How a Merchant Cash Advance (MCA) Can Lead to Business Bankruptcy

If you own a business, you’re likely bombarded with offers for merchant cash advances (MCAs). They’re largely easy to ignore, unless you’re having business cash flow issues. Then they might seem very appealing.

After all, you get fast approval and funding, there’s minimal credit requirement, and no collateral is needed to secure short-term business funding. It sounds like a magical and immediate solution to your cash flow problem!

But according to experienced bankruptcy attorneys, the short-term convenience veils a serious long-term risk. In fact, merchant cash advances (MCA) can lead to business bankruptcy.

What Is a Merchant Cash Advance?

In a nutshell, a merchant cash advance (MCA) provides businesses with a lump sum of capital in exchange for a percentage of the company’s future sales. Sounds a lot like a working capital loan. But it’s not.

Where a working capital loan offers predictable repayment schedules and clear pricing, MCAs are all about providing quick access to funds with no consideration for long-term affordability. Instead of fixed monthly payments as one would find in a traditional business loan, MCA lenders take a predetermined percentage of a business’s daily sales directly from their bank account until the advance is fully repaid. This percentage rate, also known as the “holdback rate”, can range from 5% to 20%.

In addition, although MCA providers are referred to as lenders, their products are not loans. That means that MCAs simply bypass the traditional underwriting standards that apply to traditional loans. They also don’t observe perfected lien positions and choose collection actions that interfere with business receivables. And this often does much more to hurt businesses than to help them.

Merchant Cash Advances (MCAs) Can Lead to Business Bankruptcy

An MCA lender can collect their holdback rate in one of three ways:

The first is an automatic deduction where the MCA lender partners with the business’s credit card processors to withdraw an agreed-upon percentage from the daily credit and debit card sales. This works toward paying off the debt more quickly only if the business experiences high credit card sales.

A second way to collect is through a lockbox or trust account. This is a separate account that collects all of the credit and debit card sales from which the MCA lender takes its portion before transferring the remainder to the business bank account. It’s similar to the above option, but money funnels through a third account.

Finally, the holdback rate can be collected via direct ACH withholding. In this scenario, the MCA lending company deducts fixed payments from the business’s checking account based on an estimated monthly revenue.

It’s not just the holdback rate that separates a merchant cash advance from other loans. Another area where they differ is in their charging of a factor rate rather than a traditional interest rate.

How an MCA Factor Rate Works Against Businesses

A factor rate means that there’s a flat sum a business pays to borrow money rather than paying interest that builds over time. Depending on the lender, an MCA factor rate could range from 1.1 to 1.5. This may not sound too bad, until you do the math.

The amount a business will pay is calculated by multiplying the advance amount by the factor rate. So, for instance, if you want to borrow $100,000 with a 1.2 factor rate, a $1,000 origination fee, and a maximum 120-day repayment term, you can expect a total loan payout of $121,000. That’s a 116.41% APR! Meanwhile, a traditional bank loan can offer interest rates as low as 7%.

Thus, despite being marketed as a temporary solution, a merchant cash advance provides anything but conventional financing. If anything, it’s a barrier to it and can destroy a company through overleveraging the business and eroding cash flow. Figuring in additional unexpected expenses can place a business in a tremendous cash flow crunch and produce a desperate financial conundrum if payments are not met. In this situation, many business owners may decide take on another MCA to stay afloat.

This is known as MCA stacking. And instead of providing relief, stacking results in multiple daily deductions, a reduction in operating cash, and increased dependency on new funding. So what started as promising short‑term funding becomes a debt spiral that’s nearly impossible to escape without intervention from a skilled Michigan bankruptcy attorney.

Get a New Start Through Business Bankruptcy

If you’ve experienced firsthand how merchant cash advances (MCAs) can lead to business bankruptcy, contact us today or call (248) 462-7698.

The experienced and knowledgeable Southfield bankruptcy attorneys at Gold, Lange, Majoros & Smalarz, P.C. have the extensive business and bankruptcy experience to navigate the contractual and financial inner-workings of MCA lending agreements.

We CAN do what it takes to get you and your business back on your feet.