Merchant Cash Advance is Not a Loan in Hong Kong
June 26, 2016
It’s not just the New York Supreme Court system upholding the sanctity of merchant cash advances where future receivables are sold for cash up front. In Hong Kong, Global Merchant Funding Limited was charged criminally by the Secretary for Justice for conducting business as a money lender without a license.
The Secretary argued that the Merchant Cash Advance contract was really just a loan in disguise. The court disagreed and dismissed the charges. Government prosecutors appealed the decision to the Court of First Instance, where the future of the product in Hong Kong hung in the balance.
The issue, according to the judiciary brief was one of categorization: whether the relevant transactions should be categorized as loans or as purchases of receivables under the Money Lenders Ordinance.
As a criminal case, the Court reviewed the matter seriously, acknowledging that there could be a chilling effect on commercial activity if the verdict were to be overturned and the defendant found guilty.
The prosecution argued that such receivables purchased did not actually exist:
“The Purchased Amount does not represent a debt due from any customer or other third party, including the credit card processor, but is an amount in respect of which the merchant is the only primary obligor and the guarantees given to GMF are guarantees of the merchant’s own liability and not are guarantees for the performance of any debt or obligation that has been sold.”
The court rejected this argument on the basis that such receivables were not defined by the agreement as the prosecution tried to define them:
The expression “Purchased Amount” is defined as “The total amount of the Future Receivables sold by the [merchant] to [GMF]” to be “collected by [GMF] through the deduction of a specified percentage of the [merchant’s] periodic batch settlements from the [Processor]”. […] The receivables consisting of credit card settlement payments to be made by the Processor, are assignable choses in action. In consideration of the Purchase Price received, the merchant bound itself irrevocably to instruct the Processor to pay to GMF directly the Split Settlement amounts upon processing each batch settlement until GMF had collected sums totaling the Purchased Amount. Such instruction was duly given by the merchant. This constituted an equitable assignment of the relevant sums which took effect as and when they came into existence.
Ultimately, the Court decided that even if the economic outcome of the transaction was not distinguishable from a loan with interest, it was not a loan in legal substance and effect and is therefore not covered by the Money Lenders Ordinance.
For these reasons the Secretary’s appeal was dismissed, but the prosecution appealed it even further.
In May 2016, in the Court of Final Appeal, Global Merchant Funding Limited’s contract was once again upheld as not a loan.
The Court held that the MLO’s definition of a “loan” to include “every agreement (whatever its terms or form may be) which is in substance or effect a loan of money” must be understood to be referring to an agreement which has the legal substance or effect of a loan and not an agreement with such an economic or commercial substance or effect. The Courts will only look beyond the agreement between the parties when the agreement is a sham, which was not the case in this appeal.
So decided, merchant cash advances structured in such a way as these contracts are not loans in Hong Kong.
The Unsung Disruption in Online Lending – Stacking, Litigation and Questionable Debt Negotiators
June 22, 2016
Give a small business two options, a low APR 3-year business loan and a short term loan with a high factor rate, and you’ll find advocates for each product arguing over which is better and why. We’ve been led to believe that it’s one versus the other, that one is good and one is bad, and that’s all there is to the story. Entire business models have been developed along the lines of this thinking, algorithms deployed and merchants funded, along with narratives framed in the mainstream media about why one system is superior to others.
But to hear the men and women in the phone rooms tell it, when given a choice between one funding option or the other, small businesses are often choosing both at the same time. Reuters said that stacking is the latest threat to online lenders, and in many ways they’re right. The practice isn’t new of course, the tendency for merchants to take on multiple layers of capital (often times in breach of other contracts) has been a central cause of tension between funding companies for the last few years. But the reason the story is bubbling over into traditional news media now as the latest threat, is because opponents of stacking assumed that the practice would be eradicated by now. There was this false sense of hope that government agents in black suits would show up one day unannounced after hearing that a merchant had taken a third advance or loan despite having not yet satisfied the obligations of the previous two. And when that didn’t happen, some of the models heralded as better for the merchant started to show cracks. What happens to the forecasts when the merchants priced ever so perfectly for a low rate long term loan go and take three or four short term loans almost immediately after? Back in October, Capify CEO David Goldin argued that long dated receivables were already dangerous to a lender regardless because the economy could turn south. “You’re done. You’re dead. You can’t save those boats. They are too far out to sea,” he told AltFinanceDaily.
Sue everyone?
When it comes to disruption, nothing has changed the game as much as stacking, and companies must prepare for the likelihood that it could be around forever. That means forming a long-term business model that is equipped to deal with this practice. Several lawsuits have been waged in an attempt to generate case law to deter it, including one filed last year in Delaware by RapidAdvance against a rival. Patrick Siegfried, assistant general counsel of RapidAdvance told the Wall Street Journal last fall, “we’re doing it to establish the precedent,” he said. “This kind of thing is happening more and more.” At the time, a motion to dismiss the case entirely was pending. RapidAdvance since won that motion but only by a hair and with a judge that was very reluctant to move the case forward.
Last October, MyBusinessLoan.com, LLC, also known as Dealstruck, sued five companies at once, a mix of lenders and merchant cash advance companies after one of their borrowers defaulted, allegedly because of actions carried out by the co-defendants. They were greeted with several motions to dismiss for failure to state a claim.
