On February 3, 2020, Maryland State Senator Benjamin Kramer introduced a bill that would completely prohibit merchant cash advances (MCAs) in Maryland.
MCAs are a form of small-business financing in which a finance company purchases a portion of a business’s future revenue at a discount. In a typical MCA transaction, the business agrees to remit to the finance company a specified percentage of a defined future revenue stream (such as revenue from credit card payments for the business’s products and services) until the full amount purchased has been delivered.
The structure of these transactions offers significant benefits to both the buyer and the seller. Buyers often prefer MCAs to loans because there are no set payment requirements, such as a minimum monthly payment amount. This aligns the financing obligation with the business’s cash flow and eliminates the risk that the business will not be able to make required payments in times when business is slow. Furthermore, if a business goes under, the business and its owner(s) will owe nothing further to the finance company because a business that sells future revenue is only required to give the buyer a share of its revenue if that revenue is actually generated.
MCAs are an attractive product for finance companies because they are subject to less regulation than loans. For example, MCA companies are not currently required to obtain lending licenses to engage in the business, and disclosure and other requirements applicable to loans do not apply.
Despite the significant benefits they offer to merchants, MCAs have come under increasing scrutiny due to the high pricing employed by some MCA providers and the use by a small number of providers of controversial practices, such as allowing enforcement through confessions of judgment. California recently enacted SB 1235, which will require consumer-like disclosures on certain commercial finance transactions including MCAs, although it will not take effect until the California Department of Business Oversight (DBO) adopts regulations specifying the time, manner and format of the disclosures. The Federal Trade Commission and the DBO also have made MCAs a focus of enforcement efforts.
The Maryland bill comes as somewhat of a shock to the industry, as it would ban MCAs altogether rather than seek to regulate them through licensing or disclosure requirements. Although we doubt the bill will be enacted in its current form, some form of MCA regulation appears inevitable in Maryland.
Why It Matters
The Maryland bill confirms that legislators and regulators are concerned nationwide about MCAs and will continue to seek greater regulation of the product and also small-business lending generally. Other states may well follow suit in seeking to regulate MCAs, or even prohibit them.
Efforts are underway to educate legislators and regulators about this product, which is widely misunderstood and often unfairly attacked as a “small-business payday loan.” Although we believe the product is likely to survive legislative challenge, the increasing scrutiny underscores the importance of properly structuring and documenting the transactions as well as ensuring that company policies and procedures follow best practices. The time to review compliance for these products is now.