For ISOs Only — How To Develop Your Factoring Brokerage Business (Part 1)
November 17, 2019
Let me ask you a question; If you were walking down the street and saw a $100 bill on the sidewalk, would you stop and pick it up? Of course you would, unless you didn’t see it. Or would you say, “I’m in a hurry and it’s ONLY $100. I’ll make a lot more money on that big MCA deal I’m heading into the office to work on, so I’ll just leave it on the sidewalk.” Really?!
Well, Here’s a rude awakening. For any of you who haven’t added Factoring to your financing product mix, that’s EXACTLY what you’re doing RIGHT NOW! And get this, you’re doing it with some of the SAME merchants you’re doing deals with RIGHT NOW! Here’s why; A percentage of your merchants sell Business-To Business (B2B), and get paid in 30 to 45 days, and in some cases, even longer.
Many of these are the SAME merchants who come to YOU for an advance to help cash-flow due to delayed invoice payments, so you provide an MCA, right? Right! That’s what we do. But here’s the problem: Next month they come back again, and then again, and then sometimes they get wise, secure another position somewhere else, and before long, well, we all know the story. After all that, while the last advance may have solved their immediate problem, they will ALWAYS have a continuing and on-going need for cash because they’re ALWAYS waiting to get paid. And the FASTER they grow, the BIGGER the problem! Sound familiar?
So, what does that tell us? In most cases, while an MCA may help stop the bleeding, it’s not designed to heal the wound. More specifically, the “wound” that needs to be healed is the un-predictable timing of customer payments on outstanding invoices. So while an MCA provides immediate relief, factoring solves the timing problem. Here’s how it works: The factoring funder provides an advance against approved invoices, typically 70% to 90%. Once the invoice is paid, the funder deducts the advance, along with their fee, and wires the balance to the merchant. So the advance essentially pays itself off, working much like a revolving Line of Credit (LOC). In other words, no payments! The term I use to describe this is called Self-Liquidating.
Here’s how I see it: when structured properly, factoring and MCAs can often complement each other and work well together. Factoring provides predictable cash flow because advances are based on predictable billings to their customers, whether it be monthly, weekly, or even daily. The predictable cash-flow from factoring advances is what the merchant can rely on to cover their continuing and on-going business expenses, i.e. payroll, materials, etc. MCAs can also be used to provide a lump sum injection to cover interim cash needs on a short-term basis, while factoring is being put in place.
Here’s an actual example of a real client situation we recently funded using this approach. Client is a large importer of Spanish wines selling to one of the largest spirits distributors in the country. They typically get paid in 45 to 60 days, so we established a factoring facility, which would take about a week. However, they had a container from Spain that needed to be paid for and shipped IMMEDIATELY to help fill holiday orders. We secured an MCA to pay for the container and negotiated an aggressive early pay-off discount. Once the factoring LOC was in place, the MCA was satisfied using a portion of the proceeds from the first factoring advance. We are now putting a purchase order funding facility in place to cover the upfront costs on all future container shipments from overseas.
This combined approach, enables YOU to provide FUNDING SOLUTIONS for your merchants, much like Ed McKinley described in the September/October, 2019 issue of AltFinanceDaily Magazine where he talks about Consultative Selling. A true professional focuses on solving financing problems and building a relationship with their merchants, versus simply funding a transaction. You then have the opportunity of becoming a “trusted financing resource” versus a broker simply interested in what I call “hit and run” selling. In addition, this approach can have a multiplier effect on your income, enabling you to get paid on a continuing and on-going basis.
Speaking of getting paid, you may ask, “So how much money can I make with factoring?”
I’m so glad you asked that question. Maybe now is a good time to introduce myself. For over the past 25 years, I have specialized in arranging factoring/PO and contract financing for hundreds of growing business owners all over the country, providing millions of dollars in financing. Over the years I have earned in excess of a seven-figure income, primarily as a broker. I’m sharing this information with you to make a point; there’s a LOT of money which YOU can make too with factoring, IN ADDITION TO what you’re already making with MCAs.
