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Merchant Cash Advances (MCAs) are a hot topic in SBA lending right now. Many lenders are being presented with requests to refinance MCAs, but are rightly questioning whether such transactions are eligible for refinance under SBA Loan Program Requirements. Although whether a particular MCA transaction might be eligible will depend on all the transaction-specific facts and applicable State law, refinance of MCAs with SBA loan proceeds likely presents unreasonable complexity and risk for most SBA Lenders.
The complexity with MCAs begins with the term “MCA” itself. The Federal Reserve Board has distinguished MCAs from loans and noted that MCAs “differ from term loans in that advances entail the sale of a set percentage of the borrower’s future receivables for a specified dollar amount.” Browsing to Borrower: “Mom & Pop” Small Business Perspectives on Online Lenders, Federal Reserve Board at 4 (2018).
For example, a small business might receive $50,000 in exchange for $65,000 in future sales receipts. As the small business makes sales, the provider of the MCA is paid by receiving a percentage of the small business’s daily credit card sales. In another MCA example, the agreement provided that the merchant cash advance provider had purchased $140,000 of the small business’s future receipts for the price of $90,000 and authorized the provider to automatically debit $4,000 from merchant's bank account each day. Crystal Springs Capital, Inc. v. Big Thicket Coin, LLC, 198 N.Y.S.3d 142 (2d Dep't 2023).
But the proper legal characterization of MCA contracts or similar arrangements can be very challenging. Depending on the facts, they might be considered true sales or secured loans. Since their inception as financial products in the 1990s, attorneys, courts, and commentators have struggled with how to characterize MCAs. Some refer to MCAs as the business equivalent of a “payday loan.” See Browsing to Borrower: “Mom & Pop” Small Business Perspectives on Online Lenders, Federal Reserve Board (2018). But as one attorney has noted:
“Over time, the term has simply become an “umbrella category” that covers short-term business financing characterized by daily payments and no longer exclusively refers to the purchase of future credit card sales. People, including some of those within the industry, apply the term to a wide variety of products, sometimes even loans. Today, no one truly knows what MCA means.” Jordan Stevens, The Merchant Cash Advance Industry May Have A Few Bad Apples, but That Does Not Mean It's Time to Empty the Barrel, 49 Tex. Tech L. Rev. 501, 514 (2017).
Because the term “MCA” can refer to a wide array of financial arrangements, legal analysis of the underlying agreement is essential. Courts reviewing MCAs note that such analysis is fact intensive and, as a result, have reached different conclusions. Compare Crystal Springs Capital, Inc. v. Big Thicket Coin, LLC, 198 N.Y.S.3d 142 (2d Dep't 2023) (Merchant agreement governing merchant cash advance constituted a criminally usurious loan, where agreement effected an annual interest rate exceeding 25%) with K9 Bytes, Inc. v. Arch Cap. Funding, LLC, 57 N.Y.S.3d 625, 633 (N.Y. Sup. Ct. 2017) (weighing factors and holding MCA agreement not a loan as a matter of law).
Whether courts in the relevant jurisdiction will treat an MCA as a loan or a sale of accounts receivable is critical for SBA eligibility purposes. Regarding debt refinance, SOP 50 10 7.1 provides, among other things, that the “debt to be refinanced must be, and must have been, current for at least the last 12 months or for the life of the loan, whichever is less.” SOP then lists various types of business debt that may be refinanced with SBA loan proceeds. Where MCAs are not found to be a loan, such arrangements are unlikely to meet SBA’s eligibility requirements. Among other things, an MCA that is not a loan is unlikely to be structured with a demand note, will typically not provide for interest, will not be structured as a revolving line of credit, and will not have a “maturity date” typically found in a loan. In fact, MCAs are often structured to avoid the features typical of loans so that they fall outside the ambit of federal and state lending laws, including usury laws. As a result, depending on the terms of the underlying Agreement (including, e.g. the speed of repayment and percentage of daily sales remitted to the MCA provider), “equivalent annual percentage rates (APRs) can exceed 80 percent or even rise to triple digits.” Browsing to Borrower: “Mom & Pop” Small Business Perspectives on Online Lenders, Federal Reserve Board at 4 (2018). Furthermore, whether characterized as a loan or not, MCAs may include the grant of a security interest in the assets of the small business. For example, one such Agreement provides:
“The security interest described above does not secure any loan payment obligation, since you have no such obligation under this Agreement.”
Nonetheless, the agreement:
“authorize[s] [the MCA provider] to describe the collateral as “all assets of debtor/seller, whether now owned or hereafter acquired,” or words to that effect.” See CAN CAPITAL Future Receivables Purchase and Sale Agreement (Exhibit B), pgs. 5-6.
Because MCAs are structured with numerous underwriting and SBA eligibility pitfalls, any lender attempting to refinancing them with an SBA loan must be capable for performing sophisticated legal analysis and correctly applying the applicable SBA Loan Program Requirements. Thus, for most SBA lenders, avoiding such transactions is the safest course of action.
If your lending institution has questions about Merchant Cash Advances, debt refinance, or other SBA lending matters, please contact us at SBAQuestions@JellumLaw.com.
This article is provided for general information and educational purposes only. It does not solicit, establish, or continue an attorney-client relationship. The contents should not be construed as legal advice or opinion. If the organization would like formal legal advice, our professional liability insurer (as well as the applicable attorney ethical rules) requires that we establish a formal attorney-client relationship. If you are interested in learning more about working with Jellum Law, please contact us at SBAQuestions@JellumLaw.com.
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