Generating Leads and Acquiring Borrowers Not Easy in Business Lending
July 21, 2015
“Banks are almost always losing money on small business lending,” said Manish Mohnot, TD Bank’s Head of Small Business Lending, on a panel at the AltLend conference in New York City. It’s a loss leader within the small business segment, he explained, because banks want to bring in deposits.
Funding Circle’s Rana Mookherje concurred. “Banks just can’t make a loan under $500,000 profitably,” he said.
It’s a conundrum few outside banking think about. When consumers and businesses picture banks, they might think of loans, but when banks think of consumers and businesses, they think of deposits. The sentiment amongst the experts at AltLend was that traditional banks and alternative business lenders were not competing with each other for the same customers because each party was after a different objective.
And even when banks think about loans, because obviously they do, they just don’t approach them the way that alternative business lenders do. To that end, ApplePie Capital CEO Denise Thomas said, “Most community banks are looking to make loans backed by an asset. They just don’t want to underwrite [loans] one by one under a million dollars.”
Bankers are genuinely surprised by how alternative lenders subjectively or manually approach business loans, a subject covered just yesterday here on AltFinanceDaily. Charles Green, the Managing Director of the Small Business Finance Institute and moderator of the New Pioneers panel said he never saw banks use bank transaction history to make underwriting decisions in his 35 years of banking.
The factors paraded as being more important above everything else in alternative lending today have apparently been non-factors in traditional lending for years. “There is no substitute for banking information when reviewing a client for approval,” said Andrew Hernandez, a co-founder of Central Diligence Group, in Do Bank Statements Matter in Lending? Business Lenders and Consumer Lenders Disagree. These kind of statements are mind-blowing in traditional lending circles.
Nevertheless, banks watch in awe as alternative lenders not only make small commercial loans, but do it profitably. But how they source borrowers isn’t rocket science. Jim Salters, the CEO of The Business Backer pointed out that some alternative lenders are marketing on a large scale by running TV or radio commercials. But that level of investment isn’t for everyone, especially younger companies.
“Direct mail isn’t sexy, but it converts,” said Candace Klein, the Chief Strategy Officer of Dealstruck. She also said that her company is doing radio advertising.
Matt Patterson of Expansion Capital Group is well versed in digital marketing and incorporates SEO and online paid advertising such as Facebook in his strategy. There’s a difference in the conversion rate in advertising on Facebook versus something like Google, he explained. On Google, business owners are looking for something whereas on Facebook they stumble across it.
Everyone agreed that Pay-Per-Click marketing such as Google Adwords was very expensive in this competitive landscape.
Jim Salters, CEO of The Business BackerBut where can funders and lenders reliably turn to acquire deal flow cost effectively? Salters revealed the industry’s worst kept secret, brokers. The Business Backer acquires about half of its volume from brokers and the other half directly, according to Salters.
“The broker channel is one of the most cost effective channels for us,” said Klein, who would not say on the record exactly how much of Dealstruck’s total business was from brokers.
Patterson agreed with the favorable ROI of using brokers, but saw benefits to communicating with small businesses directly. “Everything about that relationship is better when you’re talking directly to that merchant,” he said. And yet, “our direct leads convert much lower than our broker leads will,” he added.
The panelists generally agreed that this was because brokers have essentially already gathered the documents and closed the deal by the time the lender or funder is finally seeing it.
But aren’t brokers and humans the antithesis of tech-based lending?
Brett Baris, the CEO of up-and-coming lender Credibility Capital said, “We were actually a little surprised by how much a human is needed.” Baris’ company acquires most of its leads through a partnership it has with Dun & Bradstreet. Most of their borrowers are prime credit quality.
“The human element is very important to get the higher quality borrowers to the finish line,” Baris noted. TD’s Mohnot was not surprised. For applicants doing $5 million to $6 million a year in revenue, they want somebody to walk them through the loan process, he opined.
“Merchants love talking to people,” Patterson said. “Some of that comes from the frustration of calling their bank and not being able to talk to people.”
But would that mean the assumptions about automation are wrong? Not quite, explained Mohnot. It’s the younger business owners who have the impulse desire to do things fast or online, he said.
And Klein said that observing merchant behavior at least at her company has shown that those all too eager to apply for a loan in an automated online fashion are typically looking for smaller amounts like $20,000 to $40,000. Meanwhile Dealstruck’s loan minimum is $50,000.
Not everyone is as fortunate as Baris, who is able to generate leads through the trust inherent in a conversation that originated with a D&B rep, but real actual bank declines are making their way to alternative lenders. They’re not the holy grail that everyone thinks they would be though.
“Conversions tend to be lower from bank leads because they’re expecting 6% and are insulted when they hear [a higher %],” said Klein. And Salters who refers to his company as a “turndown partner of choice for upstream lenders,” shared how hard it is for a bank to partner with an alternative lender in the first place. Years ago, banks were aghast by his hands-on, manual underwriting approach that he felt was his company’s core competency. The banks were afraid their regulators would freak out over something so subjective.
And yet Merchant Cash and Capital’s founder, Stephen Sheinbaum and Credit Junction’s CEO Michael Finkelstein both told an audience that they saw banks as collaborative partners.
Meanwhile, Dealstruck actually has a graduation system where merchants graduate out of their loan program and become eligible for a real bank loan. Klein explained that a small business could be referred to them by the bank and then after a couple of years of good history, they’ll refer it back to them.
