Merchant Cash Advance 101 – Explained

Beginning early 2010, after the Great Recession, when the American housing market blew up and the world fell into a financial crisis, conventional banking institutions, for example Chase Bank and Citi, were unwilling to extend credit to small businesses.

As a direct result of the housing debacle, banks reacted with a plethora of new internal regulation, making it almost impossible for the average small business to qualify for a business loan.

Worse yet, the Government’s intervention in saving the banking industry, brought with it more regulation, laws and strict underwriting standards, making it exceedingly unlikely for a small business to obtain necessary financing.

With an abundance of new regulation, credit underwriting standards inevitably increased to such an extent, that most small businesses were left out in the cold, unable to obtain working or start-up capital, thus leaving a massive void in the lending to small business space.

As such, the time was ripe for someone or something to address the lack of credit and lending to small business.

What arrived next was enormous growth in a previously obscure lending instrument, ubiquitously known as a Merchant Cash Advance. A seemingly legal transaction whereby a predatory lender is permitted to charge what ordinarily would be considered usurious interest, without being guilty of breaking the law.

A Merchant Cash Advance or MCA (as the industry refers to it), was neither proprietary nor patented. In fact, its creation occurred more than a decade earlier. The owner of a Gymboree needing funds today to tide the business over through the slow months, invented the technology to allow for the purchase and sale of future receivables. The patent was later challenged by another Merchant Cash Advance funder, subsequently the patent was lost and the doors opened to a host of new MCA lenders.

2010 saw a large increase in MCA loan origination. This growth can be attributed to the economic circumstances and fledging economy at that time. It was a perfect combination of circumstance and timing. Small business lending had all but dried up, demand for funding had risen sharply and the resulting turmoil presented both the conditions and timing necessary for the MCA industry to grow exponentially.

As a direct result of the economic crisis back then, an environment for alternative lending opened to meet small business demand and plug the lending gap left by conventional banking institutions. The predominant and favorite tool predatory lenders leaned upon, was the offering of a Merchant Cash Advance to an unsuspecting small business owner.

The industry has been booming ever since and without regulation and no barrier to entry, hundreds of participants have entered the MCA lending sphere. While many engage in deceptive lending practices together with other predatory abuses, including illegal collection methods, harassment and fraud, there are some participants that do follow the law.

To a predatory lender a Merchant Cash Advance is like no other lending instrument. It requires no disclosures, permits usurious interest and is unregulated.

Abuses have naturally followed. Many lending scandals have since sprung forth and slowly, States like New York are accumulating a body of Case Law on MCA’s and their legality.

However, since no law presently exists to govern the MCA space, the cases that have gone before the NY Courts have been decided upon the specific case facts relating to that matter. Notwithstanding this lack of regulation, New York recently passed SB 5470 but it is yet to be enacted. SB 5740 are laws requiring Merchant Cash Advance funders to disclose certain information about the MCA and its loan terms to the potential borrowing Merchant. This is a good start to reforming the space and limiting abuses.

However, sadly many businesses have been destroyed because of these loans like funding instruments. It is easy to fall prey to an MCA. Afterall, once the business is denied conventional financing or cannot obtain an SBA loan, they are desperate and vulnerable to the non-stop barrage of cold caller sales people, offering easy and quick money.

The temptation of guaranteed same day financing is sometimes too strong to ignore for some merchants and they begin the slippery slide. The MCA industry is in fact designed to target and prey upon desperate small businesses, a common occurrence during economic downturns.

Through heavy spending and a massive focus on solicitation and marketing, primarily via robotic cold calling performed by sales people known in the industry as ISO’s (Independent Sales Organizations) these people call and call the merchant business owner day after day offering “deals” for business financing that are highly tempting but more often than not non-existent. The ISO space is competitive and like the funders, no regulation exists governing a Merchant Cash Advance broker and thus it is no wonder the Merchant Cash Advance industry has seen consistent and rapid growth year over year.

This begs the obvious question, what exactly is a Merchant Cash Advance?

To assist with the answer, imagine Factoring or perhaps a Business Pay-Day Loan. In an MCA a lender, referred to as a funder, will provide a small business with a lump sum of cash for the right (not guarantee) to receive a percentage of the Merchants future generated accounts receivables. The amount received by the funder in return is usually in excess of 100% when calculated as an APR.

Amazingly, the law currently permits this transaction and the difference between the lump sum given and the receipts received by the funder, represents arbitrage or a spread and not interest!