Even if these funding companies don’t win, simply letting the world know that they’ll sue rivals for stacking can act as a deterrent. But it’s an expensive tactic, especially when some defendants are more than happy to litigate the claims. Litigation is definitely an underrated cost of doing business for online lenders and merchant cash advance companies. In one recent case, a merchant challenged the legitimacy of a contract with Platinum Rapid Funding Group, a company whom they sold a portion of their future receivables to. The merchant asked the judge to recharacterize the contract to a loan so that they could try to use a criminal usury defense. The judge refused in a well-written decision that called the merchant’s attempt to do that “unwarranted speculation.” But even with the precedent of a favorable ruling, countless merchants have attempted to come up with strategies to wriggle their way out of their agreements, sometimes with ample legal counsel at their side.
Debt negotiators and questionable characters
Stacking has become a cost of doing business, but something else is creeping in as well. An entire cottage industry of “debt negotiators” has set their sights on online lenders and merchant cash advance companies, and at times these self-professed business experts don’t even realize there’s a difference between the two. One MCA funder told altfinancedaily earlier this week that a merchant in default claimed to be represented by Second Wind Consultants, a debt restructuring firm that lists one Don Todrin as the CEO on their website. Not mentioned among Todrin’s accolades is that he is a disbarred attorney who pled guilty to federal bank fraud charges in 1994, according to an old report by the Boston Globe, after he filed at least nine false financial statements to acquire $1.4 million in loans.
Another purported debt negotiation firm, who has the irked the ire of merchant cash advance companies, is apparently trying to assert affiliation to a native American tribe and invoke tribal immunity in response to lawsuits against them, according to court filings in New York State.
And only three weeks ago, an attempted class action against a merchant cash advance company failed because each named class representative had waived its right to participate in a class action in exchange for business financing. The initial action, before being moved to federal court, was brought by a merchant represented by an attorney who had just been reinstated to practice law, following a long suspension for pleading guilty to identity theft.
On top of it all, there are merchants themselves that act in bad faith, with some preying on the perceived vulnerabilities of an online-only experience. In the November/December 2015 issue of AltFinanceDaily Magazine, attorney Jamie Polon said some applicants don’t even own businesses at all, they just pretend to. “They’re not just fudging numbers – they’re fudging contact information,” he told AltFinanceDaily. “It’s a pure bait and switch. There wasn’t even a company. It’s a scheme and it’s stealing money.”
Weeding out bad merchants is a job for the underwriting department but for the good merchants seemingly deserving of those 3-5 year loan programs, the future is not as easy to predict as it once was. They might stack regardless, no matter how favorable the terms are. And given that government agent ninjas aren’t likely to drop down from the sky to stop them any time soon, many funding companies are faced with hard choices. Are the initial forecasts still valid? Is it economically feasible to turn the client away for additional funds because they breached their original agreement, all while the cost to acquire that customer in the first place was really high? Do you sue your rivals, make them look bad in the press, or lobby for regulations that will hurt them? How do you handle the new breed of debt negotiators who use the same UCC lead lists as lenders and brokers?
Sure, things like marketing costs are going up and the capital markets are less inviting than they used to be. But once loans and deals are funded, making sure those agreements are lived up to can take time, resources, and undoubtedly a lot of lawyers. And realistically, these issues aren’t likely to change any time soon. Help, in whatever relief form some are hoping for, is not on the way. How’s that for disruption?
Taking Stock of China’s Changing Fortunes in Fintech
June 21, 2016
It’s been called the Wild West of the financial world, and it appears the sheriff is finally headed to town.
Chinese fintech, the P2P practice of connecting borrowers to lenders via the Internet, was supposed to bring much-needed competition and efficiency to the country’s outsized, government-run banking system, turning a sizable profit for a visionary group of investors in the bargain. Investors weren’t the only ones that stood to benefit from the boom. With large Chinese banks choosing to lend primarily to mammoth, state-owned corporations, the country’s small business community was similarly poised to profit.
That’s exactly how it played out for a while. Buoyed by bullish expectations, fintech startups with good marketing skills attracted large numbers of investors. This resulted in nearly a decade’s worth of easily amassed capital, dizzying returns in high interest rate bearing vehicles, and little in the way of meaningful regulation. Before you could say “Alibaba”, roughly one fifth of the world’s largest fintech firms hailed from China, with ZhongAn, an online insurance group backed by the e-commerce titan’s founder, Jack Ma, topping the list.
It was indeed the Wild West, but there was trouble on the horizon.
The twin villains irrational exuberance and negligent oversight eventually flipped the script, and China’s fintech sector has been reeling ever since. Returns derived from investing “captive capital” into funds that returned high spreads started drying up. Payment companies came under fire for questionable practices that at least one investment research firm, J Capital Research, likened to a Ponzi scheme. Doubt set in, followed by panic. Capital began flowing out of the country instead of into it, with investors that could head for the exit door doing just that.
By the end of 2015, nearly a third of all Chinese fintech lenders were in serious trouble, according to a recent article in the Economist, “trouble” being defined as everything from falling returns to halted operations to frozen withdrawals.
A few brave souls stuck to their guns, wrangling over how to make their finance models more sustainable for the long haul. Other so-called industry leaders simply skipped town. Literally. Enter “runaway bosses” into your preferred web search engine and the hits keep coming. According to the same Economist article, the delinquent bosses of some 266 fintech firms have fled over the past six months alone. It’s a worrying trend that pessimists say represents yet another nail in the coffin of China’s so called “Era of Capital.”
I wouldn’t be so sure.
Emerging trends will always be susceptible to periods of protracted volatility. It’s how industry leaders – and government officials – respond to such crises that lays the groundwork for what happens next. Now, the “maturation” process has begun in China. Unfortunately, to date it’s happened exclusively in the form of mass consolidation, with the state sector swooping in and taking over what was up until now a strictly private sector trend.