The acquisition secret however seems to be in finding your strength. ApplePie is focused exclusively on franchises. Expansion Capital Group has formed relationships with several trade organizations. Credibility Capital goes hand-in-hand with D&B.
Still, there is no doubt that the broker channel is alluring, but it can be a slippery slope. Raiseworks CEO Gary Chodes cautioned that “brokers are incentivized to follow the money.” Klein also expressed concern. She knows firsthand how challenging brokers can be since she’s had to terminate some in the past for bad behavior.
“Transparency is extremely important,” Finkelstein proclaimed in regards to the customer experience. This means that lenders can’t simply work off the ROI metric alone. But that ROI is the envy of banks nationwide.
Banks want to refer their clients to alternative lenders because if they get approved, then the lender is going to deposit those funds at their bank, Mohnot alluded.
It would seem that there is not one particular methodology that works better than all the others to acquire a borrower and that’s okay. Alternative lenders struggling to maximize their ROI can take comfort in the fact that banks, with all the resources they have at their disposal, accepted a long time ago that it was impossible to even make money at all in small business lending.
If you’re at least in the black, you’re probably doing just fine…
Federal Government Wants Your Thoughts About Online Lending
July 19, 2015
Whether you’re a funder, lender, broker, or platform, the U.S. Treasury Department deserves to hear your input.
Only July 16th, the Treasury announced that it was seeking public comment on various business models and products offered by online marketplace lenders to small businesses and consumers. One stated purpose of this is to study “how the financial regulatory framework should evolve to support the safe growth of the industry.”
The comment period is only open for six weeks.
Over the last year, many funders and brokers have voiced their opinions on best practices, ethics, and standards. Some want regulation to curb what they believe to be immoral behavior and others just want clarity where the laws are obscure, illogical, or even in conflict with themselves.
In at least one recent case, a merchant cash advance company CEO wrote about the complexity of dealing with an endless amount of state laws. In Lift the Fog, Give us Regulation, Merchant Cash and Capital CEO Stephen Sheinbaum wrote, “It is also better, at least for the financial services industry, if the central government is the one to craft the regulation instead of getting one rule from each of the 50 state governments.”
Meanwhile the Consumer Financial Protection Bureau (CFPB) will eventually start to enforce the amendments to the Equal Credit Opportunity Act, which technically already became the law under Section 1071 of the Dodd Frank Act. As part of that, underwriters of business loans and merchant cash advance alike may no longer be allowed to meet applicants, speak with them on the phone, examine their driver’s licenses, review their social media profiles, or even ask what their business model is or how they market themselves.
One has to look at any opportunity afforded by a government agency to share input before future regulations are implemented then as a duty. It might not matter, but you should do it anyway, just like voting.
Below are the questions, the Treasury wants you to answer (or Click to view on Treasury.gov):
1. There are many different models for online marketplace lending including platform lenders (also referred to as “peer-to-peer”), balance sheet lenders, and bank-affiliated lenders. In what ways should policymakers be thinking about market segmentation; and in what ways do different models raise different policy or regulatory concerns?
2. What role are electronic data sources playing in enabling marketplace lending? For instance, how do they affect traditionally manual processes or evaluation of identity, fraud, and credit risk for lenders? Are there new opportunities or risks arising from these data-based processes relative to those used in traditional lending?
3. How are online marketplace lenders designing their business models and products for different borrower segments, such as:
• Small business and consumer borrowers;
• Subprime borrowers;
• Borrowers who are “unscoreable” or have no or thin files;
Depending on borrower needs (e.g., new small businesses, mature small businesses, consumers seeking to consolidate existing debt, consumers seeking to take out new credit) and other segmentations?
4. Is marketplace lending expanding access to credit to historically underserved market segments?
5. Describe the customer acquisition process for online marketplace lenders. What kinds of marketing channels are used to reach new customers? What kinds of partnerships do online marketplace lenders have with traditional financial institutions, community development financial institutions (CDFIs), or other types of businesses to reach new customers?
6. How are borrowers assessed for their creditworthiness and repayment ability? How accurate are these models in predicting credit risk? How does the assessment of small 10 business borrowers differ from consumer borrowers? Does the borrower’s stated use of proceeds affect underwriting for the loan?
7. Describe whether and how marketplace lending relies on services or relationships provided by traditional lending institutions or insured depository institutions. What steps have been taken toward regulatory compliance with the new lending model by the various industry participants throughout the lending process? What issues are raised with online marketplace lending across state lines?
8. Describe how marketplace lenders manage operational practices such as loan servicing, fraud detection, credit reporting, and collections. How are these practices handled differently than by traditional lending institutions? What, if anything, do marketplace lenders outsource to third party service providers? Are there provisions for back-up services?
9. What roles, if any, can the federal government play to facilitate positive innovation in lending, such as making it easier for borrowers to share their own government-held data with lenders? What are the competitive advantages and, if any, disadvantages for nonbanks and banks to participate in and grow in this market segment? How can policymakers address any disadvantages for each? How might changes in the credit environment affect online marketplace lenders?
