The Merchant Cash Advance Scheme – Predatory Lenders – PART I.

The Merchant Cash Advance (MCA) How it all Works and the DANGER SCENARIO:

 

DANGER! DANGER! DANGER!

MCA Loans are in large part Predatory Lending Strategies! They are sometimes referred to as “Payday Loans.” They can be very, very dangerous.

Let us begin by stating that these types of loans are from quasi-financial institutions that are largely unregulated. They do not following general banking regulations and they do not run afoul of typical usury laws because their “interest” structure is actually fees piled upon fees, coupled with additional fees all baked into the principal amount of the loan. So they can legally say they are “low interest.” Most, are not.

Most, with very few exceptions, are highly predatory.

Most of the loan companies are not set up as investment funds so they have no investment filings or FINRA/SEC requirements and as LLC’s it is very difficult to track the owners. Many are personal investors who themselves have their hands in multiple pockets. They are generally a tight knit group of people who use the same brokers, the same collections attorneys, the same funding groups, etc. 

Most, with very few exceptions, are predatory.

In the interest of full disclosure, there are a small number of these loan companies that are honest and upfront and you know what you are getting. They are few and far between and the desperate Borrower has no way to differentiate.

DO NOT GO WITH A MERCHANT CASH ADVANCE WITHOUT ADVICE OF COUNSEL AND AN ANALYSIS OF THE COMPANY. MOST ARE PREDATORY LENDERS!

HYPOTEHTICAL:

You are a business owner with generally high receivables ($5,000,000/month or $60,000,000/year). You find yourself in a situation where two of your biggest clients are not paying on time and you have payroll to make for your employees for the first pay period in March (You pay on the 1st and 14th) . The payroll requires $300,000, not a big deal since you have $3,000,000 outstanding in invoices (the two unpaid bills). You need cash in 4 days or you will miss payroll (sense of desperation sets in).

A Merchant Cash Advance (MCA) company “A” comes to you through a broker/intermediary or salesman and says we can offer you an immediate infusion of cash of $300,000 for a year. You will repay us on daily draws. We don’t need any major credit checks, just a list of your invoices. 

AND! You will have your money in the account in 3 days, just in time to pay your employees. 

BUT! We will have the rights to collect on those invoices (your receivables) if you cannot make the payments. We will want access to your bank account so that the money comes out immediately. We want your vendor lists. You just have to sign a bunch of papers.

BECAUSE: We are low interest at 6.5%/year or $19,500.00, you don’t have much time to decide. You just need to sign the papers.

OH YEAH… YOU ALSO NEED TO…  personally guarantee the loans AND sign a “Confession of Judgement.” 

A Confession of Judgement is a shady and dangerous legal document, lender-friendly,  borrower-unfriendly. It is akin to an absolutely inarguable Judgement against you if you triggered by a “default.” Depending upon the loan documents (which they convince you not to read carefully) the TRIGGER can be anything from missing a payment to needing additional cash. The Confession of Judgement allows the Lender to demand repayment of loans (from your vendors) without need of going to court to try a case. It will not matter why you could not make payments. It will not matter if the company “jumps the gun” and does not wait for you to actually default by missing a payment. The rules are drafted into the fine print on the loan documents. The action that the MCA company will need to take is a Declaratory Judgement action to simply give them the rights to start collections directly from the vendors who owe money.

UCC FINANCING, LIENS… Most MCA companies also take at UCC financings on the business and on the personal guarantees. Most MCA companies have judges who are “friendly” to these types of transactions and will “fast-track” the stamp on the Confession for collections purposes.

AND THE KICKER: The Confession of Judgement calculates the entire value of the loan at payment time of the entire loan + Fees for “litigation” for “Collections Actions” for other various fees. Usually a Confession of Judgement on an initial offer of $300,000 is listed as a judgement for somewhere between $425,000 and $500,000 or thereabouts, based upon experience reviewing documents.