In other words, the law holds that provided the funding transaction is one of purchasing future receivables, it is not a loan. If it is not a loan it is not governed by usury, if there is no usury the MCA funder is free to charge what the small business whatever it so desires. This legal nuance is what permits an MCA from receiving what ordinarily would be deemed usurious interest, thereby allowing for the absurd and astronomical amounts of money required to be repaid by a small business to an MCA funder.

With such a landscape at hand, there can no wonder at the sheer number of new lenders that has emerged. The barrier to entry to become an MCA lender or ISO is so minimal, it does not sway would be fraudsters and thus anyone can become a funder or MCA ISO. The lack of licensing, background checks, regulation and disclosures has made the Merchant Cash Advance a predatory lenders favorite instrument. Where else can an investor receive an Annual Percentage Rate (APR) that exceeds 500% and for it to be legal? Merchant Cash Advances is now the number one safe haven for predatory lenders to churn their funds.

What are the practical differences between a loan and a Merchant Cash Advance?

A traditional loan is repayable absolutely and gives no contingencies to the borrowing company to not pay. On the other hand, a true Merchant Cash Advance is NOT repayable absolutely and thus there are circumstances where the money provided by the Merchant Cash Advance funder is not repayable.

Even more stark is the difference when it comes to interest payments. Pursuant to State regulations, a lender cannot charge interest that exceeds State usury laws. In New York for example, the charging of interest in excess of 25%, when calculated as an APR, is illegal and considered criminal usury. However, the same law holds that if the funding instrument is structured and called a Merchant Cash Advance and refers to the transaction and the contract as the “purchase of the borrower’s future receivables.” there is no interest cap.

This is because at present the law holds that the purchase of future receivables,  at a discount, is not considered a loan. If the instrument used to finance the business is not recognized as a loan by the law, the buyer of the receivables (lender) can ask for a payback number of future receivables that ordinarily would breach usury, when calculated as an APR. Moreover, an MCA payback is usually structured to be automatically debited from the Merchants account on a daily basis. Double dipping and unauthorized debits are par for the course and often these unscrupulous parties get away with these frauds.

With no interest cap to be concerned about, seemingly endless profits available, coupled with a dearth of regulation and no barriers to entry and an entire industry was born resulting in what we know today as a Merchant Cash Advance.

As previously stated, the MCA concept, while relatively new to small business in 2010 was in fact “invented” at least a decade earlier. Twenty-Three (23) years ago information about Merchant Cash Advance loans became available and publicly accessible. Specifically, an individual by the name of Barbara S. Johnson is listed as the official inventor of split-funding, a system that allows for automatic splitting of funds received by credit card, with some going to the MCA funder and the remainder to the Merchant. This act of repayment to an MCA funder from a single credit card processor lay the grounds for Merchant Cash Advance.

Ms. Johnson obtained a Patent for this system in 1997. Johnson was running four Gymboree Playgroup & Music franchises. Unable to get working capital to fund a summer marketing campaign, she wondered whether she could borrow against future credit card sales derived from parents bringing their kids back for fall classes. About a year later, Johnson and her husband founded Advance Me, an MCA Funder. Later her company would become CAN Capital.

As with most new markets, regulation has simply been unable to keep up with the revolutionary MCA industry, its trends and has failed for the most part to reign in abuses. Accordingly, the MCA market developed into one more akin to the Wild West.

There is a fortune of money to be made in the industry and this means constant innovation and the introduction of certain methodologies by funders for making even more money off a drowning merchant.

Like most money-making bonanzas, the abusers have created systematic practices designed to drain the merchant of all revenues and hold the merchant hostage in the event the business cannot afford to make the repayments. Such practices include but are not limited to having repayments set on auto debit and on a daily basis. The use of ACH. Lock boxes. Complete access to a Merchants bank accounts. Personal Guarantees. Absolute Power of Attorney. Cross collateralization of entities and assets unrelated to the borrowing entity. Security Agreements with promises to repay irrespective of the facts. Liens filed against a small business bank account and even the merchant’s personal accounts. The illegal use of a Confession of Judgments (COJ) a legal tool whereby the funder obtains a judgment without having to litigate. 30% attorney’s fees. Permission for the funder to visit the borrowing Merchant at its place of business in the event of default. Predatory usurious lending rates. Illegal collection activities.

Excessive Origination Fees. Excessive Underwriting Fees. Excessive broker commissions. Illegal collection methods. Harassment, double dipping and debiting without authorization to name but a few of the more common schemes.

