The Unofficial Origin of Merchant Cash Advance (In Honor of St. Patrick’s Day)

March 16, 2015

In the late 1790s, two brave pioneers trekked across the North American continent in search of a bank loan alternative. A particularly harsh winter almost managed to dash their dreams, but they pressed on. “For the free market! For funding!” they cheered. Their optimism stood in stark contrast to the cold rugged landscape through which they traveled.

They weren’t the only two who sought change, but they were the catalyst. One of them was Sam Smith, an owner of Ye Olde Bar and Restaurant. His partner was John Stacker. John was the more wild and unpredictable of the two. They had always brewed their own ale but their customers had grown tired of the taste and were turning to local moonshiners.

Eager to win back their customers, Sam reached out to the distributor of a major lager but was told he could only make purchases in bulk. It would cost them $10, nearly the amount his bar would earn in a month. He was confident that if he raised the cash, he could sell it to their customers for far more than they paid for it and come out ahead. Sam knew there was only one place in town to borrow a hefty sum of $10, First American Bank and Trust. It wasn’t a national chain, but rather quite literally the first national bank and the only one that anyone could trust.

“A business loan for $10?” the bankers laughed. “Absolutely not!”

And so Sam realized that if it was capital they sought, they’d have to get it from someone out in the great beyond. John agreed, kind of. He didn’t want to settle for someone. He hoped to enlist the help of everyone.

After packing their bags and saying their farewells, the two partners set off on a 900-mile journey.

Their wagon fell apart about halfway there. When it could no longer be patched up, they continued on horseback. When the horses died, they walked. When their legs gave out, they crawled and when their knees gave out they did the worm.

With barely any energy left and ready to give up, they came upon a charming red brick building in the middle of a desert. A sign was posted outside that said “Ye Olde Barter Shop. Trade Inside.” If for no other reason than to rest, they made their way toward the door.

Behind the counter of the establishment was a dapper old man with silver hair. He spoke with a brogue and was quite possibly of Irish heritage. “Come to trade have ya lads?” He had a warm inviting smile and it caused the two friends to feign an interest, even though they had nothing to trade.

After some pleasant small talk, the Irishman asked what they were looking for. “We need money for our small business,” Sam responded. “Aye lad, well I’m not a banker ya know, but I might be able to work out a trade.”

Uninterested in anything other than money, they felt their time was being wasted and they turned to say their goodbyes. But the Irishman’s infectious voice called to them with an interesting offer. “I’ll trade ya lads. I will give you this $10 you seek, but in return you will give me $12 of your future sales. Tis’ a barter I just came up with.”

Sam was immediately interested, but had questions. “When do you need the $12 back by?” he asked. Before the Irishman could respond, Sam began to pick up on something he hadn’t before. What was a beautiful building doing in the middle of the desert? Why would an Irishman be bartering out here and wouldn’t the fact that his FICO score was below 680 be a deal breaker?

The entire experience almost seemed…magic, which made him even more receptive to the response he was about to get.

“The $12 is not due by any time. For every ten pennies you earn from your customers, take one and put it in a jar. When the amount in the jar reaches $12, you can bring it to me. As long as your bar is as consistent as you say and there’s no reason for me to believe that your business will close, I would like to invest this $10 for you to buy this fine lager. However lad, no lager is as fine as the true lager itself. I do hope this lager is Guinness.”

The Irishman continued but Sam was already sold. The stars had aligned. It was unsecured, it was fast, it was magic. As long as Sam could prove that they had no real problems with the tax man, they would receive $10.

“We should do this with every barter shop in the country at the same time!” John exclaimed. Sam just glared at him.

After the Irishman pulled their credit, ran a UCC search, and examined their bank statements, they got funded. It was just that simple.

And so the end of the story is different depending on who you ask, though every version of it has a few common elements. Sam and John’s bar thrived and the townspeople loved them for it. John Stacker opened a separate bar that was all his own and he bartered his future sales all the way up to 12th position.

Other merchants began to tap into this kind of financing by trading their future sales in exchange for cash upfront. First American Bank and Trust was unperturbed and instead focused on how to charge people for holding their money, withdrawing their money, breathing and existing. Their goal was to one day become too big to fail, blow up, and then never lend to small businesses ever again.

And as for the barter shop run by the Irishman? Legend has it that they’re currently paying 14 points to brokers and gearing up for an IPO. They’ve also rebranded themselves in the public eye as a tech company. Private Equity is now all over them.

Happy St. Patrick’s Day. It’s okay to have some fun every now and then. 🙂

Merchant Cash Advance Accounting – A How To Guide

January 13, 2015

This is the introduction and first question in an interview between AltFinanceDaily’s Sean Murray and accountants Yoel Wagschal, CPA and Christina Joy Tharp.

• 2. Do I Need a Special MCA Accountant?
• 3. and 4. Recording Merchant Cash Advance Transactions on the Books
• 5. Merchant Cash Advance Accounting Pitfalls
• 6. Revenue recognition for Merchant Cash Advance
• 7. Q&A – Real questions that MCA companies or syndicators have

---

Funding small businesses is the easy part of merchant cash advance. Anyone can fund. It’s what comes after that’s tricky and I don’t just mean capturing those receivables you’ve purchased, but also recording everything in such a way that you’re not scrambling around tax time.