THE FINE PRINT! The fine print on these loans can be any of the following, each of which can be used to trigger the Confesssion of Judgement.  1. you are precluded from incurring additional debt without advising them; 2. you advise them in the event of hardship; 3. you not place additional liens on the same assets, etc. etc. 

NEVERTHELESS: You think to yourself, this is okay. I am borrowing $319,500.00. On 100 days/year, that’s $3,195.00/day to be drawn from your account, you can do that.

AND: The broker/customer relations person/salesperson convinces you that you can prepay without penalty. He does not tell you that prepayment is prepayment of the face value on the Confession of Judgement, not what you owe on the date of payment. 

SO IN YOUR DESPERATION: You need the cash. It will all be easy because the outstanding invoices cover that no problem. There is no prepayment penalty (or so you are told). As soon as you get the money, you should be able to pay it off. You did not consider your usual use-of-funds and how you stepped into this trap in the first place, short on cash.

SO YOU TAKE THE BAIT!

IF ONLY:  that were the only money you would be paying…. It isn’t. You think to yourself, I can pull this off. 

BUT: MCA A then says that they take 4.5% immediately ($13,500.00) at the time of the loan as a service fee. The loan guy tells you not to worry because it is added to the principal balance so it is not a big deal. So, actually, you are taking out a loan of $313,500.00. The 6.5% interest is on the total

IF ONLY:  it were the only money you are paying it would total $20,377.50. Now the daily draw will actually be $3,338.78/day. 

BUT: The company then says that there is a one-time account setup fee of $2,500.00. No big deal because that is added to the principal balance also. It is baked into the loan. So, your $300,000.00 loan is actually $316,000.00. Your interest is now $20,540.00 (because it is on the total and fees). 

BUT: The company forgot to tell you that there is a daily transaction service fee of $74.71 for every withdrawal. 

NOW: Your daily withdrawal has gone from $3,195.00/day to $3,440.11 (rough numbers). That’s an additional $245.11 on the daily draw or approximate 7%. So your actual interest rate is about 11.5% on the loan.

AND: that’s not where it ends. The fee structure continues. Each fee is added to the initial loan amount, thereby increasing the principal balance of the initial loan. If you stopped there, the total payment to the company would be $344,111.00 at the end of the year. 

BUT: The Confession of Judgement includes all kinds of other fees and no one tells you that no matter what day you pay, you are paying on what is listed on that Confession of Judgement, whatever amount MCA A has added, and all of the associated fees. 

ALSO: If you fail to make the loans after 6 months of payments, even assuming you had a year, the MCA company will go to the court with the amount listed on the original confession of judgement form, not accounting for reductions. 

TWO WEEKS LATER: after making daily payments, you realize that you did not account for your usual use of funds. You need to buy supplies. You need to carry out the ordinary course of business. And you cannot because you are paying nearly $3,500.00/day of draws.

So, in walks MCA Company B.

ANOTHER LOAN: MCA company B offers you an immediate influx of $50,000.00 to keep things running, also under the same terms and conditions as MCA A. He lists MCA A as a creditor so the interest rate is a bit higher because you are now  a greater risk. 

WHAT YOU DON’T KNOW: MCA A and MCA B are largely the same investor pool. They are in cohoots. MCA A now knows that you are having cash-flow problems and need a second loan. If you call MCA A to try and renegotiate, they advise MCA B and both companies decide who is going to be the first to file on the Confession of Judgement. You have effectively warned both companies that you are having a problem with cash-flow and are in danger of default.

What do they do? They send in their friend from MCA C…

 

FOR ADDITIONAL READING:

https://loans.usnews.com/what-is-a-merchant-cash-advance

https://www.pymnts.com/news/b2b-payments/2019/open-banking-merchant-cash-advance-mo-technologies/

https://www.post-gazette.com/business/money/2019/09/15/Small-businesses-high-interest-lenders-merchant-cash-advances-bank-loans-refinance/stories/201909150025