The Merchant Cash Advance World – An Update
Marc Mellman, managing director at MCA Stacking Solutions, is back with more advice and updates on the merchant cash advance, where it fits into the lending landscape and what to expect in the next few years from usury states as well as non-usuary states.
By MARC MELLMAN, MANAGING DIRECTOR, MCA STACKING SOLUTIONS
The world and, particularly, the alternative finance marketplace have changed dramatically in the past few years since I penned my article for IFA’s Commercial Factor E-Magazine, Out of the Rabbit Hole: How to Help Clients Dealing with Stacked MCA Debt. COVID-19 almost brought the economy to a halt, liquidity has nearly dried up at times and small to medium sized businesses have experienced greater challenges than ever in trying to stay afloat.
A Bit of History – The Underlying Problem
Among constants that seem to permeate the alternate finance space, after experiencing a marked downturn in 2020 through early 2021, the merchant cash advance world has come back strong. While it’s true that in 2020, as the pandemic took hold, the MCA industry, like most industries, experienced significant problematic effects – the industry consolidated as small MCAs, experiencing unaffordable losses, were either driven out of business or their remaining portfolios were acquired by their larger, better funded competitors. In the past 18 months, the MCAs have been funding more and greater “loans” to the small, mid-level, business community, charging the same usurious interest rates, all on the ruse that the MCA contract is a “true sale” rather than a “loan,” to avoid the prospect of having a court decide that the very nature of the transaction is exactly a loan at a usurious rate of interest and thereby void and uncollectable.
The question continues to be, why then would a business continue to turn to MCAs in the first place? Why would an owner-entrepreneur, who is typically the person making all decisions for the business operation, seek financing from an MCA rather than from a bank, factoring company or other alternate finance source? There are, unfortunately, very simple answers to these questions. The typical need that drives a business operator to an MCA for financing results from a strained cash flow situation in the company coupled with an immediate need for a sizable amount of money to pay large and recurring expenses (e.g., payroll, taxes, insurance, raw materials, etc.). The small to mid-size company typically does not qualify for bank financing, does not have accounts receivable that will support a factoring relationship and in many cases cannot get approved for any alternate financing because of various reasons (e.g., company and owner credit history, creditworthiness of account debtors, debt stack, length of time in business, etc.). The situation presents the owner with nowhere to turn other than to an MCA. The MCA provides almost immediate availability, even as soon as within 24 hours, with online application and approval, e-document agreements and with little or no underwriting (although the MCAs will say otherwise [with their tongues firmly planted in their cheeks]). Under this stressful cash flow pressure and need for funding, the typical owner does not worry or consider the fact that, no sooner than the proceeds are received from the MCA, the following business day repayment commences with an automatic debit from the company’s operating bank account. And that is where the real trouble begins or is further escalated.
Post Pandemic – Continued Growth and Presence of the MCA Industry
While many in the alternate finance space believed during the pandemic that the industry would see the MCA business shrink, just the opposite took place. Consolidation strengthened and led to further growth of the MCA. A significant number of the same players in this space that existed pre-pandemic continue to exist post-pandemic and have enlarged their operations. New players of all sizes are on the scene as well. Notably, the MCA finance space is larger than ever before, the cash is readily and easily available, and the debt created from these loans continues to grow at an astounding rate, thereby placing small to mid-size businesses in a hardship situation resulting from the inability to make the called-for payments under the contracts.
Usury and the Law – the MCA Lender End-Around
What we have also experienced post-pandemic is the use of deal structures that are loans in addition to structures that are classic MCA loans disguised as True Sales. A growing number of companies provide loans at stated interest rates for fixed terms, even though the interest rates would usually be considered usurious under state law. It is quite common now to see transactions with interest rates ranging from more than 25% to more than 99%, where the usury rate in the state in which the borrower is located is less than those rates. The MCA disguised as a lender utilizes a few tools to accomplish this feat. Even though the usury rate in California is 10%, a company can obtain a finance lender’s license with relative ease, for example. The lender’s license allows the lender to receive borrower’s payments at a rate far greater than 10%. In some states, like Utah and others, for example, where there is no usury restriction, loans may be made to companies outside these non-usury states at high interest rates because the loan agreement provides for law, jurisdiction and venue in Utah. We see more and more MCAs “piggybacking” on these lenders to facilitate their businesses. The form of the loan agreement in these instances may casually appear to be a loan, but the substance of the agreement is the same as an MCA contract.
The Law It is Evolving – But Not Just Fast Enough
Historically and until recently, the bulk of finance law, particularly as it relates to the MCA industry, has been developed in New York state. New York state has been a creditor-friendly environment, and in this regard, has been friendly to the MCA world through court decisions that have upheld the concept that an MCA contract is a True Sale versus a loan, thereby facilitating enforcement of the contracts. Recently, however, in the past few years, there have been more and more cases in NY state and federal courts that have decided otherwise, but most of these cases are still trial level decisions and have not gone up to appeals courts for final decisions affirming this result. But, the law here is evolving and it is most certainly likely, in the next few years, we will see a seed change to the point where the True Sale interpretation of the classic MCA contract will fade away. And, of course, as mentioned in the preceding section of this article, with the advent of the greater use of loan transactions in licensed states like California or non-usury states like Utah, where the lender does not have to concern itself with characterizing the transaction as a True Sale, much of the enforcement litigation now heads to other jurisdictions rather than New York. Time will only tell if state legislatures and courts will ultimately decide to regulate this area to protect the companies that have no alternative but to borrow this money.