10. Under the different models of marketplace lending, to what extent, if any, should platform or “peer-to-peer” lenders be required to have “skin in the game” for the loans they originate or underwrite in order to align interests with investors who have acquired debt of the marketplace lenders through the platforms? Under the different models, is there pooling of loans that raise issues of alignment with investors in the lenders’ debt obligations? How would the concept of risk retention apply in a non securitization context for the different entities in the distribution chain, including those in which there is no pooling of loans? Should this concept of “risk retention” be the same for other types of syndicated or participated loans?
11. Marketplace lending potentially offers significant benefits and value to borrowers, but what harms might online marketplace lending also present to consumers and small businesses? What privacy considerations, cybersecurity threats, consumer protection concerns, and other related risks might arise out of online marketplace lending? Do existing statutory and regulatory regimes adequately address these issues in the context of online marketplace lending?
12. What factors do investors consider when: (i) investing in notes funding loans being made through online marketplace lenders, (ii) doing business with particular entities, or (iii) determining the characteristics of the notes investors are willing to purchase? What are the operational arrangements? What are the various methods through which investors may finance online platform assets, including purchase of securities, and what are the advantages and disadvantages of using them? Who are the end investors? How prevalent is the use of financial leverage for investors? How is leverage typically obtained and deployed?
13. What is the current availability of secondary liquidity for loan assets originated in this manner? What are the advantages and disadvantages of an active secondary market? Describe the efforts to develop such a market, including any hurdles (regulatory or otherwise). Is this market likely to grow and what advantages and disadvantages might a larger securitization market, including derivatives and benchmarks, present?
14. What are other key trends and issues that policymakers should be monitoring as this market continues to develop?
The Treasury asks that you include your name, company name, address, job title, email address, and phone #. You can submit your responses on http://www.regulations.gov/. Just click on the tab that says “Are you new to the site?”
You can also submit by mail:
To: Laura Temel,
Attention: Marketplace Lending RFI,
U.S. Department of the Treasury, 1500
Pennsylvania Avenue NW., Room 1325
Washington, DC 20220
If you have questions, email marketplace_lending@treasury.gov or call 202-622-1083.
Letter From the Editor – July/August 2015
July 1, 2015
G’day mates,
Merchant cash advance and similar financial solutions have expanded beyond the United States. Canada was always the next logical option but it’s made its way far beyond that, all the way to Australia. And in the land down under, Australian natives are competing with American-based companies for market share. There’s not a lot of information available about the landscape there so we went out and got the inside scoop, fair dinkum!
Speaking of international, the race is on here at home to obtain a national or state bank charter. Loans allow for much more customization than is possible with merchant cash advances, noted Glenn Goldman, CEO of Credibly. But is the industry setting itself up for a stable future or are some companies betraying their roots as a bank alternative by in essence becoming banks themselves?
And even while the crowd cheers for charters, a baffling appellate court ruling in New York State threatens to undermine that strategy completely. If you haven’t heard of Madden v. Midland Funding, we’ve got some information about it inside.
I must note that AltFinanceDaily celebrated its 5-year anniversary this past July. The world was much simpler when I started it. In 2010, I was able to quantify the industry’s size with ease, but today it’s a challenge to define what the industry even is, let alone calculate how big it is.
Everything is evolving and quickly, but some things still say the same, like when a broker’s commission is pulled back because a deal defaulted. Shouldn’t lenders take full responsibility for their own underwriting decisions? Not all brokers thought so apparently when we asked them. It appears that today’s broker is thinking more like a lender and if long-term growth is one of their goals, they’re probably thinking about becoming a lender themselves. That of course brings us right back to bank charters and court rulings to make that possible.
And if those topics are exhausting to think about, then sit back, relax and let us guide you through the beautiful Australian Outback. From Uluru to a kangaroo, alternative lending is never out of reach.
–Sean Murray
Still Reviewing Paper Bank Statements? Stop
June 26, 2015
Are the bank statements you received legitimate? Underwriters in the business financing industry are scouring paper documents for abnormalities hoping to catch fraud in the inducement. And word on the street is that small business owners are doctoring statements and engaging in trickery in record numbers.
Technology has made it easier to create authentic looking documents and the rise in online lending seems to be bringing out the worst in people. Somebody in a desperate situation might not have the guts to look a banker in the eye and hand him a stack of fraudulent documents but they might roll the dice with somebody over the Internet they’ll never have to meet.
The fakes aren’t obvious anymore. Anyone can go online and buy doctored documents from professionals. The business is booming on Craigslist for example where fraudulent documents can be made to order in under an hour.
In the Miami area, fraud hucksters are even beginning to offer deals such as buy 2 fake documents, get 1 free.
Industry-wide, funding companies are complaining that attempted fraud is out of control. One broker recently took to the dailyfunder forum to share her frustration. “I can spot them a mile away!!! 2 different deals submitted this week with fraudulent statements!!!,” she vented.
Other brokers chimed in, sharing their stories such as a merchant whose doctored statements were only noticed because ATM withdrawals were listed with odd amounts like $90.83.
Oddly, nobody seems to be reporting this fraud to the authorities. It all seems to get swept under the rug as business as usual. Orchard co-founder David Snitkoff for example, was asked just last month about the rate of marketplace lending fraud and he apparently said, “No worries, none to date.” He seemed to be implying that fraudulent applicants are getting screened out. But that doesn’t mean people aren’t trying.
Seven months ago, merchant cash advance underwriter Pierre Mena wrote in detail about the challenges he faces in detecting fraud. He said:
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.