I have a B.S. in Accounting but I asked the experts Yoel Wagschal, CPA and Christina Tharp his staff accountant for their insight on managing the books for a merchant cash advance company. We’re still a ways off from April 15th so now is your opportunity to fix whatever you might not have done in 2014 and start off on the right foot for this year. Thanks again to Yoel and Christina for answering these questions.

Q: As a funder, what systems should I have in place to make sure I can:
a. Prepare business tax filing
b. Be ready for an audit to raise capital
c. Know whether or not I am making money

A: First of all you have to understand that every type of business has this exact same question. The answer is that you need to have proper accounting entries and records which will then aid you in creating the financial statements (ie: balance sheet, income statement, statement of retained earnings, and statement of cash flows).

Whether it is a tax filing, a bank audit, or an internal inquiry, the solution is identical because all of those situations require the same financial material in order to answer them. In order to prepare a business tax filing a company must provide its profits and losses. That is the same information provided in an audit to raise capital and it is the same information a business owner needs to see how much money they are making (or losing!).

The exact system is obviously custom fit to your individual business model but it should follow these very basic steps:

i) Think the entire process through from cradle to grave
ii) Be sure to codify where funds are coming in from:
a. Investments from syndicators
b. Payments from merchants
c. Commissions
iii) Be sure to codify where funds are being sent to:
a. Funds to merchants
b. Funds to syndicators
c. Commissions
iv) Be sure there is a system of checks and balances which will alert you to the following common errors:
a. Funds not received from/sent to syndicator
b. Funds not received from/sent to merchant
c. Commissions not received
v) The bank account is the authority while the system is only a representation:
a. Your system balance should reconcile with your bank account
b. It is advisable to have a separate bank account for funding transactions

You will also want to pull up trial balances and earnings reports, which must be input correctly from the very beginning in order for these reports to be accurate and effectual.

What makes this industry different is that an accounting system can make or break an MCA company. For example, a supermarket usually has good POS software for inventory control. If an employee drops a “box of tomatoes” it’s not the end of the world. The loss is either immaterial or if it is material the accounting system will pick up the big monetary discrepancy.

In the MCA industry a “box of tomatoes” could be anything from a $0.05 loss to a $500,000 loss. Because the MCA industry deals with money as its product and is often processing transactions at breakneck speed, there needs to be safeguards in the system to catch any and all mistakes in real time.

Our accounting firm has seen where people built attractive systems which seemed good to the funder. However, if the funder lacks accounting knowledge when this “box of tomatoes” falls out they may not be able to place exactly where the loss occurred. Or even worse, they may not realize a loss has taken place until it is too late. For example, if you wait until the end of the tax year and then discover that merchant payments have been missed how do you recoup those funds? It’s the same situation if incorrect amounts are funded to merchants, if incorrect commissions are paid out, or if syndicators have not invested the funds they were expected to.

---

This interview was done with Yoel Wagschal CPA and his staff accountant Christina Tharp. They can be reached at:

Phone (845) 875-6030
Fax (845) 678-3574
Email: cjt@ywcpa.com
http://ywcpa.com

---

Please consult with an accountant to assess your particular situation and needs.

---

• 2. Do I Need a Special MCA Accountant?
• 3. and 4. Recording Merchant Cash Advance Transactions on the Books
• 5. Merchant Cash Advance Accounting Pitfalls

Merchant Cash Advance Underwriting For Humans

December 11, 2014

There is no doubt that the merchant cash advance industry has undergone significant expansionary changes within the past decade. The first-mover advantage is past its prime in this industry and no longer proves to be as profitable as it once was for some of the earlier entrants to the market.

Although the alternative lending industry still has not garnered enough attention for change and reform from policymakers, it has attracted attention from Wall Street and wealthy Main Street investors alike. As today’s merchant cash advance providers continue to grow their capital bases, these larger players have the option and arguably an incentive to explore new products that will help them capture a larger market share of small businesses financing needs and ultimately will help them improve their bottom line.

Several of the more established companies have continued to grow either organically through strategic leadership and good timing, while others have been able to grow and cover new markets through mergers and acquisitions. Of all changes that have been affecting this space, one of the more interesting ones is the introduction of proprietary software used by some of these companies that will allow them to pre-qualify a merchant based on an online application, rate their credit risk, briefly scan submitted bank statements, merchant account statements and financial statements.

Several companies in this industry have invested extensively into making this process a reality, believing it will help them excel against their competitors by creating an economies of scope situation.

Not so fast though…

While automation can help make a company more efficient by converting applications into funded accounts, it can also create a gap in a company’s risk management policies if the company does not have steps in the process to reduce two important risks in any financial services business:
a) Information Asymmetry
b) fraud detection.

For those companies that still use human underwriters, I have compiled some pointers on my experiences relating to things I pay tremendous attention to when underwriting new accounts that help me spot fraudulent documents.