So, then you say, “Well that’s great for you Watson, but how much money can I make?” Good question. Let’s take a look at how it’s structured. With factoring, you’re paid by the funder, just like an MCA. Two major differences. The first is that broker commissions for factoring typically range between 10% to 15% of the fee income earned by the funder per month. Fee income is earned once the outstanding funded invoices have been paid by the merchant’s customers. Broker commissions are then paid by the funder the following month. As an example, if the fee income earned by the funder was, say, $10,000 per merchant, per month, you would be paid $1,000 to $1,500 per merchant, per month. Ten merchants would pay you $10,000 to $15,000 per month and so on. Broker commissions will continue to be paid for the life of the factoring relationship and provide you with residual income, or what many refer to as, mail-box money, because it’s actually like getting a renewal every month from the same merchants, and you don’t even have to get out of bed!
A second source of income which is OPTIONAL, is to establish a fee agreement with the client to pay a success fee or origination fee based on the size of the facility. It is a one-time fee paid at closing and funding, either from the first factoring advance or over several advances based on what you work out with your merchant. Success fees are much like points in a closing on a real estate loan and typically range from 1% to 5% of the facility size. The fee is paid to you directly by your merchant once they have been funded. It is designed to provide you with IMMEDIATE INCOME. As an example, a $250,000 facility at 2% will pay you $5,000 or $10,000 at 4%. And that’s just for one merchant. How many could you do per month? For large contracts, we’ve established factoring facilities up to $5 million. I’ll let you do the math to see the potential.
Combining these two income streams can potentially provide a significant increase to your existing MCA income base, and in some cases from your EXISTING book of merchants. These are what we refer to as the low hanging fruit. They include your construction contractors, service and supply companies, transportation, manufacturing, medical and professional services firms, or anyone else who invoices B2B. Some retail merchants also sell B2B, while others, like restaurants, may have catering contracts. Take a look through your files. For many of these merchants you are already asking for A/R Aging Schedules as a stip, right? Now that aging schedule takes on a whole new meaning! And if they’re not factoring now, my friends, THAT’s the $100 bill you “didn’t see” laying on the street, and potentially THOUSANDS more you are leaving on the table! To be sure, close the MCA they need right now, make the money, and set them up with Phase II by establishing a factoring facility on their behalf. Then continue to provide MCAs as needed to cover unexpected problems or take advantage of opportunities. Make sense?
The next article will be what I call Factoring 101 and will focus on 4 major areas: (1) What is Factoring? (2) How does it work? (3) What are the costs? and (4) How do you qualify? We will also talk about identifying and selecting potential factoring funders, HOW TO deal with UCC filing issues, Subordination Agreements, and Fee Agreements with your merchants. We will also touch on Purchase Order Funding as well.
The last article will be designed to bring it all together and talk about HOW TO establish a game plan and options for getting started with your factoring brokerage business and a few key tips on maximizing success in the business.
Consultative Selling in Small Business Finance
October 16, 2019
It’s nearly impossible to teach fiscal responsibility to most consumers, according to researchers at universities and nonprofit agencies. But alternative small-business funders and brokers often manage to steer clients toward financial prudence, and imparting pecuniary knowledge can become part of a consultative approach to selling.
Still, nobody says it’s easy to convince the public or merchants to handle cash, credit and debt wisely and responsibly. Consider the consumer research cited by Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and co-director of the Common Cents Lab, which works to improve the financial behavior of low- and moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” Beasley says. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influences lower-income people even less.
The problem stems from trying to teach financial responsibility too late in life, says Noah Grayson, president and founder of Norwalk, Conn.-based South End Capital. He advocates introducing young people to finance at the same time they’re learning history, algebra and other standard subjects in school.
Yet Grayson and others contend that it’s never too late for motivated entrepreneurs to pick up the basics. Even novice small-business owners tend to possess a little more financial acumen than the average person, they say. That makes entrepreneurs easier to teach than the general public but still in need of coaching in the basics of handling money.
Take the example of a shopkeeper who grabs an offer of $50,000 with no idea how he’ll use the funds to grow the business or how he’ll pay the money back, suggests Cheryl Tibbs, general manager of One Stop Commercial Capital, Douglasville, Ga. “The easy access to credit blinds a lot of merchants,” she notes.
Entrepreneurs often make bad decisions simply because they don’t have a background in business, according to Jared Weitz, CEO of New York based United Capital Source. “Many of the people who come to us are trying their hardest,” he observes.
Weitz offers the example of his own close relative who’s a veterinarian. That profession attracts some of the brainiest high-school valedictorians but doesn’t mean they know business. “He’s the best doctor ever and he’s not a great businessman because he doesn’t think about those things first. What he thinks about is helping people. That’s why he got into his profession.”