-Pierre Mena, Rapid Capital Funding
A lot of these issues can be easily overcome by simply disregarding paper statements altogether. Microbilt’s instant bank verification tool for example, will allow you to pull the most recent 90 days worth of transaction data directly from the banks themselves. Funders using these automated checks swear by their effectiveness and the capability is essential for any company that wants to scale.
But a recent conversation with the owners of a broker shop in NYC said this is easier said than done. Merchants are still using fax machines to send statements or claiming they don’t have access to computers or email accounts, they said. They added that their clients would suffer if approvals were completely contingent upon online verifications.
Cultural differences play a role in this according to Gil Zapata, the founder of Florida-based Lendinero. Zapata recently wrote that latino business owners over the age of 45 are not accustomed to doing business over the Internet, email, fax, or phone. “This group has a high level of distrust in doing business via the Internet,” he said.
So is there a middle ground? On the dailyfunder forum, Chad Otar, a managing partner of Excel Capital Management said that he tells merchants they can change their online banking passwords after a verification. And Andy McDonald of Yellowstone Capital wrote that verifying the bank data is beneficial for the merchants too. “It protects the merchant by allowing us to check their account to make sure our pulls aren’t going to bounce,” he wrote in a thread back in April. He also added that he comes across 2-3 applications PER DAY with altered statements.
Humans can only do so much. Pierre Mena actually wrote, “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.” At this point, an instant bank verification would probably work wonders.
Online business lender Kabbage might have the best model. On their website, applicants are instructed to enter their email address followed by their bank account username and password. Their system will analyze their bank transactions and if eligible, will then ask the applicant for their first and last name. It flies in the face of all the pushback that funders claim merchants give them over data privacy and security.
Four months ago Kabbage announced they were already up to funding $3 million per day. Obviously there is an entire segment of small business owners that are sucking up whatever concerns they had about bank verifications in order to get the capital they need.
The majority of the small business financing industry is still relying on paper statements and probably shouldn’t be. If you have to zoom in upwards of 300% to find a comma that should actually be a period and if con artists are offering discounts for bulk orders of fraudulent statements, it may be time to throw in the towel and join the rest of the world in using the Internet…
Coming to the Rescue: Consolidation Can Save Merchants
June 24, 2015
In the last 18 months, funders have begun offering consolidations that combine more than one advance. First, the funders buy out the merchant’s existing advances. Then funders lower the percentage collected from a merchant’s card receipts or debited by ACH. Sometimes, consolidation can even include an infusion of cash for the merchant.
“Consolidations are a way to help merchants avoid defaulting,” said Chad Otar, managing partner at New York-based Excel Capital. Consolidation works if the buyout price is low enough and the terms allow enough room to handle the obligation.
“It can free up some cash and give the merchant some room to breathe, sustain the business and avoid taking on more debt,” he noted.
It’s helpful to think of consolidation as the equivalent of refinancing a house, according to Stephen Halasnik, managing partner at Payroll Financing Solutions, a Ridgewood N.J.-based direct lender. Payroll has been offering the service for about six months, he said.
Brokers and funders can benefit from consolidation because it puts a merchant back on track towards long-term sustainability, said a broker who requested anonymity. Moreover, the broker said that one in three of the potential deals he sees have multiple advances outstanding, which means companies could lose an alarming chunk of market share by declining too many potential funding candidates. “That’s what I believe the catalyst was to opening the doors to consolidation,” he contended.
SECRET TO SUCCESS
Success in consolidation lies in finding merchants worthy of another chance, said Otar. Clients who have taken two or three advances but stick to the new plan and stop stacking advances from other brokers have a reasonably good chance of succeeding, he said. His company can work with a merchant that has as many as three advances outstanding if they have sufficient revenue.
Otar provided the example of a merchant who’s diverting 20% of his gross revenue to three advances. Together, the advances have led to a total of $50,000 in future revenues sold. If the merchant generates enough monthly revenue to qualify for $100,000, Excel can buy out the three advances, provide the merchant with $50,000 in cash, and lower the payment to 8% to 12% of gross revenue. “All of a sudden they have all this cash flow to play with that really wasn’t there,” he said of merchants in that situation. “They tend to do really well.”
Halasnik of Payroll Financing Solutions offered the example of a trucking company that had taken three advances and was delivering a total of $1,138 a day on average to the funders. Payroll bought out the three funders and is charging the trucker $615 a day.
One of Payroll’s clients needed to repair a commercial vehicle but already had too many advances and couldn’t get another, Halasnik said. Payroll consolidated the positions and lowered the payment, enabling the merchant to save enough money in two weeks to have the vehicle fixed.
To qualify for a consolidation, the merchant has to meet the “50% Rule” by netting 50% of what Excel is offering, Otar said. Between 40% and 50% of the distressed merchants that the company considers for consolidation meet that criterion, he said. An additional 30% of the merchants can meet that standard in the near future, once they’re further along on their agreements.
Under the 50% Rule, a merchant that is still obliged to deliver $70,000 and qualifies for $100,000 would not be a candidate for consolidation, Otar said. In that situation, a merchant can wait until he has delivered more of the sold revenues to the funders and then get a consolidation, he said. “In the meantime, don’t take on any more debt,” Otar tells the merchants. That too could impact their ability to sell additional revenue streams in return for cash upfront down the road.
