Whether Something Is a Disguised Loan
A merchant cash advance is supposed to be a purchase of future sales, meaning the more you sell, the more you repay. Payments are keyed off your estimates of future revenue. A big issue is whether there’s an adjustment if your sales are lower. If not, it may be a loan, not a sale of future revenue. If you have a reconciliation clause, don’t let your account drain out of funds before asking for an adjustment. Know the consequences of default and whether you have any protections.
Sometimes the MCA eats more money than the business is bringing in, leaving too little revenue for expenses. Other programs charge a fixed daily, weekly or monthly debit, and estimate future revenue to calculate how much you can afford to send them. When the business has a slow month, there isn’t enough sales money for other expenses. Providers are looking at the likelihood that you’ll make the payments, so they’ll look at your industry, your years in business, your recent revenues, your credit card volume, and often your personal credit score. Riskier businesses get higher rates.
New York courts deciding whether something is a disguised loan tend to look at three things:
- whether it has a reconciliation provision;
- whether it has a finite termination date; and,
- whether it says MCA company has recourse if you file bankruptcy.
The leading New York case on MCA is LG Funding v. United Senior Properties, a 2020 decision by the NY appeals court. In that case, the merchant had agreed to daily debits of 15 percent of the daily revenue, which aligned the merchant’s payments with its sales.
Effective Rate
Another problem is cost. How much is this financing going to cost? A factor rate of 10-15% seems small, but a factor rate is a misleading number. MCA debt usually costs more than it seems because the faster you repay, the higher the effective rate. Sometimes triple digits. For example: let’s say the advance is $100,000, the factor rate is 12%, and the agreement says you have to pay off $112,000. You make $250,000 a month in sales. 15% of sales is $37,500 a month. At that pace you can repay the debt in about three months and move on. Your effective rate would be about 48%. But let’s say business is tough. Your sales decline.
With the 15% arrangement, as your sales decline, the payment shrinks. If they drop all the way to $62,219 a month, 15% is $9,333 a month. If they continue, it will take about a year to pay off your merchant cash advance debt. At $9,333 a month, the effective rate is about 12%. But at a fixed withdrawal, you pay $37,500 a month no matter what you bring in, leaving you short for other expenses. The convenient fix is a new MCA. Getting a second merchant cash advance “consolidation” can make things worse because you have to pay twice for the money. Before taking more cash, shop around for less costly options like a small business line of credit, SBA loan, equipment or inventory financing, or invoice factoring. Small banks and credit unions usually offer better terms.
Default Can Have Worse Consequences
What happens if you fall behind? Default can have worse consequences with a merchant cash advance. The contract may say it’s a sale not a loan, so lenders aren’t under federal lending rules. You could lose the option to defend in court. Your business and personal bank accounts can be frozen. Your credit can take a hit.
Are there any limits on what they can do? Yes. New York signed a new law, on August 30, 2019, that says a confession of judgment may only be filed in the New York county where the debtor lived. That is good for businesses in other states. Regulators have stepped in. In August 2020 the FTC sued Yellowstone Capital, saying it kept collecting money after merchants had paid in full. The FTC said refunds sometimes took weeks or months. In January 2025, the NY Attorney General reached a settlement with Yellowstone canceling about $534 million in debts.
A Texas rule taking effect July 9, 2026 bars merchant cash advance companies from setting up automatic debits of your deposit account unless they hold a perfected first-priority security interest in all your receivables. Also there is the Commercial Finance Disclosure Law in New York. It requires certain disclosures including the estimated APR on deals of $2.5 million or less, making you better able to compare the cost.
What if they’re draining the account? The last resort may be a bankruptcy. A bankruptcy triggers an automatic stay that stops collection of debts from before the filing. A bankruptcy for small business called Subchapter V is available for companies with less than $3,424,000 of debt.
Bottom line: if you have a merchant cash advance contract with a reconciliation clause, ask to lower payments if your sales are down. Try it before default. Know your state’s rules.