The Chinese government’s fondness for consolidating its interests is no state secret of course, but it would be a mistake for it to use the failings of the fintech sector to reassert the dominance of the country’s state-owned banking sector. The reason for this is straightforward enough. Big banks aren’t usually the biggest allies of small business, and every economy needs a robust small business sector in order to thrive.
Where could the Chinese government look for guidance? Not the US, unfortunately. If anything, the fintech market in America suffers from too much regulation. Everyone knows there’s no friendlier country on the planet for budding entrepreneurs than the US, and you certainly don’t have to look far to find examples of fast-growing American fintech success stories. You could go so far as to argue “disruptive innovation” in the financial sector is in our DNA, from the rise of Western Union to the emergence of giant credit card companies like Visa and Mastercard to the recent arrival of game changers like Lending Club, OnDeck and Venmo.
And yet, ask any fintech startup CEO about the thicket of regulation he or she has to routinely navigate in order to figure out which agencies have jurisdiction over, or which laws apply to, the various aspects of their businesses. Better yet, don’t. The alphabet soup of regulatory bodies they will be obliged to list – the SEC, the Fed, FINRA, OCC, FDIC, NCUA, CFPB, etc. – will put you both to sleep. The point is that these days the US lags behind other regions of the world in creating the environment the fintech industry needs to flourish. (One discouraging example: In the United States, the licenses needed to become a money services business (MSB) have to be acquired on a state-by-state basis; in the European Union, a single license is all it takes to do business in Berlin, Paris, Madrid, and Rome.)
Making finance safer is one thing, but blinding business with an unusually harsh regulatory spotlight isn’t the answer.
Why does it matter if the fintech sector goes belly up in China, the US, or anyplace else? To reiterate: Fintech isn’t some passing trend or get-rich-quick scheme. It’s one of the essential engines that drives small business development. According to the site VentureBeat.com, the World Economic Forum recently reported that a healthy fintech industry could close a $2 trillion funding gap for small businesses globally. You could drive a healthy uptick in the global GWP through a gap that size.
This brings us back to China. Chinese regulators may be tempted to capitalize on the country’s fintech troubles to reassert their influence, but they should strongly resist the urge. Instead, they might focus their efforts on taking steps to create a healthy ecosystem for the country’s fintech sector, one with regulatory controls that are clear, efficient, and properly implemented. Transparency will be key. One of the things American fintech companies do right is publishing essential information about those seeking loans, including their credit history, employment status, and income. This is to ensure that the investors putting up the money know what they’re getting into. It’s a critical confidence-builder, and China’s fin-tech model will need to be similarly transparent if it wants to succeed.
I happen to believe that it will succeed, and that it will continue to attract big money. The case could be made that it’s already happening. In December 2015, Yirendai, the consumer arm of P2P lender CreditEase, became the first Chinese fintech firm to go public on an overseas exchange, listing on the NYSE with a valuation of around $585 million. In January of this year, Lufax, a platform for a range of products, including P2P loans, completed a fundraising round that valued the company at $18.5 billion, setting the stage for a highly anticipated IPO.
Both companies pride themselves on their transparency protocols and risk controls.
The bottom line is this: No financial sector benefits from descending too far into a Wild West of laissez-faire everything, and China’s regulators were right to ride to the rescue. They would do equally well not to strong arm the sector’s brightest leaders. The country should strive to create a safe, healthy environment for third-party service providers to prosper and grow. If they do, it won’t just be investors in mobile transactions and digital currencies who benefit.
China’s entire economy will.
Stairway to Heaven: Can Alternative Finance Keep Making Dreams Come True?
April 28, 2016
The alternative small-business finance industry has exploded into a $10 billion business and may not stop growing until it reaches $50 billion or even $100 billion in annual financing, depending upon who’s making the projection. Along the way, it’s provided a vehicle for ambitious, hard-working and talented entrepreneurs to lift themselves to affluence.
Consider the saga of William Ramos, whose persistence as a cold caller helped him overcome homelessness and earn the cash to buy a Ferrari. Then there’s the journey of Jared Weitz, once a 20 something plumber and now CEO of a company with more than $100 million a year in deal flow.
Their careers are only the beginning of the success stories. Jared Feldman and Dan Smith, for example, were in their 20s when they started an alt finance company at the height of the financial crisis. They went on to sell part of their firm to Palladium Equity Partners after placing more than $400 million in lifetime deals.
The industry’s top salespeople can even breathe new life into seemingly dead leads. Take the case of Juan Monegro, who was in his 20s when he left his job in Verizon customer service and began pounding the phones to promote merchant cash advances. Working at first with stale leads, Monegro was soon placing $47 million in advances annually.
Alternative funding can provide a second chance, too. When Isaac Stern’s bakery went out of business, he took a job telemarketing merchant cash advances and went on to launch a firm that now places more than $1 billion in funding annually.
All of those industry players are leaving their marks on a business that got its start at the dawn of the new century. Long-time participants in the market credit Barbara Johnson with hatching the idea of the merchant cash advance in 1998 when she needed to raise capital for a daycare center. She and her husband, Gary Johnson, started the company that became CAN Capital. The firm also reportedly developed the first platform to split credit card receipts between merchants and funders.
BIRTH OF AN INDUSTRY
Competitors soon followed the trail those pioneers blazed, and the industry began growing prodigiously. “There was a ton of credit out there for people who wanted to get into the business,” recalled David Goldin, who’s CEO of Capify and serves as president of the Small Business Finance Association, one of the industry’s trade groups.
Many of the early entrants came from the world of finance or from the credit card processing business, said Stephen Sheinbaum, founder of Bizfi. Virtually all of the early business came from splitting card receipts, a practice that now accounts for just 10 percent of volume, he noted.
