When it comes to securing quick funds, a Merchant Cash Advance might seem like the perfect solution, but it can also lead your business into hot water if you’re not careful – yes, we mean merchant cash advance default. It can steer your business in the wrong direction.
And the truth is, without proper planning and cash flow management, repaying MCAs can become overwhelming. In this article, you’ll explore practical strategies to prevent MCA loan default, ensuring that an MCA works as a stepping stone for growth, not a pitfall for failure.
Understanding MCA default: What it means
MCA default occurs when a business fails to meet the repayment terms agreed upon with the MCA provider. Unlike traditional loans, an MCA is repaid through a fixed percentage of future card sales, so if a business experiences slower sales than expected, default can become a real possibility. But what exactly does MCA loan default entail?
Definition of default
MCA loan default isn’t just about missing a payment – it’s about the inability to meet the daily or weekly deduction obligations tied to your sales. Since MCA repayments are based on revenue, a downturn in sales can make it hard to meet these obligations.
Consequences of default
The consequences of an MCA loan default can be severe, affecting both cash flow and long-term business prospects. If the default isn’t managed early, the MCA provider may increase fees or take legal action, leading to bank account freezes or even lawsuits.
Additionally, defaulting on an MCA can damage your business’s credit score, which can limit future access to financing options like accounts receivable factoring, bank loans and merchant services from other providers.
Early warning signs
Recognising early signs of default can help your business take proactive measures. One of the most common red flags is declining sales. If your business experiences a revenue slump, you’ll want to immediately assess whether you can still manage the MCA’s daily deductions.
Another early indicator is cash flow issues – if cash on hand isn’t sufficient to cover operating expenses along with MCA repayments, you may be on the brink of default.
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Major causes of MCA default
Understanding the primary reasons behind MCA default is key to avoiding financial pitfalls.
1. Declining sales
The most common cause of an MCA default is a significant drop in sales. You’re paying for the MCA repayments with your daily/weekly revenue; failing to keep the needle moving up can result in a struggle to meet the repayment obligations. For instance, a retail store relying on holiday sales might face serious repayment challenges during the off-season.
If your business doesn’t plan for these fluctuations in cash flow, the probability of default increases. To counter this, businesses should create a realistic sales forecast, accounting for seasonal dips and unexpected downturns.
2. Overborrowing
Taking too many MCAs or borrowing more than your business can handle is another fast track to default. It increases the pressure on revenue streams and can turn cash advances into a debt spiral, leaving your business with insufficient funds to convert multiple repayments.
3. Unrealistic sales projections
Optimism is a great asset for business owners, but overestimating future sales can be dangerous when taking an MCA. If sales don’t meet the projections you used to justify taking on the advance, you’ll find yourself unable to make consistent repayments, which will trigger an MCA loan default.
4. Inadequate profit margins
When businesses have thin profit margins, even a slight increase in costs can lead to financial strain. If the profits aren’t enough to cover the daily MCA deductions along with operational expenses, default becomes almost inevitable.
For example, a coffee shop operating on thin margins may use an MCA to boost capital for a new marketing campaign, but if the campaign doesn’t result in higher sales, those daily repayments will eat into its already limited profits.
5. Failure to understand MCA terms
Some businesses enter MCA agreements without fully understanding the terms, including the costs, repayment percentages and additional fees. Without a clear understanding of how repayments will affect daily cash flow, you can quickly become overwhelmed. This is why it’s integral to get help from an experienced accountant and financial planner.
How to avoid merchant cash advance default?
Avoiding an MCA default requires careful planning and proactive management. It’s not rocket science, but without a strategy, businesses can quickly find themselves in hot water. Here are some actionable ways:
1. Evaluate MCA terms carefully
Before taking out a normal or emergency Merchant Cash Advance, it’s crucial to read the fine print. Repayment terms, fees and the percentage of sales taken daily or weekly. A great deal might not be so great if it stains your cash flow. Ask yourself, “Can I manage these deductions during slower sales periods?”
2. Monitor cash flow regularly
Maintaining healthy cash flow is key to avoiding default. Regularly monitor your incoming revenue and outgoing expenses, making sure you always have enough to cover the MCA repayments.
It’s not enough to just pay attention during good sales months – keep an eye on it year-round. For example, an e-commerce store might see a spike in sales during a Black Friday promotion, but poor cash flow management after the season could result in repayment issues.
According to an article in Zippia, bank studies have shown that almost 82% of businesses close due to cash flow issues.
3. Negotiate MCA terms
What’s the biggest advantage of MCA? The flexible repayment structure. Right? But they can become a roadblock in your cash flow as well. If the initial terms of your MCA seem too aggressive, don’t hesitate to negotiate. MCA is not regulated in the UK (at the time of writing) so you can always discuss possibilities with providers.
Many reliable MCA providers in the UK will be willing to adjust the percentage or offer more flexible repayment plans. You don’t need to sign the first contract put in front of you.
4. Avoid taking multiple MCAs
It can be tempting to stack multiple MCAs, especially when cash is tight, but this is a dangerous strategy. Taking on several advances at once increases your repayment obligations and raises your probability of default. It’s like digging yourself into a deeper hole.
If you find yourself needing additional financing, consider other options like a business loan or a line of credit.
5. Consult a financial advisor
Sometimes, a fresh perspective can make all the difference. Consulting with a financial expert allows you to evaluate your overall health and assess whether an MCA is the right choice for your business. They can also help you structure a realistic repayment plan to reduce the risk of default.
Alternatives to taking out an MCA
While an MCA can provide quick access to cash, it’s always good to have other options in sight as well. If you’re looking for ways to boost capital while avoiding the risks of MCA loan default, here are some alternative financing options:
1. Business loan
- Lower risk of default as they have a fixed repayment amount that isn’t dependent on your daily or weekly sales.
2. Line of credit
- Draw as much or as little as you need and only pay interest on the amount you use. Line of credit ensures you’re not locked into high repayment percentages like with merchant funding.
3. Invoice financing
- Lower probability of default since repayments are tied to the collection of outstanding invoices.
4. Crowdfunding
- A creative alternative to traditional small business financing. It involves raising money from backers who believe in your product or service. In many cases, you won’t owe them anything other than the product/service.
Avoid the risk of MCA default by connecting with reliable providers with ComparedBusiness
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