Understanding the New Landscape for Law Firm Financing
The Small Business Administration (SBA) has implemented a significant rule change that directly affects law firms carrying Merchant Cash Advance (MCA) debt. Effective June 1, 2025, SBA loans—including 7(a) loans, Small loans, SBA Express loans, and Export Express loans—can no longer be used to refinance MCA debt or factoring agreements. This regulatory shift creates important considerations for law firms that have utilized MCAs as a financing solution.
What This Change Means for Your Firm
The SBA rule change prohibiting the refinancing of MCA debt with SBA 7(a) loans for new applications represents a significant shift for law firms with existing MCA debt. These firms now face increased difficulty in alleviating the burden of high-cost advances characterized by short repayment terms and frequent deductions from their revenue streams.
The Deadlines
The window for refinancing MCA debt with SBA loans closes permanently on May 31, 2025. Law firms carrying MCA debt face an urgent decision point with less than two weeks remaining to initiate SBA refinancing.
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Why the Change?
The SBA’s policy change aims to reduce loan defaults. The agency observed a pattern where businesses refinanced expensive MCA debt with SBA loans, received remaining loan funds, and subsequently incurred new MCA debt. This practice undermined the SBA loan’s intended benefit and contributed to higher default rates.
The Challenge of MCA Financing for Law Firms
A Merchant Cash Advance (MCA) is a type of financing that provides a business with an upfront sum of cash in exchange for a portion of its future sales or receivables. Unlike a traditional loan, an MCA is technically structured as a sale of future receivables and not as a debt instrument. Repayment to the MCA provider is typically made through a percentage of the business’s daily credit card sales or direct withdrawals from its bank account via ACH.
Key features of MCAs include
- Absence of a fixed Annual Percentage Rate (APR); costs are determined by a factor rate.
- Short repayment terms, generally 3 to 18 months.
- Frequent repayment schedules, often daily or weekly.
- Minimal underwriting, focusing primarily on revenue rather than credit score.
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The High Cost of MCAs
MCA financing can be substantially expensive, with effective APRs often ranging from 60% to 350% or higher, significantly exceeding conventional loan interest rates. Factor rates, typically between 1.1 and 1.5, determine the total repayment amount, leading to a higher cost of capital compared to traditional interest rates.
For law firms, daily or weekly automatic deductions from MCAs create significant operational challenges. For instance, required monthly payments for an $80,000 MCA might be $5,000, compared to $800 for comparable specialized law firm financing, with effective interest rates of approximately 65% for MCAs versus 24% for specialized solutions.
Unique Impacts on Law Firms
Law firms might turn to MCAs for various reasons, often seeking quick access to capital to address immediate cash flow needs, fund marketing initiatives, or facilitate business expansion. This can be particularly appealing for law firms that experience irregular cash flow cycles, especially those working on contingency fee cases or with clients who have extended payment terms, potentially making it challenging to secure traditional bank loans.
Contingency fee law firms, in particular, face distinctive cash flow challenges that historically made MCAs appealing despite their high costs:
- Unpredictable, lengthy case timelines
- Varying settlement amounts
- Risk of unsuccessful cases affecting profitability
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The Risks Going Forward
Without SBA refinancing, law firms face an elevated risk of defaulting on MCA obligations, potentially leading to severe financial distress and legal action. Defaulting on MCA payments can trigger aggressive collection efforts, including forced repayment, restraint letters to clients directing payments to the MCA company, and increased bankruptcy risk.
Furthermore, traditional lenders may become more hesitant to provide other financing to law firms holding MCA debt, perceiving them as higher-risk borrowers. The presence of MCA debt on a law firm’s balance sheet might cause banks to adjust underwriting models, potentially leading to more loan application rejections.
Alternative Financing Solutions for Law Firms
Given the upcoming restriction on SBA refinancing of MCA debt, law firms will need to explore alternative financing solutions to manage their capital and address existing MCA obligations.
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Business Lines of Credit: These offer flexible access to working capital, with interest charged only on the outstanding balance. They can be cost-effective for short-term needs and potentially for consolidating MCA debt but often require a decent credit score and solid financial history.
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Term Loans: Providing a lump sum for various purposes, including significant investments or debt refinancing, term loans feature predictable fixed monthly payments over a set term. They offer a stable repayment structure and can be used to refinance MCA debt at more favorable rates. However, approval processes may be stricter, requiring extensive documentation and a strong credit profile.
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Specialized Law Firm Loans: Certain financial institutions offer loans tailored to the unique financial needs of legal practices. These loans often accommodate irregular cash flow and distinctive billing cycles, with flexible repayment options that align with client payments, providing a more sustainable solution. The litigation finance industry, now a $15.2 billion market, offers case-specific funding that doesn’t impact firm-wide finances; over 80% of attorneys who have used it would do so again.
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Debt Consolidation and Settlement: Law firms with multiple debts, including MCAs, can consider debt consolidation loans from non-SBA sources. These loans combine several debts into a single loan with one monthly payment, simplifying repayment and potentially offering a lower overall interest rate. However, firms should carefully evaluate fees and interest rates. Firms struggling with MCA debt can also negotiate more favorable repayment terms or settle the debt for a reduced amount. Seeking assistance from attorneys or debt relief companies specializing in MCA debt can be beneficial for reviewing agreements and negotiating with providers.
Strategic Recommendations for Law Firms
In light of the SBA’s upcoming rule change, law firms with existing MCA debt need to proactively consider their options and develop effective strategies for managing their financial obligations.
Immediate Actions
Law firms that have already initiated the SBA refinance process must expedite their applications to ensure submission before the June 1, 2025, deadline. All law firms with MCA debt should thoroughly assess their current financial situation, evaluating the terms and overall cost of existing MCA agreements, including effective APR and associated fees, to understand the true debt burden.
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Long-term Financial Planning
Implementing effective cash flow management strategies is paramount. This includes proactively negotiating favorable client payment terms, diligently managing firm expenses, and developing accurate financial forecasting to anticipate and address potential cash flow shortfalls. Law firms should strongly avoid “stacking” MCAs—taking out new MCAs to cover existing ones—as this can quickly lead to an unsustainable debt cycle.
Cartiga: A Better Alternative for Law Firm Financing
While many traditional financing options may not fully address law firms’ unique needs, specialized legal funding providers like Cartiga offer tailored solutions to manage cash flow challenges more effectively than MCAs.
Cartiga provides specialized financing solutions that understand law firms’ unique cash flow patterns, particularly those on contingency fees. With flexible repayment terms aligning with case resolutions, competitive rates significantly lower than MCAs, and no daily or weekly withdrawal requirements, Cartiga offers a sustainable alternative to the high-cost, high-pressure world of merchant cash advances.
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Conclusion
The SBA rule change prohibiting MCA debt refinancing significantly alters the financing landscape for law firms. With the June 1, 2025, deadline rapidly approaching, law firms with existing MCA obligations must act swiftly to explore their options, whether expediting SBA loan applications or transitioning to more sustainable financing alternatives. By understanding the implications of this rule change and proactively addressing their financing needs, law firms can navigate this transition successfully and establish a more stable financial foundation.