At first, brokers, funders and their channel partners spent a lot of time explaining advances to merchants who had never heard of them, Goldin said. Competition wasn’t that tough because of the uncrowded “greenfield” nature of the business, industry veterans agreed.
Some of the initial funding came from the funders’ own pockets or from the savings accounts of their elderly uncles. “I’ve met more than a few who had $2 million to $5 million worth of loans from friends and family in order to fund the advances to the merchants,” observed Joel Magerman, CEO of Bryant Park Capital, which places capital in the industry. “It was a small, entrepreneurial effort,” Andrea Petro, executive vice president and division manager of lender finance for Wells Fargo Capital Finance, said of the early days. “A number of these companies started with maybe $100,000 that they would experiment with. They would make 10 loans of $10,000 and collect them in 90 days.”
That business model was working, but merchant cash advances suffered from a bad reputation in the early days, Goldin said. Some players were charging hefty fees and pushing merchants into financial jeopardy by providing more funding than they could pay back comfortably. The public even took a dim view of reputable funders because most consumers didn’t understand that the risk of offering advances justified charging more for them than other types of financing, according to Goldin.
Then the dam broke. The economy crashed as the Great Recession pushed much of the world to the brink of financial disaster. “Everybody lost their credit line and default rates spiked,” noted Isaac Stern, CEO of Fundry, Yellowstone Capital and Green Capital. “There was almost nobody left in the business.”
RAVAGED BY RECESSION
Perhaps 80 percent of the nation’s alternative funding companies went out of business in the downturn, said Magerman. Those firms probably represented about 50 percent of the alternative funding industry’s dollar volume, he added. “There was a culling of the herd,” he said of the companies that failed.
Life became tough for the survivors, too. Among companies that stayed afloat, credit losses typically tripled, according to Petro. That’s severe but much better than companies that failed because their credit losses quintupled, she said.
Who kept the doors open? The firms that survived tended to share some characteristics, said Robert Cook, a partner at Hudson Cook LLP, a law office that specializes in alternative funding. “Some of the companies were self-funding at that time,” he said of those days. “Some had lines of credit that were established prior to the recession, and because their business stayed healthy they were able to retain those lines of credit.”
The survivors also understood risk and had strong, automated reporting systems to track daily repayment, Petro said. For the most part, those companies emerged stronger, wiser and more prosperous when the crisis wound down, she noted. “The legacy of the Great Recession was that survivors became even more knowledgeable through what I would call that ‘high-stress testing period of losses,’” she said.
ROAD TO RECOVERY
The survivors of the recession were ready to capitalize on the convergence of several factors favorable to the industry in about 2009. Taking advantages of those changes in the industry helped form a perfect storm of industry growth as the recession was ending.
They included making good use of the quick churn that characterizes the merchant cash advance business, Petro noted. The industry’s better operators had been able to amass voluminous data on the industry because of its short cycles. While a provider of auto loans might have to wait five years to study company results, she said, alternative funders could compile intelligence from four advances within the space of a year.
That data found a home in the industry around the time the recession was ending because funders were beginning to purchase or develop the algorithms that are continuing to increase the automation of the underwriting process, said Jared Weitz, CEO of United Capital Source LLC. As early as 2006, OnDeck became one of the first to rely on digital underwriting, and the practice became mainstream by 2009 or so, he said.
Just as the technology was becoming widespread, capital began returning to the market. Wealthy investors were pulling their funds out of real estate and needed somewhere to invest it, accounting for part of the influx of capital, Weitz said.
At the same time, Wall Street began to take notice of the industry as a place to position capital for growth, and companies that had been focused on consumer lending came to see alternative finance as a good investment, Cook said.
For a long while, banks had shied away from the market because the individual deals seem small to them. A merchant cash advance offers funders a hundredth of the size and profits of a bank’s typical small-business loan but requires a tenth of the underwriting effort, said David O’Connell, a senior analyst on Aite Group’s Wholesale Banking team.
The prospect of providing funds became even less attractive for banks. The recession had spawned the Dodd-Frank Financial Regulatory Reform Bill and Basel III, which had the unintended effect of keeping banks out of the market by barring them from endeavors where they’re inexperienced, Magerman said. With most banks more distant from the business than ever, brokers and funders can keep the industry to themselves, sources acknowledged.
At about the same time, the SBFA succeeded in burnishing the industry’s image by explaining the economic realities to the press, in Goldin’s view.The idea that higher risk requires bigger fees was beginning to sink in to the public’s psyche, he maintained.
Meanwhile, loans started to join merchant cash advances in the product mix. Many players began to offer loans after they received California finance lenders licenses, Cook recalled. They had obtained the licenses to ward off class-action lawsuits, he said and were switching from sharing card receipts to scheduled direct debits of merchants’ bank accounts.
As those advantages – including algorithms, ready cash, a better image and the option of offering loans – became apparent, responsible funders used them to help change the face of the industry. They began to make deals with more credit-worthy merchants by offering lower fees, more time to repay and improved customer service. “The recession wound up differentiating us in the best possible way,” Bizfi’s Sheinbaum said of the changes.
His company found more-upscale customers by concentrating on industries that weren’t hit too hard by the recession. “With real estate crashing, people were not refurbishing their homes or putting in new flooring,” he noted.
Today, the booming alternative finance industry is engendering success stories and attracting the nation’s attention. The increased awareness is prompting more companies to wade into the fray, and could bring some change.
WHAT LIES AHEAD
One variety of change that might lie ahead could come with the purchase of a major funding company by a big bank in the next couple of years, Bryant Park Capital’s Magerman predicted. A bank could sidestep regulation, he suggested, by maintaining that the credit card business and small business loans made through bank branches had provided the banks with the experience necessary to succeed.
