While many companies are easily approved for a Merchant Cash Advance (MCA) funding, it has become one of the most popular ways for many business owners to easily access cash. The challenge becomes trying to pay it off when the payments exceed the income stream. When this happens, the shortfall requires the business owner to take on a new funding creating two daily or weekly stacked payment obligations that are no longer sustainable.
MCAs were never intended to be used as on ongoing cash flow solution (Overlapped & Stacked) with a 30% to 50% cost of funds. There are very few businesses that can sustain this type of dilution in their cash flow cycle.
A recent case we encountered with a staffing agency that was growing and offering credit terms to customers ended up with 5 MCA loans stacked. Eventually, the debits were more than the incoming deposits. The staffing agency was profitable, but the stacked payments made it impossible to meet its obligations for payroll and insurance expenses. The owner was no longer taking a salary and the future of the business was at risk of defaulting.
If a business is growing and offering credit terms, MCA options are not the solution and the receivables outstanding will eventually outgrow the MCA availability. At some point the cost of MCA loans will exceed the net profit and the business will not be able to exit its liabilities. Reaching out for more MCA loans at this point will just extend the life of the business incurring more debt.
The best financial solution for businesses offering credit terms to customers is invoice factoring. If a business has enough outstanding receivables to payoff the MCA debt, this is the best time to exit. Invoice factoring is a form of financing that provides instant cash flow to businesses by selling their invoices on an ongoing basis. There is no debt incurred, and the business pays a minimal fee per invoice rather than daily/weekly draws like an MCA loan.
In some cases, getting the MCA lenders to reduce the amount of the draws may help if the business owner can demonstrate a legitimate payment plan matching the deposit cycle. The problem that remains is growth and continuing to offer credit terms to clients with limited funding.
If the lenders refuse to negotiate, the business can file Chapter 11 using Debtor in Possession (DIP) Factoring. In this case, the client enters Chapter 11 bankruptcy and simultaneously assigns a factoring company to finance its receivables. The court will grant the factor a superior lien on all the accounts receivable assets and issue a stay order to all the lenders and vendors. The business will be able to continue with a new receivable-based financing arrangement while it negotiates with the previous lenders.
Learn more How DIP Factoring can help businesses in this scenario.
Raul Esqueda, President of 1st Commercial Credit, LLC