Some merchants combine debt and advances, seeking advances only after maxing out their credit lines, said Otar. More commonly, however, it’s a matter of stacking advances, he said. “When we see there are three, four, five, six, seven cash advances out, that’s a merchant we tend to stay away from,” he noted.
Brokers should also bear in mind that every deal’s different, cautioned Steven Kamhi, who handles business development and ISO relationships at Nulook Capital, a Massapequa, N.Y.-based direct funder. “It has to be the right deal,” he advises.
Brokers can identify distressed merchants within the first two minutes of a phone conversation when they say things like, “I need the money right now,” Otar said. Looking at the paperwork, the broker can see within 10 minutes whether the potential client is hard-pressed.
Asking the right questions helps reveal distress quickly, sources said. That can include asking how many advances the merchant has outstanding, how much in future sales they still have to deliver and how much revenue they’re grossing monthly. Asking what company advanced them cash can reveal a lot if they’re working with less-reputable companies.
Listening’s under-rated, too. Merchants sometimes explain that they’re coming up with more ways of making money and are, therefore, making themselves a better bet for sustainability, Otar said.
OTHER WAYS OF HELPING
Brokers can make deals more palatable to some distressed merchants by deducting payments weekly instead of daily, Otar said. “It’s something I’m seeing a big migration toward,” he noted. “It’s a big selling point.” Manufacturers and contractors don’t have customers swiping cards every day and especially appreciate the change. More widely spaced payments can also fit better with some clients’ seasonal cash flow.
Besides consolidation, brokers can help distressed merchants by providing traditional accounts-receivable financing, which can prove particularly helpful for manufacturers and construction companies, Otar said.
Suppose Customer A owes a contractor $100, Otar said by way of example. The contractor can get $90 from the factor, and the factor collects the $100 from Customer A. The client pays the cost of the financing upfront but reduces the waiting time to receive the cash and avoids daily or monthly payments.
Accounts-receivable financing costs merchants much less than a cash advance, Otar noted. But putting the deal together takes longer than approving an advance, and merchants in immediate need of cash might not be able to wait.
In another example of helping merchants, Payroll had a client who was a bicycle shop owner with good credit and equity in a home, so it granted him an advance that gave him time to go to a bank and get a home equity loan. “I counseled him to do that and then buy us out,” Halasnik said.
PREVENTING DISTRESS
On the sales side of the business, brokers can help distressed merchants by preventing stacking from occurring in the first place, sources said. Otar recommended, “listening to the customer, understanding the business and offering a product that is going to benefit the customer in the long run.” That way, the broker positions himself to work with the client for years, not two or three months. “At the end of the day, they appreciate that,” he said.
Halasnik relies on his experience as a small-business owner who has operated a printing company, staffing company and nurse registry to help him understand aspects of a client’s business that people from a purely financial background might not fathom.
Brokers seeking long-term relationships should know a client’s business well enough to advise against taking on more financial obligations when the time isn’t right, agreed Payroll’s Halasnik. However, after the broker urges caution, the decision rests with the business owner, he maintained. “We are on the same page as the client,” Halasnik said. “We are looking out for their best interest because, ultimately, we have to get paid back.”
THE CASE AGAINST CONSOLIDATION
Some members of the industry prefer to avoid the consolidation trend. “The guy’s already shown that he’s going to go and take three or four advances,” said Isaac Stern, CEO of New York-based Yellowstone Capital. “Doesn’t history just show he’s going to do the same thing over again?”
When a merchant’s overextended, he should wait before taking another advance, Stern said. But when some merchants are denied another advance, they immediately seek out another funder, he maintained.
Yellowstone has put together a few consolidations but chooses not to create too many, Stern said. Some merchants find themselves a month or two away from going out of business unless they can find a source of cash, he observed. “They’ve been declined for that last credit card, and things are getting really rough,” he said.
Some members of the industry advocate coming together to improve standards and provide training. Wall Street’s testing and licensing could serve as an example, suggested one source. Background checks could also help root out unethical players, he noted.
But creating a training and certification infrastructure would prove a formidable task, according to Stern. The industry would have a hard time agreeing upon who should head a trade association to administer the standards, he said. He views the industry as a collection of Type A personalities – sometimes defined as ambitious, over-achieving workaholics – who would resist consensus. “It’s a nice idea, but I don’t see it working,” he said.
REASON TO BELIEVE
Though industry players are contending with some distressed merchants, Stern noted that the average credit score of his company’s clients is beginning to rise as the economy improves.
Though statistics on distressed merchants aren’t readily available, other industry veterans feel they’re not encountering as many now as a year ago. However, they said they may see fewer cases of distress because bigger players are beginning to offer consolidations.
“A year ago, nobody would consider doing it,” a broker said of consolidation. But as funders become more open to the product when they see competitors using it to gain market share. “It’s becoming more mainstream,” he said.
How brokers market their services can also determine how many distressed merchants they encounter, sources said. Using the same prospect lists that competitors use can lead to calling on overextended clients, they maintained.
Whatever the number of distressed merchants may be, stacking sometimes makes sense, said Halasnik. What if a client needs $30,000 to win a contract, and a funder is willing to provide only $15,000, he asked rhetorically. Perhaps another funder will put in $15,000, too.
Problems arise, however, if the two funders don’t know the merchant has made two deals because they happened the same day. It’s the kind of situation that sours some members of the alternative-funding community to consolidation. As Halasnik put it: “You’re dealing with somebody who’s in trouble. It’s the highest risk a lender could take.”