Smaller players are paying attention to the industry, too, with varying degrees of success. Predictably, some of the new players are operating too aggressively and could find themselves headed for a fall. “Anybody can fund deals – the talent lies in collecting the money back at a profitable level,” said Capify’s Goldin. “There’s going to be a shakeout. I can feel it.”
Some of today’s alternative lenders don’t have the skill and technology to ward off bad deals and could thus find themselves in trouble if recession strikes, warned Aite Group’s O’Connell. “Let’s be careful of falling into the trap of ‘This time is different,’” he said. “I see a lot of sub-prime debt there.”
Don’t expect miracles, cautioned Petro. “I believe there will be another recession, and I believe that there will be a winnowing of (alternative finance) businesses,” she said. “There will be far fewer after the next recession than exist today.”
A recession would spell trouble, Magerman agreed, even though demand for loans and advances would increase in an atmosphere of financial hardship. Asked about industry optimists who view the business as nearly recession-proof, he didn’t hold back. “Don’t believe them,” he warned. “Just because somebody needs capital doesn’t mean they should get capital.”
Further complicating matters, increased regulatory scrutiny could be lurking just beyond the horizon, Petro predicted. She provided histories of what regulation has done to other industries as an indication of the differing outcomes of regulation – one good, one debatable and one bad.
Good: The timeshare business benefitted from regulation because the rules boosted the public’s trust.
Debatable: The cost of complying with regulations changed the rent-to-own business from an entrepreneurial endeavor to an environment where only big corporations could prosper.
Bad: Regulation appears likely to alter the payday lending business drastically and could even bring it to an end, she said.
Still, regulation’s good side seems likely to prevail in the alternative finance business, eliminating the players who charge high fees or collect bloated commissions, according to Weitz. “I think it could only benefit the industry,” he said. “It’ll knock out the bad guys.”
BlueVine a Serious Player After Citigroup Investment (And it Could Land Them Citigroup Referrals)
April 27, 2016
When BlueVine announced raising $40 Million from Menlo Ventures three months ago, they raised eyebrows in the marketplace lending community but they didn’t steal the spotlight. That’s because BlueVine’s core focus, invoice factoring, is arguably the least sexy segment of small business finance. Just hearing the phrase invoice factoring is enough to induce one into a coma. That of course is what made the age-old practice ripe for disruption. But even so, BlueVine isn’t limiting themselves to just that.
The company now offers business lines of credit with interest as low as 6.9%, according to their website. That makes them a competitor of OnDeck, Lending Club, Funding Circle and many others in a crowded field.
A new investment from Citigroup however could change everything for them. While the terms from Citi Ventures (the banks’s investing arm) were not disclosed, Arvind Purushotham, told CNBC that it’s possible that Citigroup forms a referral arrangement with BlueVine to help small business customers of the bank find attractive credit. That’s significant because Purushotham is a managing director at Citi Ventures.
Two weeks ago, OnDeck CEO Noah Breslow, told the crowd at the LendIt conference that partnering is a company’s only chance now to gain a real foothold in the industry. Breslow could speak from experience since OnDeck currently has a unique arrangement with JPMorgan Chase.
While the sources interviewed by CNBC stressed that the BlueVine-Citigroup investment did not constitute a commercial partnership, the stage seems to have been set for that to be possible in the future.
Even though BlueVine just started making loans 3 months ago (they have been factoring since 2013), loans already make up 15% of their overall business. This is one invoice factoring company that rival small business lenders won’t want to sleep on.
Is That a Bird, a Plane or a Recession in the Wings?
April 26, 2016
The R-word has been rearing its ugly head with more frequency in recent months, propelled by falling stock prices, higher borrowing rates and the dollar’s ascent.
While a recession—typically defined as a fall in GDP in two consecutive quarters—is far from certain, it would most definitely be a double whammy for an industry that many believe is already ripe for a pullback due to multiple years of unfettered growth. Indeed, many funders have experienced great success riding on the coattails of the long-running favorable market. Some industry participants fear these funders are masking loss rates behind strong volume—a particularly problematic strategy if the volume were to taper off due to an economic downturn.
“It’s no different than what happened in the housing market in 2008,” says Andrew Reiser, chairman and chief executive of Strategic Funding Source Inc. in New York. If and when a recession occurs, several industry participants expect there will be a culling of the weakest firms. They say inexperienced and less-diverse funding companies are particularly at risk, as are MCA funders that don’t keep close tabs on their business dealings. They also believe that venture capital funding will be even harder to come by and regulation will rain down more heavily on the industry.
RISK FACTORS THAT SPELL TROUBLE IN RECESSIONARY ENVIRONMENT
For a variety of reasons, Glenn Goldman, chief executive of Credibly, a New York-based small business lending platform, believes that fewer than 50 percent of the funders today are prepared to weather a recession. Many don’t have strong data science and risk management, for example. Some newer platforms also don’t have the seasoned management to help guide them appropriately, he says.
Another red flag is when funders rely too heavily on a single source of funding. Goldman points back to 2008 when the commercial paper market disappeared. Companies that had on balance-sheet funding capacity were able to weather that storm because they weren’t exclusively relying on commercial paper or securitization, he says.
Goldman believes the prudent way to manage an alternative funding business is to utilize a combination of on-balance sheet financing, whole loan sales and securitization. “If the market moves sideways and you rely only on a single source of funding, you are at risk. It’s an incredibly obvious statement, but it becomes more acute when the economic environment comes under pressure,” he says.