Entrepreneurs often devote themselves to a vision that isn’t businesses-oriented. “They start a business because they have a great idea or a great product, and that’s what excites them,” Grayson says. “They jump in with both feet and don’t think much about the business side.” The business side isn’t as much fun.
Merchants also attend to so many aspects of an enterprise—everything from sales, production and distribution to hiring, payroll and training—that they can’t afford to devote too much time to any single facet, notes Joe Fiorella, principal at Kansas City, Mo.-based Central Funding. Business owners respond to what’s most urgent, not necessarily what’s most important.
For whatever reason, some business owners spiral downward into financial ruin, bouncing checks, stacking merchant cash advances and continually seeking yet another merchant cash advance to bail them out of a precarious situation, says Jeremy Brown, chairman of Bethesda, Md.-based Rapid Advance.
Weitz advises sitting down with those clients and coming to an understanding of the situation. In some cases, enough cash might be coming in but the incoming autopayments aren’t timed to cover the outgoing autopayments, he says by way of example.
Informing clients of such problems makes a demonstrable difference. “We can see that it works because we have clients renewing with us,” says Weitz. “We’re able to swim them upstream to different products” as their finances gradually improve, he says.
The products in that stream begin with relatively higher-cost vehicles like merchant cash advances and proceed to other less-expensive instruments with better terms, says Brown. Those include term loans, Small Business Administration loans, equipment leasing, receivables factoring and, ultimately the goal for any well-capitalized small business—a relationship with the local bank.
Failing to consider those options and instead simply abetting stackers to make a quick buck can give the industry a “black eye,” and it benefits none of the parties involved, Tibbs observes. But merchants deserve as much blame as funders and brokers, she maintains.
Prospective clients who stack MCAs, don’t care about their credit rating and simply want to staunch their financial bleeding probably account for 35 percent to 40 percent of the applicants Tibbs encounters, she says.
Just the same, alt-funders continue to urge clients to hire accountants, consult attorneys, employ helpful software, shore up credit ratings, keep tabs on cash flow, calculate margins, improve distribution chains and outline plans for growth. It’s what helps the industry rise above the “get-money quick” image that it’s outgrowing, Weitz, says. Many funders and brokers consider providing financial advice an essential aspect of consultative selling. It’s an approach that begins with making sure applicants understand the debt they’re taking on, the terms of the payback and how their businesses will benefit from the influx of capital. It continues with a commitment to helping clients not just with funding but also with other types of business consultation.
“It’s not so much selling as building a rapport with clients—serving as a strategic advisor or financial resource for them, identifying their needs and directing them to the right loan product to meet those needs,” says Grayson. “They should feel they can call you about anything specific to their business, not just their loan requests.” He also cautions against providing information the client will not absorb or will find offensive.
Justin Bakes, CEO of Boston-based Forward Financing also advocates consultative selling. “It’s all about questions and getting information on what’s driving the business owner,” he says. “It’s a process.”
Consultative sales hinges on knowing the customer, agrees Jason Solomon, Forward Financing vice president of sales. “Businesses are never similar in the mind of the business owner,” he notes. “To effectively structure a program best-suited to the merchant’s long-time business needs and set a proper path forward to better and better financial products, you need to know who the business owner is and what his long term goals are.”
“It’s taking an approach of actually being a consultant as opposed to a $7 an hour order taker,” Tibbs says of consultative selling. “I like to teach new reps to think of it as if you were a doctor. Doctors ask questions to arrive at a final diagnosis. So if you’re asking your prospective customer questions about their business, about their cash flow, about their intentions of how they’re planning to get back on track.”
Learning about the clients’ business helps brokers recommend the least-expensive funding instrument, Tibbs says. “I really hate to see someone with a 700 credit score come in to get a merchant cash advance,” she maintains. The consultative approach requires knowing the funding products, knowing how to listen to the customer and combining those two elements to make an informed decision on which product to recommend, she notes.
Consultative sales can greatly benefit clients, Weitz maintains. If a pizzeria proprietor asks for an expensive $50,000 cash advance to buy a new oven, a responsible broker may find the applicant qualifies for an equipment loan with single-digit interest and monthly payments over a five-year period that puts less pressure on daily cash flow.