Merchant Cash Advance: Do You Know What You’re Selling?
June 22, 2015
Continuing on with the Year of The Broker discussion, I want to now shift focus to the continued wave of new broker entrants that are not receiving sufficient training. I don’t believe that it’s so much the fault of the brokers, as it’s the fault of the companies they are reselling for. Those companies usually fail to provide a structured training regime. Training provided to new broker entrants is typically centered around the memorization of sales scripts, the practice of outdated rebuttals, and the repetition of lines that can end up sounding very canned and robotic.
If I had to recommend new age sales training, I’d have to go with my favorite, which is Diagnostic Selling, promoted by the likes of Jeff Thull from Prime Resource Group (www.primeresource.com). Thull explains that as the sales consultant, you should be a valued source of business advantage for your client, rather than just a person that goes through a series of sales material regurgitation. You should have access to products, services, platforms, big data, knowledge, key players, new solutions, forecasts, trends, etc., that the merchant does not have access to, which allows them to see you as a “valued extension” of their organization. This leads to not just new client acquisition, but the real key to making money in our space, and that’s client longevity.
In order to truly achieve this level of sales consultancy, it’s important that you truly understand the products being sold because, firstly, you want to be able to distinguish between the products you are selling so that you can provide a valued consultation. You might find yourself selling one product when you should be referring another. Secondly, understanding these products is important from a regulatory standpoint as the legal connotations of the products must be disclosed properly or mistakes in disclosure, marketing, or funding agreements could become costly.
If you are an independent broker in the alternative commercial lending space, you are usually going to be selling one or multiple of the following products:
- The Merchant Cash Advance
- The Alternative Business Loan
- Equipment Leasing
- Accounts Receivable Factoring
- Accounts Receivable Financing
- Purchase Order Financing
To begin, let’s discuss the Merchant Cash Advance…
Product Value Points
Don’t Let The Critics Win
Critics of the product focus mainly on its high cost and it can be very expensive, but when used properly the product is a great leveraging tool.
Critics fail to shed light on the value of the product in terms of the merchant’s usage. Going back to that Growth Investment example, if the product had not been available, then what were the other sources available for the merchant to take advantage of the growth opportunity? In actuality, there were no other credible sources. Had the Merchant Cash Advance not been available, that investment would not have been made, and a ton of national, state and local economic activity would not have taken place, such as:
- The Equipment Manufacturer’s sale of the equipment
- The Merchant’s generation of $300,000 in revenue based on having the equipment
- The Purchaser’s revenue from borrowing costs incurred from the client using the advance
- My individual commission
- Then all of the federal, state and local taxes that would have been paid as a result
All of that economic activity vanishes if said transaction does not take place. Despite the high cost of the product, the fact is that this transaction would have been a win across the board for all parties involved including the Manufacturer, the Client, the Purchaser, Myself, as well as the Federal/State/Local Government. The true value of business capital, no matter if it’s conventional or alternative, is that the capital should produce enough new revenues so that it truly pays for itself.
Wall Street Has a New Landlord
June 20, 2015
“You stole my deal bro!”
“No I didn’t. The merchant hated your offer,” replies back a 25-year old dressed in a dark pinstripe suit with no tie.
He then takes a pull from his half-smoked cigarette and continues, “The guy wanted 90k and you offered him twenty. I was at least able to get him fifty. What’d you think was going to happen?”
I walk past the two who eye me suspiciously and am quickly out of hearing range of their conversation. They were strangers, but I know exactly what they were talking about. Walking around the neighborhood here, I feel oddly at home.
This is Wall Street, a new stronghold for the small business financing industry. Midtown has traditionally been the epicenter for merchant cash advance companies, but somewhere along the way, new players started opening up their shops in lower Manhattan.
As a born and bred New Yorker, I never really saw a need to visit the actual street of Wall Street. To my knowledge, it was simply emblematic of high finance, not really a physical place anymore.
But earlier this year when I signed a lease at 14 Wall Street, I would be thrust into the middle of America’s biggest breeding ground for financial brokers and learn once and for all that the ebb and flow of Wall Street isn’t exactly gone, just transformed.
From my office up on the 20th floor, I can see into the windows of the top five stories of the New York Stock Exchange building. The floors appear to be set up for traders, with long white continuous desks peppered with large monitors on both sides. Everyone sits and stares intensely at their screens, pressing buttons on their keyboard at rapid fire pace. Nobody runs around screaming orders anymore.
Outside, tour guides tell excited onlookers about the stock exchange’s past. It’s a historical landmark, a place to learn about history, not necessarily witness it. The spirit is still alive though in a zombified made-for-the-cameras kind of way. OnDeck recently kicked off their IPO there and so too did Lending Club.
While tourists dance around aimlessly and upload photos to facebook to show they were there, men and women in the office floors above them are engaged in a different kind of dance. Packed in elbow to elbow with phones glued to their ears, commercial financing brokers shout large numbers at an accelerated pace.
Often lacking luxury amenities such as windows, brokers on Wall Street are weathering the heat and lack of oxygen to move money to Main Streets all across America.
When they come out for air to breathe, the tourists move out of their way, as if they’ve suddenly become aware that people are actually trying to get some work done down here.