Notably, there are very few sizable alternative funders who successfully survived the last big recession, meaning there are hundreds of companies now doing business in this space that don’t have years-worth of data to help them make more prudent underwriting decisions. Strategic Funding, for example, had the highest loss rate in its history in the third quarter of 2008 and has used its wealth of data to learn from past mistakes. “There’s no doubt that it is critical to be able to correlate events with history,” Reiser says.
Funders are also going to have to batten down the hatches when it comes to their underwriting standards. “Just because someone paid you back yesterday doesn’t mean he’s going to pay you back tomorrow,” Reiser says. “You have to be right more often in a recessionary environment.” Indeed, liquidity for originators and investors will become even more critical in a recession.
“Liquidity is king,” says David Snitkof, chief analytics officer and co-founder of Orchard Platform, a New York-based technology and data provider for marketplace lending. He points out the large number of companies that went belly-up in the last big recession for lack of liquidity. “The more that participants in this market are able to diversify their capital structure, diversify their funding sources and work with multiple providers, the better off they will be,” he says.
Another challenge will be for funders that haven’t had their servicing and collection capabilities adequately stress tested, Snitkof says. These firms should consider working with an outside provider to help them scale their collections as necessary. In this way, a company that needs additional resources can scale up pretty quickly without disrupting operations.
THE P2P OUTLOOK
To be sure, all types of companies fall under the alternative funding umbrella and each will have its own special challenges in a recession. In the P2P space, for example, having a diverse investor base and a sound credit model will become increasingly important. Peter Renton, an investor and founder of Lend Academy, an educational resource for the peer-to-peer lending industry, predicts that some of the newer P2P platforms will struggle more in a recession. That’s because they haven’t had as much time to accumulate and interpret borrower data and adapt their models accordingly.
Lending Club, for example, has gone through many iterations of its credit model over its multiple years in business, and it’s much better than it was even five years ago, says Renton, who had around $37,000 invested with Lending Club as of the third quarter of 2015. “The best data that anyone can get is payment history with your existing borrowing base,” he says.
Particularly in a recession, P2P players need to be extra careful about maintaining strict underwriting standards. Marketplaces may have to tighten their borrowing standards to lend to more solid companies, so the likelihood of defaults isn’t as great. So, for instance, if their standard was once borrowers with a FICO score of at least 640, they could up it to 660, Renton says.
Platforms also have to make sure they have enough investors to satisfy their borrowers, which is why having a diverse investor base is so important. In a recession if you have three hedge funds and that’s your entire investor base, they could all go away. By contrast, if a platform has five thousand individual investors, they aren’t all going away. You may lose 10 percent or 20 percent of them, but if you still have four thousand investors, you can still have your loans funded, Renton explains.
One way to do well even in a recessionary environment is for P2P players to tweak their credit model to be more restrictive so their default rates are lower. “If your default rates are only 3 percent and your competitors are at 6 percent, you’re going to get more business,” Renton says.
Certainly, alternative funding companies can get into trouble if they don’t act early enough when they see a change in activity and economic performance, says Ron Suber, president of Prosper Marketplace, a P2P lender based in San Francisco. Funders need to be able to nimbly adjust their pricing, risk models and expected default rates as needed. “Every marketplace will see a change in borrower behavior as unemployment increases and there are economic declines. Therein lies the question: what does the marketplace do?” Prosper, for instance, recently raised rates on loans, telling investors it had increased its estimated loan loss rates and therefore was updating the price of loans to reflect increased risk. Understanding risk and pricing loans accordingly is always important, but even more so in a shaky economic environment. “You always have to stay on top of it,” Suber says.
MANY MCA FUNDERS AT HIGH-RISK IN RECESSION
If a recession strikes, some observers believe the risk to certain MCA funders will be particularly acute. That’s because new players have entered the MCA space over the past several years, and a sizable number of them don’t have a good handle on their business. Higher default rates could force many of them to shutter operations. Certainly merchants especially those with bad credit—will need more access to capital during a recession and MCA is a natural place for these businesses to turn. But MCA funders have to do a better job of adjusting for risk and keeping adequate records if they hope to weather an economic downturn, says Yoel Wagschal, a certified public accountant in Monroe, New York, who has worked with a number of struggling MCA funders. “A small recession could lead to big failures if you don’t take the right steps,” he says.
To avoid business-threatening issues, Wagschal recommends that MCA funders take steps now to develop stronger underwriting systems to vet merchants better. He believes it’s more prudent to do fewer deals with higher rated merchants than to continue taking on risky businesses as customers. If they see more defaults are coming in, funders should also consider raising their factor rates, he says. Another option is to halt new funding for three to four months to re-energize the business. “It’s much harder to make money than to lose money,” he notes.
If they don’t already have them—and many don’t—MCA funders also need to invest in a good accounting system that can flag their profits, losses and defaults on a real-time basis. This information allows funders to make swift decisions about the business so they can take necessary steps at the right time, he says. “You don’t wait for months, or year end, to analyze all the facts. You might have already lost your business and lost your money because money is just turning around so quickly.”
UNCERTAINTY ABOUNDS FOR VENTURE CAPITAL INVESTMENT
Existing funders won’t be the only ones to struggle in a recession; the well of venture capital funding for new entrants could easily dry up as well,like it did in the last big recession. That’s not to say VC firms will lose interest entirely, but new funders will have to work even harder to get noticed. “There are so many originators, for any new entrants, the bar gets higher and higher to prove that you have something truly unique,” says Snitkof of Orchard Platform. Reiser of Strategic Funding already sees this scenario playing out. “I don’t think the market [lately] has been very favorable to our space,” he says, noting the dearth of exit strategies that have made it riskier for VC firms to invest. “It’s always easy to get in; it’s hard to get out,” he says.
