A Funder’s Guide to Managing MCA Defaults

Let’s be honest—missed payments and defaults on merchant cash advances are an ugly and unfortunate reality that MCA funders are sometimes forced to deal with. 

When a merchant defaults, not only is it a headache, but it can eat into your bottom line. Plus, if the deal represents a good chunk of your portfolio, defaulting can disrupt your cash flow and limit your ability to fund new merchants. 

High default rates can also attract regulatory scrutiny, adding more stress to the mix. And as if that wasn’t enough, managing MCA defaults takes time and resources, diverting attention from other critical areas of your business.

But it doesn’t have to be this way. 

In this article, we’ll dive into early detection, prevention, and proactive strategies to help you tackle these challenges and minimize MCA defaults. 

Understanding MCA Defaults

Put simply, a “default” in an MCA agreement occurs when a business misses its agreed-upon repayments—usually structured as daily or weekly deductions tied to sales.

So, how common are merchant cash advance defaults? According to some sources, MCAs have a default rate of about 7-12%. 

While that might not sound high, MCA defaults are starkly higher than business loans from traditional banks. As of early 2024, the default rate on business loans was 1.13%. Even the historical high for loan defaults—6.75% in April 1987—was still lower than the current MCA rate.

As for what’s driving businesses to default on their MCA repayments, several factors contribute to this issue, including:

• Cash flow problems: Seasonal variations in revenue, inconsistent earnings, poor financial management, inadequate budgeting, and a lack of emergency funds can leave businesses vulnerable.
• Economic downturns: Wider economic issues like recessions or increased competition can cut into consumer spending and create a sharp drop in sales.
• Overleveraging: Taking on too many financial commitments, whether through multiple merchant cash advances or other debts, can strain a business’s resources and hinder effective financial management.
• Unforeseen expenses: Unexpected costs like equipment breakdowns, emergency repairs, or legal issues can quickly deplete cash reserves, affecting a merchant’s ability to make timely payments.
• Operational challenges: Supply chain disruptions, staffing shortages, or operational inefficiencies can impede a business’s ability to generate revenue.

But while it’s important to recognize the causes of MCA defaults, we don’t have to accept them as inevitable. 

Rather, through proactive strategies, MCA funders can simultaneously manage the risk of defaults, protect and foster their business growth, and even enhance client satisfaction in the long run.

Taking Legal Action: A Last Resort

While it might be tempting to pursue legal action against a merchant who defaults on their MCA payments, this approach is usually not advisable. Here’s why:

• First, the key appeal of merchant cash advances is their speed and flexibility. Businesses turn to MCAs for quick funding with fewer requirements—and if you quickly resort to litigation, this could undermine that trust, lead to negative publicity, and deter future clients who prefer supportive partnerships. 
• Second, MCAs are structured as purchases of future sales. They are not loans, so they are not regulated the same way. Pursuing litigation can therefore be tricky. Moreover, it can be costly and lengthy. It may not even be worth it, given how many MCA clients are small businesses with limited assets. 

Also, legal action can seriously impact small businesses, threatening their financial stability and future funding opportunities. Many do actually intend to repay but face challenges—and a history of defaults could label them for years to come as high-risk, complicating approvals. 

For all these reasons, it’s important to consider whether pursuing legal action is truly worthwhile, or if adopting more empathetic and flexible strategies—like those discussed below—might be the better option.

Default Management Strategies

As a merchant cash advance funder, investing in and implementing preventative strategies isn’t just about avoiding losses—it’s about building a stronger, more sustainable business model for your funding operation. 

These five default management approaches are vital for thriving in the MCA sector, where balancing risk and reward is key. 

1. Enhance Your MCA Underwriting Processes

Different small businesses have unique risks and cash flow patterns, so it’s essential for funders to consider the specific industry of each merchant. For instance, freelancers and gig workers often experience fluctuating incomes, making traditional assessment methods less effective. 

Consider customizing your underwriting criteria to fit various sectors, which will enable you to evaluate repayment capacity more accurately. 

For example, instead of relying solely on FICO scores, consider alternative credit assessments, which involve looking at payment histories from utilities or rent; and/or 

Also, you can (and should) implement advanced data analytics into your operations—this will help you uncover critical risk factors of applicants, leading to better-informed lending decisions and improved outcomes.

2. Set Up Early Warning Systems 

For MCA  funders, setting up automated and continuous monitoring systems to track a merchant’s sales and real-time banking activities can be a game-changer. These systems can help you catch potential distress signals early on, such as sudden shifts in financial behaviors.

