A new type of lending has emerged in recent years that has the potential to wipe out unsuspecting businesses that aren’t aware of how it works. Known as merchant cash advances (or MCAs), these loans feature usurious interest rates in the triple-digits annually. They also allow lenders to deduct loan repayments directly from borrowers’ accounts on a weekly or even daily basis. This can result in serious cash flow problems and excessive NSF charges for borrowers.
MCAs have been getting more attention recently after an article in Bloomberg Businessweek late last year revealed how some businesses suffered significant financial consequences after participating in MCA lending. Several of the businesses featured in this article went bankrupt due to the predatory lending practices of MCA lenders.
Service Business Gets into Trouble with MCA Lenders
A 15-year-old service business in Florida that CFG has worked with is among the hundreds of businesses that have been victimized by MCA lenders. The problems for this business started with a split between the two owners. While this isn’t unusual in the realm of small business, it forced the remaining owner to seek outside capital to aid in severing the split and repair some of the financial damage to the company that was caused by the split.
The owner was approached by a fintech lender who promised fast and easy access to capital with minimal qualification requirements and few questions about what the money was for. “They just wanted to see three months of business bank and financial statements,” explains the owner. “I was short on cash to meet payroll that month so I took out a merchant cash advance for $100,000.”
In addition, the business was also working with an asset-based lender (ABL) that was financing accounts receivable to support the company’s growth. The ABL was already growing frustrated with the over-advances that resulted from the financial damage caused by the owners’ split. When they learned of the merchant cash advances the business received, they declared the business to be in default of their security agreement.
Upon this declaration, the ABL stopped funding the business. “They sent us a demand letter saying we had 10 days to repay the asset-based loan,” says the owner. This made a bad situation worse for the company, which found itself with no access to working capital. Not only was the ABL foreclosing, but the fintech lender was sweeping its checking account weekly for repayment of the high-interest merchant cash advance.
In a desperate attempt to keep her business open, the owner borrowed money from family and friends and took out two more merchant cash advances from other fintech lenders. Eventually, she ended up owing more than $450,000 in MCAs to three different fintech lenders and paying interest rates in excess of 60% APR. Not surprisingly, managing these payments and covering the overhead necessary to run the business resulted in a severe cash flow gap for the business.
Banker Makes Referral to CFG
Soon after this, the owner sought assistance from a trusted bank to help her get out of this dire financial situation. The banker referred her to CFG. “I didn’t know where to turn for help, but my banker told me that CFG was familiar with these kinds of lenders,” says the owner. After evaluating the situation, CFG recommended that the business file for Chapter 11 bankruptcy, which would allow them to shed the usurious debt and provide time to recapitalize and emerge from bankruptcy as a healthy business again.
“Chapter 11 allows a company to reorganize while providing a mechanism to restructure debt and liens at more market-based rates,” explains an attorney who eventually worked with the owner. “It also consolidates the forums and provides breathing space to the business in a chess match with the MCAs by allowing a court to actually consider the issues. This may not be done prior to a Chapter 11 filing.”
Here, it’s important to note that the company’s business model was working fine. It was the capital structure that was broken and in need of repair, which the Chapter 11 process would allow.
However, the owner wasn’t ready to file for bankruptcy yet. Instead, she sought input from other ABLs who she hoped would suggest a different solution. Some of these lenders made empty assurances that not only would they lend her enough money to repay all of the MCA debt, but they would also provide the additional capital needed to operate the business going forward.
During initial conversations with the owner, CFG explained that the business’ current collateral base was insufficient to cover the MCA debt and capital for future operations. Since the company is a service business, there are no hard assets that can be pledged as collateral — the only lendable assets are contracts and accounts receivable. The only way for the business to receive ABL funding would be if they pledged additional assets as collateral.
The owner wasn’t hearing this from the other ABLs, who were essentially just telling her what she wanted to hear and offering empty promises. CFG advised her to ask whether the term sheets she received from other ABLs were underwritten or merely sales materials, which is what CFG strongly suspected, and also recommended that she not pay any application fees. Unfortunately, the owner lost an application fee she paid to one ABL when it turned out that the term sheet wasn’t underwritten.
CFG Provides DIP Loan Facility
About 45 days later, CFG contacted the owner to see how things were going. She said that the ABL loan had not closed because the terms in the contract didn’t match those in the term sheet, so she withdrew from further conversations with the ABL lender.
Additionally, the owner said she had decided to file for Chapter 11 bankruptcy and asked if CFG would assist with this. CFG also provided a debtor in possession (DIP) loan facility that prevents the MCAs from garnishing funds from the business. “Calvin Blount and Tracy Eden at CFG stepped in and provided the financing I needed to keep my business afloat,” says the owner.
“Going into bankruptcy isn’t what I wanted to do,” the owner adds. “But CFG helped guide me through this complex and difficult process, and ultimately to find a financing solution that worked.”
HOW THE COMMERCIAL FINANCIAL GROUP CAN HELP
When you partner with The Commercial Financial Group, you can be assured we won’t jeopardize your business. Our goal is to grow your business in a fiscally responsible way. In fact, when you contact us for one of our small business loan solutions (factoring or asset-based loans), we spend a lot of time getting to know you, your company, what your needs are, where you’re going, and how we fit in. If we don’t think we’re a good fit, we’ll say so! The Commercial Financial Group is in your corner always. Contact us today to see how we can help!