GET READY FOR MORE REGULATORY ACTION
Industry watchers also believe the alternative funding industry will become more heavily regulated in a recession and its aftermath.
Reiser points to all the additional restrictions placed on the mortgage industry in the wake of the housing market bust in 2008. At a time when the housing market was restricting, you had more compliance placed on it as well. “I think you’ll have more compliance in our industry too. That’s just another cost that will have to be absorbed,” Reiser says.
In a recession, there’s more likelihood that harm can come to customers and that will drive regulatory action as well, he adds.
THE ART OF MAKING TOUGH DECISIONS
If the economy turns south, many alternative funders will be forced to make tough underwriting decisions. It can be hard if your analysis of data tells you that things are going to turn downward and your competitors don’t take the same stance, says Stephen Sheinbaum, founder of Bizfi, a New York-based online marketplace.
In that case, funders have to decide whether they are willing “to tighten and pivot while the rest of the players in the space are going full steam ahead,” he says. “That’s where you have to have some conviction and trust your data and do the right thing.”
Of course, even as the rest of the economy is faltering, recessionary times can also be a boon for enterprising companies. For example, the 2008 recession turned out to be positive for Bizfi, which at the time was called Merchant Cash and Capital. Using housing starts, consumer spending and other data, the company correctly predicted the economy was going to take a severe turn downward. It therefore made tweaks to its underwriting guidelines, moving into certain industries and away from others it deemed riskier. “Change can be hard, but it can be for the better,” Sheinbaum says.
Indeed, alternative funders that embrace new opportunities can be successful even in a broad economic downturn. “It’s about having the foresight to be able to discern good from bad and just being really disciplined about it,” says Snitkof of Orchard Platform.
Having Problems With Leads? Don’t Feel Alone
April 24, 2016
Having problems with leads? Don’t feel alone. Funders and lead providers say response rates to offline marketing have been cut in half while the price of pay-per-click campaigns has skyrocketed. They blame intense competition in an increasingly crowded field of funders, market saturation by lead generation companies, better email spam filters and comparison shopping by small-business owners who are becoming more savvy about how much they need to pay for merchant cash advances and loans.
Clicks that cost $5 each seven years ago now command a price of nearly $125, says Isaac Stern, CEO of Yellowstone Capital LLC, Green Capital and Fundry. “Pay-per-click marketing has gotten out of control,” he laments. “So you need a hefty, hefty budget to compete in that world.” He reports spending $600,000 to $700,000 a month on internet marketing, compared to $100,000 monthly on direct mail.
Even when the price of individual clicks isn’t measured in hundreds of dollars, the cost of the multiple clicks required to create a lead can mount up, according to Michael O’Hare, CEO of Blindbid, a Colorado Springs, Colo.- based provider of leads. If it takes 15 clicks that cost $25 each to obtain a lead, that comes to $375, he notes. Still, some companies manage to use key words that cost $8 or so per click to get decent leads for less than $100, he says.
While the cost of pay per click is exploding, the response to direct mail marketing is declining precipitously, says Bob Squiers, who owns the Deerfield, Fla.-based Meridian Leads. The percentage of small-business owners who respond to advertising they receive in the mail has fallen from 2 percent just a few years ago to 1 percent now, partly because they receive so many mailings from so many more lead-generation companies, he says. “There weren’t too many people doing direct mail into this space five years ago,” he notes. His company’s leads range in price from pennies to $60, he says.
While Blindbid and Meridian both specialize in finding leads by sending out direct mail pieces and then qualifying the respondents in phone conversations, one of their competitors, Lenders Marketing, takes a different approach, according to Justin Benton, sales director for the Camarillo, Calif.-based company. Benton’s data-driven method combines his company’s databases with the databases of financial institutions. He cultivates relationships with the banking industry’s executives to facilitate that process, he says, and his company does not make phone calls to qualify leads.
But placing too high a value on data gives rise to two problems, the way O’Hare views the search for leads. First, analyzing the data creates plenty of challenges, he says. Second, human beings just aren’t rational enough in their decision-making to fit data-driven profiles or cohorts, he maintains. “The holy grail is to find some algorithm that will predict that a merchant needs funding, and they can then find these people through massive data,” he says with skepticism.
Whatever path a company takes to finding and verifying leads, it pays to establish three elements before classifying them, O’Hare says. First, prospects should qualify financially for credit or advances. Second, prospects should demonstrate a genuine interest in obtaining funding, as opposed to less-than-serious “tire kicking.” With both of those characteristics in place, O’Hare informs prospects they can expect to hear from funders.
Blindbid also wants to guide the expectations of the funders who are calling the leads, O’Hare says. To that end, the vendor invites funders to listen to recordings of the phone calls it makes to qualify leads. Just the same, funders should bear in mind that they may not receive the same reception when they contact the lead, he cautions. “We see it all the time, he says. “We speak to the merchant in the morning and they’re pleasant. Then in the afternoon when they speak to the funder or the broker, the merchant is grumpy.”
Retailers’ mood swings aside, funders can soon gauge the quality of the leads they’re buying. “You can’t judge a lead on cost, Squiers admonishes. “Judge them by performance.” However, performance fluctuates according to the funder’s sales skills, product offering and product knowledge, he maintains.
Meanwhile, the problems plaguing the lead business should prompt funders to become creative in their approach to finding prospects. That’s why even vendors who make their living selling leads encourage funders to search for prospects on their own. “We always advise generating your own leads,” says Benton. “The only leads you can truly count on are the ones you generate yourself.”