The starting point in the fraud detection process begins with the application and a thorough review of the information provided. Google everything. Make sure the business is not reported as being closed, that the merchant is not going through extensive litigation that could result in jail time or in the business being sold off to another individual. Information on the internet is bountiful, and most of it is completely free. Unlike traditional financial services companies, he who pays the piper calls the tune does not apply in the alternative finance industry. Merchants are almost completely unbound with how to spend their advance, and sometimes engage in reckless borrowing to achieve their means, oftentimes altering documents in the process.

Credit Reports
In my experience with underwriting, many of the fraudulent accounts that I view have owners with either bad credit, limited credit history or no credit history. Furthermore, pay close attention to any fraud alerts on the 1st page of the report, and especially the date of the alert if it is fairly recent. Lastly, pay close attention to the number of recent inquiries on the credit inquiries. Today’s small businesses receive dozens of inquiries from cash advance companies and ISOs. While the inquiries themselves do not outright indicate any fraud and may even be encouraged by ISOs looking to get their merchant the best deal, the combination of a fraud alert and say 20 inquiries from competitive cash advance companies could signify that the other competitors found something that may not add up on the file and will warrant a close eye on the other submitted documents.

Bank Statements
Through community websites, fraudulent bank statements, merchant account statements, or any other type of statement are made easily accessible to purchase. The number of submitted fraudulent bank statements that I have seen within the past year has dramatically increased. Some statements can take as little as 5 seconds to determine if they are fraudulent and there are others that are so clever that they can take close to an hour of close scrutiny to find.

I personally use Adobe Acrobat to read and navigate through bank statements. Some of these statements are doctored so well that you may have to zoom in upwards of 300% to find a comma that should actually be a period to separate dollars from cents to put as a simple example. Be sure to quickly glance over all the statements, checking to see that you have a complete page sequence and the page count is correct.

One of the more common amateur mistakes is to use a prior year’s bank statement and simply change the year to read current year. Fortunately for underwriters, that process is not as simple as it seems on the surface. Not only do they have to make changes on the header of every page, but many times banks and credit unions make announcements throughout the statement for the current year. Other statements include full dates (month, day, year) on some line items usually in the withdrawals section but sometimes in deposits, subtotals and totals. This is more work for merchants to alter, and leaves them more prone to forgetting to change one of the dates.

Just one inconsistency that happens to somehow conveniently flow with the rest of the statement can be the only evidence that you need. Some of the other common amateur mistakes include poor spelling throughout the statement, whiting out of numerical figures, inconsistent margin changes, font changes, and repetitive use of the same check numbers paid month after month (excluding those with default 0’s or 1’s issued by bank tellers directly).

Some of the more well hidden fraud can usually be found by comparing the summary page and last page of the bank statement to other statements. Typically, most banks and some credit unions offer you a snapshot of the starting balance, which should generally match up with the ending balance of the previous month. If it doesn’t, you should look for any transactions from the previous month that did not settle until the current month. If there is none, this is usually a red flag indicating that the merchant forgot that statements are continual time series financial data whose totals carry on to the following month.

Also, be sure to check that the summary data at the beginning of each statement matches the counts for deposits, withdrawals, and checks written each month. I’m also particularly skeptical when I see unusual consistency in the number and value of summary data with very little bank activity. Such an example would be a bank statement that consistently shows only 3-4 deposits each for over $100,000 and miniscule withdrawals such as a few small checks or a handful of fast food POS debits comprising all withdrawals for example. The business could be legitimate and the merchant simply submitted the wrong bank statement, which does not allow you to see the better cash flow picture from first glance, or the merchant could have simply taken the easy way out in creating a basic bank statement. Again, it is helpful to reference the type of business that you are underwriting in order to see if these transactions make sense. I am much more willing to acknowledge and accept this type of statement from a construction company per se than a brick-and-mortar retail shop.

Final Tips
Don’t let analysis paralysis stop you from sticking to your conviction on an account. Underwriting is not directly focused on generating revenue for a firm, but rather minimizing bad debt expenses at the end of the day. If you feel like something is off on the statements that you are looking at but you just cannot find what is wrong, step away from your computer for a few minutes and focus on something else. When you return to your computer, you’ll better be able to scrutinize the statements and more likely to catch something miniscule that you may have missed from closely going over the statements again and again.

You can also ask fellow colleagues to look at the statements. Try experimenting and let at least one know that you have suspicions on a particular account and if they could take a close look at the statements; it also helps if you have someone else simultaneously looking at the same account but do not tell them about your suspicions on the account. If they also have a strange feeling about the statements, chances are that there is something off that warrants even closer examination. Lastly, when in doubt try to confirm the statements with the source of the statement. It may be beneficial to request that your merchants provide you with a bank representative’s contact information so that you can verify the legitimacy with the bank yourself.

Another source of action would be to have a merchant provide your company with a view only access of the account. This would also allow you to directly confirm the legitimacy of the statements eliminating any left over suspicions. The only downsides to these last two approaches is that they make take some time to complete, oftentimes a merchant is not willing to wait a few more days and will willingly go to a competitor who can promise to have them funded within 24 hours. In these cases, your last line of defense comes down to the merchant interview part of the process.