It’s also about pointing out errors. Brokers and funders see common mistakes when they look at tax returns and financial records, says Brown. “The biggest issue is that small-business owners—because they work so hard— make a profit of X amount of money and then take that out of the business,” he notes. Instead, he advises reinvesting a portion of those funds so that they can build equity in the business and avoid the need to seek outside capital at high rates.
Another common error occurs when entrepreneurs take a short-term approach to their businesses instead of making longer-term plans, Brown says. That longer-term vision includes learning what it takes to improve their businesses enough to qualify for lower-cost financing.
Sometimes, small merchants also make the mistake of blending their personal finances and their business dealings. Some do it out of necessity because they’re launching an enterprise on their personal credit cards, and others act of ignorance. “They don’t necessarily know they’re doing something wrong,” Grayson observes. “There are tax ramifications.”
Some just don’t look at their businesses objectively. Take the example of a company that approached Central Funding for capital to buy inventory in Asia. Fiorella studied the numbers and then informed the merchant that it wasn’t a money problem—it was a margins problem. “You could sell three times what you’re wanting to buy, and you still won’t get to where you want to be,” he reports telling the potential customer.
Consultative selling also means establishing a long-term relationship. Forward Financing uses technology to keep in contact with clients regularly, not just when clients need capital, Bakes notes. That cultivates long-lasting relationships and shows the company cares. As the relationship matures it becomes easier to maintain because the customers want to talk to the company. “They’re running to pick up the phone.”
The conversations that don’t hinge on funding usually center on Forward Financing learning more about the customer’s business, says Solomon. That include the client’s needs and how they’ve used the capital they’ve received.
“We have our own internal cadence and guidelines for when we reach out and how often and what happens,” says Solomon. Customer relationship management technology provides triggers when it’s time for the sales team or the account-servicing team to contact clients by phone or email.
Do small-business owners take advice on their finances? Some need a steady infusion of capital at increasingly higher cost and simply won’t heed the best tips, says Solomon. “It’s certainly a mix,” he says. “Not everybody is going to listen.”
Paradoxically, the business owners most open to advice already have the best-run companies, says Fiorella. Those who are closed to counseling often need it the most, he declares.
Moreover, not everybody is taking the consultative approach. “New brokers are so excited to get a commission check they throw the consultative approach out the window,” Tibbs says.
Yet many alt-funders bring consultative experience from other professions into their work with providing funds to small business. Tibbs, for example, previously helped home buyers find the best mortgage.
Consultative selling came naturally to Central Funding because the company started as a business and analytics consultancy called Blue Sea Services and then transformed itself into an alternative funding firm, says Fiorella. Central Funding reviews clients’ financial statements and operations between rounds of funding, he notes.
Consultations with borrowers reach an especially deep level at PledgeCap, a Long Island-based asset-based lender, because clients who default have to forfeit the valuables they put up as collateral—anything from a yacht to a bulldozer—says Gene Ayzenberg, PledgeCap’s chief operating officer. Conversations cover the value of the assets and the risk of losing them as well as the reasons for seeking capital, he notes.
No matter how salespeople arrive at their belief in the consultative approach, they last much longer in the business than their competitors who are merely seeking a quick payoff, Tibbs says. Others contend that it’s clearly the best way to operate these days.
“The consultative approach is the only one that works,” says Weitz. “Today, everything is about the customer experience. People are making more-educated, better informed decisions.” What’s more, with the consultative approach clients just keep getting smarter, he adds.
The days of the hard sell have ended, Grayson agrees. Customers have access to information on the internet, and brokers and funders can prosper by helping customers, he says. “Our compensation doesn’t vary much depending upon which product we put a client in so we can dig deeper into what will fit the client without thinking about what the economic benefit will be to us.”
Even though the public has become familiar with alternative financing in general, most haven’t learned the nuances. That’s where consultative selling can help by outlining the differing products now available for businesses with nearly any type of credit-worthiness. “It’s for everybody,” Weitz says of today’s alternative small business funding, “not just a bank turn-down.”
Does The Borrower Even Exist? Image Algorithms, Site Inspectors Spot The Fakers
May 24, 2019
Their product research lab was the real deal. That’s what a business seeking capital hoped to convince a lender of when they snapped a photo of a $450,000 microscope and sent it over to underwriting along with two dozen other photos of their warehouse.