Knowing where to look for leads can require a thorough grasp of what’s happening in a particular market. “You can look at what industries are hot,” O’hare suggests. The trucking business is heating up, for example, because so many truckers need funding to buy expensive equipment to meet new requirements for electronic logs, he says. Meanwhile, the recession has wracked the martial arts industry, so dojos might require funding for marketing to help them recover, he notes.
Understanding every industry in that much detail isn’t practical, so lead generation companies urge funders to specialize in just a few niches. Building a network of customers who know each other can result in referrals, Benton observes. It also soothes skeptical prospects, he notes. “Once you say I’ve worked with Fred down at Tony Roma’s – they can feel more comfortable, especially if you’ve done it in the same city,” he maintains.
Whether leads arise internally or come from a vendor, funders have to work them properly to succeed in closing deals, lead-generating companies agree. “The real key is being consistent and persistent,” Benton says. “Research has shown the average lead is called 1.3 times, so once you make that second call you are ahead of the curve.” He advocates that funders use their CRM system by taking copious notes on their calls, setting up nurture campaigns and following up with leads in an organized manner.
And don’t forget that at least some prospects are getting pummeled with calls. “A lot of brokers are carpet bombing – they’re on the phone all day,” says O’Hare. “I talked to one guy who said he makes 400 or 500 calls a day on a manual dial. I’d like to do a video of that.
Splits Glitz or Fritz? – Transact 16 highlighted strange chapter in merchant cash advance history
April 21, 2016
It’s Opposite Day in the alternative business funding industry. Lenders are splitting card payments and merchant cash advance companies are doing ACH debits.
Jacqueline Reses was not an odd choice for Transact 16’s Wednesday morning keynote. Square, the company she works for, has continued to be a hot topic in the payments world for years. But what was striking is that Reses heads the lending division, the group that allows merchants to pay back loans through their future card sales. If that sounds very merchant-cash-advance-like, it’s because that’s exactly the product they used to offer before changing the legal structure behind them.
Split-payments, not ACH payments, have literally propelled Square and PayPal to the top of the charts of the alternative business funding industry. One individual on the exhibit hall floor posited that Square’s ability to originate loans through their payments ecosystem was the company’s real value; Payments itself was secondary. It’s a testament to the opportunities that split-payments affords to (as I argued 3 years ago on the ETA’s blog) a company well positioned to benefit from it.
Meanwhile, the companies at Transact that one would have historically described as merchant cash advance companies have mostly transitioned away from split-payments to ACH. Essentially, Square and PayPal embraced splits as an incredible strength while yesterday’s merchant cash advance companies viewed splits as a handcuff that limited scalability. The payment companies became merchant cash advance companies and the merchant cash advance companies became something else entirely, a diverse breed of loan and future receivable originators operating under a label people are now calling “marketplace lenders.” But even Square and PayPal, arguably the two companies at Transact doing the most split-payment transactions, claim to make loans, not advances.
Merchant Cash Advance as anyone knew it previously is dead
Ten years. That’s the average age of the small business funding companies that exhibited at Transact this week. They are but the last remaining players that probably considered the debit card interchange cap imposed by the Durbin Amendment of Dodd-Frank as being among the most significant legislation that affected their businesses.
A senior representative for one credit card processor told me at the conference that their biggest gripe with new merchant cash advance ISOs today is that they know almost absolutely nothing about merchant accounts. It’s not that they know less, they know nothing, he said.
One company was notably absent from the floor this year, OnDeck. They’ve since embraced the marketplace lending community as their home, just as many others have.
Nine years ago, I overheard a very influential person say that the first company to be able to split payments across the Global, First Data and Paymentech platforms would be crowned the “winner” of the merchant cash advance industry and by extension the wider nonbank small business financing space.
If one were to define the winner as the first company from that era to go public, well then those 3 platforms played no role. OnDeck was the first and they relied on ACH payments the entire way. They also refer to themselves these days as a nonbank commercial lender. If that doesn’t sound very payments-like, it’s because it’s not.
What cause is being Advanced?
At least four coalitions are currently advocating on the marketplace lending industry’s behalf, the Coalition for Responsible Business Finance, the Marketplace Lending Association, the Small Business Finance Association, and the Commercial Finance Coalition. The Transact conference is put on by the Electronic Transactions Association whose tagline is “Advancing Payments Technology.” In an age where new merchant cash advance ISOs know nothing about payments, it’s no wonder there’s a growing disconnect.
Could Transact now be one of the best kept secrets?
A few people from companies exhibiting say that they believed they stood a better chance to land referral relationships from payment companies by being there and that there was still a lot of value in landing those deals. Partnerships like these may be why the average exhibitor has been in business for 10 years while today’s new companies relying solely on pay-per-click, cold calling, or handshakes are falling on hard times.
Some payment processors acknowledged that merchant cash advance companies were still a good source to acquire merchant accounts, though the process by which that happens is not the same as it used to be. A lot of it is referral based now, according to one senior respresentative for a card processor. The funding company funds a deal via ACH and then refers them to the payment guy to try and convert that as an add-on. The residual earnings may not be as good as they used to be but that’s because they don’t have to do any work in this circumstance. In a sense, funders are still leading with cash but instead of the boarding process being mandatory, it’s an entirely separate sale that sometimes works and sometimes doesn’t. In that way, small business funding companies can be a good lead source for payments companies.
When I asked the senior representative if they really had success closing merchant accounts just off of a referral from a funding company, he looked at me incredulously, and said, “you used to do this, of course we do. that’s how this whole industry started.”
“What industry?” I asked.
What industry indeed…