The little strip of Broad Street between Wall Street and Exchange Place is kind of like a schoolyard for the merchant cash advance industry. War stories are exchanged, cigarettes shared and dreams dreamed. One day, I’m going to start my own ISO and I’ll do it differently because…
You can walk in any direction. The industry can be found on Broad Street, William Street, Pine Street, and Broadway. It’s on Water Street, Rector Street, Maiden Lane, and Fulton Street. It extends outward almost infinitely to Midtown, Brooklyn, Queens, Long Island, Staten Island, The Bronx, Westchester, Orange County, and New Jersey.
And while there are hubs in the outer parts, the most unique experience by far is down here on Wall Street, where you’re infinitely more likely to overhear professionals shouting “ACHs” and “stacks” than “puts” and “calls.”
Although the guides teach tourists that Wall Street as they imagined it to be is dead, Wall Street itself can never die.
Every now and then a pedestrian will look up at the offices above and wonder if the magic of fast-talking finance still exists. Is that world gone forever?
Not quite…
The stockbrokers may be gone, but there’s a new landlord. Wall Street belongs to the small business financing industry now.
Bless You, Fund Me: What Words Predict About Loan Performance
June 7, 2015
Way back in 2006 when I was just a baby merchant cash advance* underwriter, I encountered a book store that was borderline qualified. The final phone interview would make or break their approval so I grabbed my pen and paper and dialed their number.
I went through the checklist of questions and they passed. But what really convinced me that it was a deal worth doing was the amount of times the owners made references to God. They were clearly religious people which indicated to me that they were probably also of high moral character. It didn’t matter what religion it was or if their beliefs aligned with mine, I was simply captivated by their values.
After approving the deal and funding them, they actually mailed me a handwritten letter to express their gratitude. It concluded with, “God Bless You!” and I hung it up on the wall of my cubicle to remind myself of the good I was doing for small businesses.
A few weeks later, the payments stopped. All of their contact numbers were disconnected and the owners of the store could not be located. They completely disappeared along with almost all of the money. Looking up at the note on my wall, a shiver went up my spine. Had I been duped? And did they use religion as a tool to influence my decision?
I thought that surely they must’ve encountered legitimate financial difficulty but I believed that even if so, people with their values would’ve been more forthcoming about it. Instead they just took the money and split and were never heard from again.
I learned a lesson about being emotionally influenced on a deal and it turns out there were clues this outcome might happen all along.
Bless you
In a study titled, When Words Sweat: Written Words Can Predict Loan Default, Columbia University professors Oded Netzer and Alain Lemaire, and University of Delaware professor Michal Herzenstein analyzed the text of more than 18,000 loan requests made on Prosper’s website. Applicants that used the word God were 2.2x more likely to default on their loans. And the phrase Bless you correlated higher on the default scale as well, though not as high as other non-religious words.
On the list of words more likely to be mentioned by defaulters are, I promise, please help, and give me a chance. Statistics actually show that someone promising to pay is less likely to pay than someone that doesn’t explicitly promise.
Among the other more common words likely to be mentioned by defaulters is hospital. This word holds special significance to me because in my last year as a sales rep, almost all of my underperforming accounts were supposedly due to the business owners or their family members being in the hospital.
And it wasn’t just me. It seemed like every deal that was going bad in the office involved the hospital. Any time one of us was due to contact an account with an issue, we made bets that a hospital would come up in the story. (Seb, if you’re reading this, apparently it’s not a coincidence.)
I express no opinion regarding whether or not their stories were true, but statistics show that borrowers that mention hospital are more likely to default.
In the study’s Abstract, the professors wrote:
Using a naïve Bayes analysis and the LIWC dictionary of writing styles we find that those who default write about financial hardship and tend to discuss outside sources such as family, god and chance in their loan request, while those who pay in full express high financial literacy in the words they use. Further, we find that writing styles associated with extraversion, agreeableness and deception are correlated with default.
While the study focused on Prosper, their almost identical competitor, Lending Club, may have realized this trend earlier. In March 2014, Lending Club announced that investors would no longer be able to view the free-form writing portion of the borrower loan application. Citing “privacy reasons,” investors lost a valuable clue into the repayment probability of their notes.
But would it really have helped? The researchers wrote:
Using an ensemble learning algorithm we show that leveraging the textual information in loan requests improves our ability to predict loan default by 4-5.7% over the traditionally used financial information.
Nothing to see here folks, move along and approve
Curiously, Lending Club doesn’t want its investors to have access to a data point with such significant importance. Perhaps it’s because of disasters like this, where one borrower used the free-form writing section to spew profanities. Ironically, the loan was approved and issued anyway.
For tech-based platforms like Lending Club however, they noticed the “story” aspect of a loan had become less relevant because of overwhelming investor demand. Investors weren’t evaluating the written portion of the loan application as much anymore. According to their blog post at the time of the announcement, “Fewer than 3% of investors currently ask questions and only 13% of posted loans have answers provided by borrowers. Furthermore, loans are currently funding in as little as a few hours – well before borrower answers and descriptions can be reviewed and posted.”
It had become all algorithms and APIs where loans were fully funded by investors before the written portions could even be published on the website. Had anyone actually taken the time to read the above loan application answers, they probably wouldn’t have allocated money towards it.
But while removing the storyline from the data might give investors fewer methods to detect a good loan, it could actually protect them from getting drawn into a bad loan.