Most of the pictures were genuine, but the microscope was not. Truepic, a virtual site inspection and photo verification company that the lender had relied on, algorithmically determined that the microscope was actually a photo of a photo, one that had been grabbed off the web.
If they had just emailed these photos directly to the lender, the loan would’ve been issued, but this image analyzing technology changed everything.
Truepic founder and COO Craig Stack said that they were able to identify the false ones because of software they have that can detect when a photo is being taken of a two-dimensional image. Truepic didn’t just obtain the photos, they were taken in real time using their mobile photo-taking app. In addition to detecting only two dimensions, Truepic also found the real photos online through a reverse-image search to show where the photos came from.
Photo verification isn’t brand new. Nationwide Management Services has been providing these very same services to their customers since 2015, according to its CEO John Marsh. Marsh started his company in 2005 and originally provided traditional on-site inspections with certified field agents taking pictures.
“You can’t tell the difference,” Marsh said of photos taken by a field agent, compared to those taken virtually by the owner of the store or office. In the virtual one, the merchant receives a text and clicks on a link that essentially turns the merchant’s phone into a live video feed for the lender.
Commonly, the lender wants to see, among other things, the company’s signage, credit card machine and merchant’s driver’s license. Using GPS technology, Nationwide Management Services can tell exactly where the merchant is, so they can’t be taking photos – in real time – of a different store.
Marsh still offers on-site inspection for clients, but mostly as discreet, unannounced visits to check up on a merchant that is having a hard time making payments. Sometimes a field agent will find that a direct competitor moved in across the street or the neighborhood is declining and there are a number of vacant stores, Marsh said.
Marsh’s virtual video verification product is instantaneous, allowing the lender to see the merchant’s space – and face – in real time, virtually eliminating misrepresentation of the merchant’s store. Stack said that Truepic also has a video verification product that they will be releasing in less than three weeks.
Marsh said that would-be merchant fraudsters get scared as soon as they hear about a real time virtual inspection.
“When we reach out to them for the virtual inspection, they go dark,” Marsh said.
Most of the deception Marsh has encountered is of merchants giving a P.O. Box address as the address of their “physical store.”
Gayle Juhl, President and CEO of Metro Inspections, said that one of her field agents found a merchant with a far more unusual distortion of its company address. The field agent went to the address of the merchant only to find a 1970s bright blue Volvo station wagon with a sign on it, parked in front of the address listed, which belonged to a completely different store.
The man seeking funding, who came out of the car-turned-store, was apparently confrontational, according to the field agent’s report.
Juhl said that she will coordinate a virtual inspection upon request, but that her company primarily does onsite inspections.
“You can’t replace a handshake and an eye-to-eye to see what’s really going on,” Juhl said.
This may be true, but Marsh said that it can take 24 to 48 hours to collect photos for his onsite inspections whereas it can take as little as four minutes with his virtual video or virtual photo services. (This depends on how many images the lender is looking to capture.) Granted, Juhl said that Metro Inspections’ on-site inspections can be collected and delivered on the same day it was requested, given that the request comes early enough in the day.
Stack, who has only been servicing the online lending industry for about five months, says that he has gotten financial services clients who are very excited about the speed of virtual inspections and the fact that they are far less invasive for the merchant. Rather than have a stranger come in to take pictures – raising questions among employees and customers – the business owner can discreetly photograph their space at their convenience. Stack’s company has never offered onsite inspections and says he never will.
“Our camera doesn’t lie,” he said.
Online Loans You Can Take To The Bank
April 16, 2019
OnDeck, the reigning king of small business lending among U.S. financial technology companies, is sharpening its business strategies. Among its new initiatives: the company is launching an equipment-finance product this year, targeting loans of $5,000 to $100,000 with two-to-five year maturities secured by “essential-use equipment.”
In touting the program to Wall Street analysts in February, OnDeck’s chief executive, Noah Breslow, declared that the $35 billion, equipment-finance market is “cumbersome” and he pronounced the sector “ripe for disruption.”
While those performance expectations may prove true – the first results of OnDeck’s product launch won’t be seen until 2020 – Breslow’s message seemed to conflict with OnDeck’s image as a public company. Rather than casting itself as a disruptor these days, OnDeck emphasizes the ways that its business is melding with mainstream commerce and finance.
