High Risk Businesses or Risky Lenders?

Jacob Maslow  |

With arguments coming from both sides of the table it’s hard to determine who poses more risk, the MCA (merchant cash advance) companies or the small businesses that use them.

Understandably, business owner who turn to merchant cash advances are typically “high risk,” but how noble are the merchant cash advance companies who stand by ready to provide factoring terms at high costs and with strict contracts?

Villains or Superheroes?

Have these MCA companies stepped in to fill a void - as they claim - left by banks and traditional lending companies which refuse to loan money to “high risk” small businesses struggling with bad credit, limited collateral, and other factors? Can risk justify the high costs and protective terms that MCA companies demand? Businesses who default on a merchant cash advance would likely say “No!”

Reviewing the Nature of the Business

In contrast to traditional interest based credit and business loans, a merchant cash advance is structured more like a purchase of a business’s future revenue. Opponents consider this a technical loophole being exploited by MCA companies to avoid stricter regulations and specific usury laws. With this type of “factoring,” high costs are passed on to the business owners beyond what a bank or credit institution could demand in the form of interest.

While MCA companies defend their product by citing high average default rates greater than 15% (compared to the less than 3% experienced by banks and credit cards), detractors further insist that the advantages enjoyed by the MCA companies are highly unfair to the business owners who use them and can’t pay them back.

The Conversation (In the news)

Publications like Bloomberg have taken the stance that MCA companies are no better than the Big Banks and Government Agencies who have their hands in the costs imposed on business owners who default. However, the contrasting narrative rapidly emerges as each side asserts opposing facts, as can been seen by the Debanked reaction to a Bloomberg story that alleged unfair conduct protected by antiquated state laws and loopholes. Most scathing is the accusation of employing aggressive collection tactics and requiring borrowers to sign a Confession of Judgement agreement prior to receiving funds.

Of all the tools at the MCA lenders’ disposal, the Confession of Judgment, which can provide the authority to place a lien on a business owner’s bank account thereby protecting payment, is by far the most contentious. Merchants with bad credit and no collateral may be asked to sign this legal document as a way of adding an element of security to a sometimes undesired resulting situation.

In New York and many U.S. states, Confession of Judgment documents are legal, permissible and enforceable in the courts, and judges overwhelmingly have adopted the view that by signing the document the borrowers have knowingly waived their rights and have agreed to pay the the MCA companies the stated amount of money owed.

The Heart of the Matter

While confessions of judgement are commonly used by credit providers of all sorts, this tool clearly gives the MCA companies an overwhelming legal advantage in the the courts if the need to use them arises. It seems that the real question that needs to be asked is: Should MCA companies continue to benefit from the protective measures provided by law?

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