit APRs. That’s an expensive funding solution. 
• Daily payments: A fixed percentage of your daily sales can mean very high payments on some days. If you are facing cash flow issues, this is a major problem. 
• Risk of default: MCAs are expensive with very short terms. If your business can’t keep up with the cost, you might find a need to apply for a loan to satisfy your MCA obligations. Unfortunately, it’s easy to spiral into a cycle of debt. 

How to Avoid Legal Issues when Getting a Merchant Cash Advance

Concerned about merchant cash advance legal issues impacting your business? Here are some strategies you can implement to avoid merchant cash advance problems. 

Research the Merchant Cash Advance Company

The first line of defense is to research a merchant cash advance company before committing to work with them.

• Check out reviews: Look on Trustpilot and the Better Business Bureau to find out how the company treats its customers. 
• Look for pending litigations: If a company is already facing scrutiny for shady business practices, steer clear. 
• Consult with a qualified legal counsel. Because these advances have the bare minimum oversight, the fine print of your contract is very easily manipulated to create obligations that can be impossible to uphold. 

Convert the Factor Rate into an Annual Percentage Rate

Factor rates can make the borrowing cost seem more affordable than it actually is. That’s because we are used to comparing loan options in terms of the annual percentage rate (APR). To put the cost of the advance into perspective, convert the factor rate into an APR. Here’s how:

• Determine the total cost of the advance: Let’s say you receive a $10,000 advance with a 1.2 factor rate. The total cost of the advance is $2,000. 
• Determine the cost of the advance: You’ll get the $10,000 upfront. So, the cost of the advance is $2,000. 
• Calculate percentage cost: Divide the cost of the advance by the advance amount. In this case, divide $2,500 by $10,000 for a percentage cost of 0.20. 
• Annualize the interest rate: Multiply the percentage cost by 365. In this case, you’d multiple 0.20 by 365 to equal 73. 
• Divide by the number of days in the term: If you took out a 6-month MCA, then divide the annualized interest rate by the total number of days in the advance. In this case, you’d divide 73 by 180 to arrive at an APR of 40.56%. 

Consider Other Financing Options

After you run the numbers on an MCA, you might determine that the costs are too steep for your business. The good news is there are other options available. Consider the following options:

• Short-term business loan
• Long-term business loan
• Equipment financing
• Business lines of credit 
• Business credit card

What to Do If You Experience Merchant Cash Advance Legal Issues

No one wants to encounter a legal issue over their merchant cash advance. But if you are facing this uncomfortable issue, there are steps you can take. 

Take Out a Debt Consolidation Loan 

A debt consolidation loan can help you eliminate your merchant cash advance.

• Pay off the MCA: You can use a debt consolidation loan to pay back your MCA. 
• Lock in a better rate: Typically, debt consolidation loans have significantly lower costs attached. 
• Regular payments: You’ll make regular monthly payments, which can help you manage cash flow more efficiently. 

Check the Confession of Judgment for Errors

Many merchant cash advance contracts include a confession of judgment. Essentially, this document gives the company the right to sue you. But it’s possible they made a mistake.

• Look for mistakes: A few possible mistakes include the wrong date, address, factor rate, and more. 
• Bring it to their attention: A mistake in the confession of judgment could mean the document is invalid. With that, the company might not have the right to sue you anymore. 

Settle the Debt for Less Than What’s Owed

Even if the company could sue you, this costs time and money. So, they might be willing to take a lump sum payment for less than what you owe.

• Determine what you have to spend: Pool your resources to give this a try. 
• Reach out with an offer: If the advance is in default, reach out to the customer service team. Explain the situation and your offer. In some cases, they may be willing to work out a deal. 

Consult a Merchant Cash Advance Attorney 

If you don’t have any luck sorting out the issue on your own, consult a merchant cash advance attorney.

• Experience matters: An MCA attorney deals with these issues every day. With their experience, you might save time and avoid a headache. 
• Many offer free consultations: If you are on the fence, reach out to an attorney that offers a free consultation. They can let you know whether or not they can help. 

Final Word 

Merchant cash advances aren’t a loan. In this unique grey area, many legal issues are starting to come into the light. Before signing up for a merchant cash advance, learn about the potential dangers. If you can wait a few days for funding, consider a different business financing solution.

FAQs about Merchant Cash Advance Legal Issues

If you have questions about merchant cash advance legal issues, you’ll find the answers below.