One of the authors of the above referenced study, Professor Michal Herzenstein of University of Delaware, found in 2011 that borrowers could manipulate lenders into not only approving them, but giving them more favorable terms.
You can trust me 😉
In a story that appeared on UD’s website in 2011, titled Good Storytelling May Trump Bad Credit, Herzenstein’s research discovered that borrowers who constructed a trustworthy picture of themselves “could lower their costs by almost 30 percent and saved about $375 in interest charges by using a trustworthy identity.”
The study referred to six possible categories or identities that borrowers would try to impress upon lenders to describe themselves (trustworthy, successful, economic hardship, hardworking, moral, religious). The story explains:
The more identities the borrowers constructed, the more likely lenders were to fund the loan and reduce the interest rate but the less likely the borrowers were to repay the loan – 29 percent of borrowers with four identities defaulted, where 24 percent with two identities and 12 percent with no identities defaulted.
It’s a case of measurable borrower manipulation.
“By analyzing the accounts borrowers give and the identities they construct, we can predict whether borrowers will pay back the loan above and beyond more objective factors like their credit history,” said Herzenstein. “In a sense, our results offer a method of assessing borrowers in ways that hark back to the earlier days of community banking when lenders knew their customers.”
Today’s tech-based lenders that are dead set on removing this human aspect from the equation may be taking a shortsighted approach after all as they evidently still struggle to make predictions with their numbers-only approach.
For example, a poster on the Lend Academy forum recently wrote this to me about early defaults in today’s algorithmic environment, “It would be nice if LC could predict who is going to default in the first few months of the loan and deny them, but I don’t think that is entirely possible.”
It reminded me of a big merchant cash advance deal I approved years back that passed all of the qualifying criteria with flying colors and still defaulted on the very first day. The merchant’s response to why he defaulted on day one? He felt like screwing us over… “Come sue me,” he said.
In a later meeting to review the deal’s paperwork, a group of managers agreed that I had done all I could to make the approval decision except one. I failed to account for the asshole factor.
Far from satire, it is not uncommon for financial companies to refer to an asshole factor in some regard. It’s a very subjective variable but it can make all the difference between an applicant that’s going to pay and one that’s not. Suddenly none of the hard data matters.
Is the applicant an asshole?
In a recent blog post by loan broker Ami Kassar, titled The Single Most Important Rule in Our Company, Kassar wrote, “if a customer, employee, or partner acts like a jerk – we don’t want to do business with them. If you want to be less diplomatic, you can call the rule – the no ###hole rule.”
In many circumstances, the measure of someone being an asshole is relative to another person’s perception. There’s even an entire book on that subject if you’re interested. But what’s trickier, is that according to some studies, being an asshole is a positive thing in business. Would that also make them better borrowers statistically?
Referring back to the original cited study, one has to wonder if there might potentially be a list of words that more closely correlate with being an asshole. I don’t think anyone’s ever examined the Prosper data for that before.
You might not be able to quantify asshole-ishness from the text, but something as basic as a person’s pronouns can speak volumes about their personality or intentions. According to Professor James Pennebaker in the Harvard Business Review:
A person who’s lying tends to use “we” more or use sentences without a first-person pronoun at all. Instead of saying “I didn’t take your book,” a liar might say “That’s not the kind of thing that anyone with integrity would do.” People who are honest use exclusive words like “but” and “without” and negations such as “no,” “none,” and “never” much more frequently.
But saying “I” over “we” doesn’t necessarily make you less of a liar. Pennebaker discovered that depressed people use the word “I” much more often than emotionally stable people.
Being emotionally stable would probably make for a better borrower than a depressed one, but with all these influential and conflicting language clues, how can an underwriter possibly make the right choice?
For instance, if the following line appeared on the free-form writing portion of an application, how should it be interpreted?
Using all of the mentioned research as a guide, I’m inclined to consider the applicant a: trustworthy depressed lying asshole that’s not going to pay.
I = Depressed
We = Liar
God = 2.2x more likely to default
Have always been able to pay back = trustworthy
Hurry up and fund me = asshole
We could easily get caught up in the language here and ignore the obvious positives about this hypothetical applicant, such that they have an 800 FICO score and a solid six figure income. Shouldn’t that weigh more heavily? It’s easy to get distracted.
Perhaps Lending Club’s removal of the free-form writing section was for the investors’ own good. Even the borrower that repeatedly wrote, “None of your f**king business I thought this was a bank loan don’t waste my time with this sh**t!” is still current on all their payments after two and a half years.
To brokers like Kassar, the asshole factor is not so much about the likelihood of default anyway, but peace of mind. “Why invest emotional energy in putting up with shenanigan’s when there are so many good people who need our help,” he wrote.
Word is bond?
Regardless of what one study revealed about applicants that invoked God said about the likelihood of default, declining applicants on the basis of writing or talking about God could certainly be argued as religious discrimination. In many instances, religion is a protected class. Sometimes you have to ignore correlations because they can be deemed discriminatory.
One thing is for sure though, back in 2006 the upstanding characters I had created in my mind about the religious book store owners were upended when they disappeared into the night with all the money. Their words got in my head and I approved them perhaps because of it.
Years later, an asshole defaulted on the first day and not long after that, there would be a mysterious spate of accounts whose poor performance would be attributed to supposed hospital related events.
What’s buried in a person’s words? The answers allegedly. I promise…