Unfortunately, instead of increasing scrutiny and introducing legislation, all that the last decade has done is allowed the market to grow unregulated. Even the so called pristine are involved. Several publicly traded companies are entering the world of Small Business Lending or Merchant Cash Advance. In fact, prestigious investment banks like Morgan Stanley have invested money with some of the largest MCA lenders and more investors want in. Where else can you charge 100, 200 or even 1000% interest on your money and have the law call it legal?

Moreover, large credit card processors such as Square, PayPal and Stripe are offering Merchant Cash Advance today add in Shopify and now even Amazon has got into the MCA lending space. With their merchant’s data readily available, it is particularly worrisome that conglomerate players such as this are involved too.

What about usury? Most States have usury laws on their books that set the maximum amount of interest you can charge on a loan. This number may vary depending on State, for example; California, Texas, New York, Florida, Michigan, Pennsylvania, Illinois, Tennessee, Ohio, New Jersey, Georgia, Arizona, North Carolina, Massachusetts, Indiana and Missouri all permit Merchant Cash Advance loans but also have usury laws on their books.

However, as delineated above, the law holds that usury applies to a loan – i.e. to borrowed money and not to an MCA that it considers to be the purchasing of a percentage of the merchant’s future revenues, and therefore usury will generally not defeat a bona fide MCA, since the MCA is not subject to usury caps.

It is imperative that legislation be passed to provide more protections to borrowers. Thankfully New York is on the cusp. SB 5740 was passed in 2021 and is expected to take effect in mid-2022. California has similar legislation on its books to New York.

Humbly, I believe the Courts also have a critical role to play in the fight against predatory lending abuses and it is hoped that more of the abusive Merchant Cash Advance be found to be loans merely in the guise of an MCA. As institutions of equity and fairness, refuge, and justice for all, the Courts must go beyond the mere label on the financing documents.

Just because the document says Merchant Cash Advance or Purchase of Future Receivables, does not automatically make the instrument a bona fide Merchant Cash Advance. Rather, the actions of the funder must be analyzed and the particular facts examined to determine whether the matter is a loan or a legal MCA. Unfortunately, without the guard of usury, small business owners are sitting ducks for predatory lenders.

The industry is crying out for regulation, laws and accountability. Until this happens we must challenge the funders. Challenge their contracts. Challenge their fees. Challenge the actual APR. Challenge their abusive practices and illegal collection tactics and end this “non-loan” sham.

If it looks like a loan, acts like a loan, requires a pay back and has the hallmarks of a loan, it should be treated as one. Simply calling it a receivable purchase in the contract is not enough indicia of a bona fide MCA.

Someone needs to stand up for small business. Better yet, new and transparent methods of merchant lending must be created. Too many businesses have been forced to shut or file bankruptcy because of these insidious loans. It is our hope that SB 5740 when enacted, will address many of the current abuses taking place in the MCA world.

With many Court opinions stating an MCA is essentially legal, is there a way to challenge, settle or legally fight a Merchant Cash Advance?

The answer is an emphatic yes! Seeking assistance when struggling to repay the MCA is your right and it should be taken. You must be allowed to restructure the MCA and if need be to challenge any abuses. Contact a Merchant Cash Advance Attorney. By working with a Merchant Cash Advance law firm and attorney, you will have the benefit of experience and knowledge of the law at your side.

You will know your rights and more importantly you will know what can be done to end daily ACH payments, stop illegal collection efforts and have your MCA loan settled.

The attorneys at Grant Phillips Law, PLLC are experts in the practice of Settling, Litigating and if applicable Terminating a Merchant Cash Advance. We stand shoulder to shoulder with our clients. Our long-term goal is to see the industry regulated and the players vetted, have interest rates capped and the adoption of a uniform MCA contract with standard terms and conditions and a cap on fees.

Our law firm serves clients across the United States. You do not need to be a resident of New York to receive our law firm’s assistance.

The attorneys at Grant Phillips Law, PLLC have assisted hundreds of Merchants with their Merchant Cash Advance Loans in most States, including but not limited to: California, Texas, New York, Florida, Michigan, Pennsylvania, Illinois, Tennessee, Ohio, New Jersey, Georgia, Arizona, North Carolina, Massachusetts, Indiana, Missouri and all across the United States.

516.670.5165 or speak with someone 24/7 via the Live Chat on our website at www.grantphillipslaw.com