By leveraging SaaS platforms/tools to spot red flags, you can take a hands-on approach to manage merchant risk and tackle issues before they become major problems. Regularly check in on your clients’ financial performance and keep in mind market conditions. 

Both will give you valuable early warnings of any trouble ahead.

This proactive strategy puts you in a position to act quickly, helping you minimize defaults and support your clients’ financial health.

3. Prioritize Transparent, Proactive Communication

Ongoing, proactive communication is essential for reducing defaults on MCAs. From the very beginning of the relationship, funders should:

• Clearly outline all terms—including repayment schedules and fees—to ensure merchants fully grasp their financial obligations;
• Provide ongoing access to educational resources, empowering merchants to navigate their MCA contracts effectively; and
• Promote and hold regular check-ins, creating a comfortable space for merchants to discuss performance and potential challenges, and share concerns. 

When merchants communicate early about difficulties, funders can intervene before issues escalate into defaults. 

Ultimately, effective communication builds trust, fosters long-term relationships, and allows for collaborative solutions that benefit both parties, reducing default risks and preserving valuable partnerships.

4. Customize and Adjust Repayment Plans

MCA repayments, based on a percentage of daily or weekly sales, naturally adjust with a business’s cash flow—with higher payments during good times, and lower ones during slow times. 

However, sometimes the MCA terms don’t align well with a merchant’s revenue patterns, complicating timely repayments.

The good news is that, given the inherent flexibility of MCAs, there is often room for customization to help prevent defaults. 

If a default arises from a temporary issue and the merchant is open to collaborating on a solution, consider restructuring the advance. 

This could mean reevaluating pricing, adjusting repayment percentages for seasonal changes, or temporarily pausing payments. The goal is to make repayments manageable while still recovering your investment.

5. Conduct Soft/Hard Collections

When it comes to recovering overdue payments on MCAs, funders typically use two main approaches: soft and hard collections.

Soft collections focus on “gentle” communication like reminder emails and phone calls to encourage repayment, while still preserving positive relationships. This collaborative method is generally effective for merchants who face temporary financial struggles but are otherwise willing to cooperate. 

Many merchant cash advance funders will start with this approach before turning to hard collections—a more aggressive, less personal and more costly tactic. 

Hard collections often involve hiring a collections agency. 

But buyer beware: if you must go this route, it’s important to choose an ethical partner who can carry out effective collections in a respectful manner. This will help safeguard your reputation among potential and current clients, and maintain a positive business image.

Managing MCA Defaults: Tech Can Help

While implementing the above strategies may initially seem resource-intensive, numerous SaaS lending platforms and funding tools can help you execute them quite easily, while also enabling you to maintain daily MCA funding operations. 

Here are some key benefits these solutions offer to funders:

First, data and predictive analytics. 

Save time and reduce the risk of defaults from the get-go by gaining access to industry-specific data related to the applicant, including revenue trends, cash flow patterns, and historical payment behaviors; and then monitoring merchants’ financial activities in real-time, identifying early warning signs like revenue declines. 

Second, enhanced reporting and insights.

SaaS platforms offer comprehensive reporting tools that provide insights into portfolio performance, merchant behavior, and market trends. By quickly identifying at-risk merchants, you can implement targeted strategies to mitigate defaults—such as offering financial education or tailored repayment options—without the need for extensive manual analysis.

Third, automated reminders and streamlined communication. 

These platforms/tools facilitate consistent engagement with merchants, keeping them informed about their repayment status and available options. Automated reminders and personalized outreach can also help streamline soft collections, allowing you to handle these efforts internally rather than relying on costly external agencies. This not only saves you money but also strengthens relationships with your merchants.

Lastly, minimize manual and repetitive tasks. 

Make term adjustments quickly within the system so you can customize merchants’ solutions without the hassle of extensive paperwork. Automating routine tasks frees up your resources for strategic decision-making, enhancing overall operational efficiency and enabling you to focus on growth rather than administrative burdens.

Onyx IQ Equips MCA Funders for Every Default Challenge

Ultimately, managing defaults as a merchant cash advance funder requires a flexible and compassionate approach. 

It’s about understanding the unique challenges your merchants face, fostering an environment of open communication, and strategically implementing technology to mitigate risks while strengthening client relationships.

And that’s where Onyx IQ enters the picture.

Our all-in-one MCA funding platform will automate your funding decisions and workflows so you can mitigate risk and quickly adapt to any default-related situation.

Plus with Onyx IQ, you can also fund more MCA deals, empowering your business to grow while genuinely supporting your merchants through their financial journeys.

Want to handle defaults with greater efficiency? Set up a demo today to explore how Onyx IQ can support your efforts.