Consider that the New York-based company, which saw its year-over-year revenues rise 14% to $398.4 million in 2018, is collaborating with Visa and Ingo Money to launch an “Instant Funding” line-of-credit that funnels cash “in seconds” to business customers via their debit cards. With the acquisition of Evolocity Financial Group, it is also expanding its commercial lending business in Canada, a move that follows its foray into Australia where, the company reports, loan-origination grew by 80% in 2018.
Perhaps most significant was the 2018 deal that OnDeck inked with PNC Bank, the sixth-largest financial institution in the U.S. with $370.5 billion in assets. Under the agreement, the Pittsburgh-based bank will utilize OnDeck’s digital platform for its small business lending programs. Coming on top of a similar arrangement with megabank J.P. Morgan Chase, the country’s largest with $2.2 trillion in assets, the PNC deal “suggests a further validation of OnDeck’s underlying technology and innovation,” asserts Wall Street analyst Eric Wasserstrom, who follows specialty finance for investment bank UBS.
“It also reflects the fact that doing a partnership is a better business model for the big banks than building out their own platforms,” he says. “Both banks (PNC and J.P. Morgan) have chosen the middle ground: instead of building out their own technology or buying a fintech company, they’ll rent.
“J.P. Morgan has a loan portfolio of $1 trillion,” Wasserstrom explains. “It can’t earn any money making loans of $15,000 or $20,000. Even if it charged 1,000 percent interest for those loans,” he went on, “do you know how much that will influence their balance sheet? How many dollars do think they are going to earn? A giant zero!”
Similarly, Wasserstrom says, spending the tens of millions of dollars required to develop the state-of-the art technology and expertise that would enable a behemoth like J.P. Morgan or a super-regional like PNC to match a fintech’s capability “would still not be a big needle-mover. You’d never earn that money back. But by partnering with a fintech like OnDeck,” he adds, “banks like J.P Morgan and PNC get incremental dollars they wouldn’t otherwise have.”
The alliance between OnDeck and old-line financial institutions is one more sign, if one more sign were needed, that commercial fintech lenders are increasingly blending into the established financial ecosystem.
Not so long ago companies like OnDeck, Kabbage, PayPal, Square, Fundation, Lending Club, and Credibly were viewed by traditional commercial banks and Wall Street as upstart arrivistes. Some may still bear the reputation as disruptors as they continue using their technological prowess to carve out niche funding areas that banks often neglect or disdain.
Yet many fintechs are forming alliances with the same financial institutions they once challenged, helping revitalize them with new product offerings. Other financial technology companies have bulked up in size and are becoming indistinguishable from any major corporation.
Big Fintechs are securitizing their loans with global investment banks, accessing capital from mainline financial institutions like J.P. Morgan, Goldman Sachs and Wells Fargo, and finding additional ways — including becoming publicly listed on the stock exchanges – to tap into the equity and debt markets.
One example of the maturation process: through mid-2018, Atlanta-based Kabbage has securitized $1.5 billion in two bond issuances, 30% of its $5 billion in small business loan originations since 2008.
In addition, fintechs have been raising their industry’s profile with legislators and regulators in both state and federal government, as well as with customers and the public through such trade associations as the Internet Lending Platform Association and the U.S. Chamber of Commerce. Both individually and through the trade groups, these companies are building goodwill by supporting truth-in-lending laws in California and elsewhere, promoting best practices and codes of conduct, and engaging in corporate philanthropy.
Rather than challenging the established order, S&P Global Market Intelligence recently noted in a 2018 report, this cohort of Big Fintech is increasingly burrowing into it. This can especially be seen in the alliances between fintech commercial lenders and banks.
“Bank channel lenders arguably have the best of both worlds,” Nimayi Dixit, a research analyst at S&P Global Market Intelligence wrote approvingly in a 2018 report. “They can export credit risk to bank partners while avoiding the liquidity risks of most marketplace lending platforms. Instead of disrupting banks, bank channel lenders help (existing banks) compete with other digital lenders by providing a similar customer experience.”
It’s a trend that will only accelerate. “We expect more digital lenders to incorporate this funding model into their businesses via white-label or branded services to banking institutions,” the S&P report adds.
Forming partnerships with banks and diversifying into new product areas is not a luxury but a necessity for Fundation, says Sam Graziano, chief executive at the Reston (Va.)-based platform. “You can’t be a one-trick pony,” he says, promising more product launches this year.
Fundation has been steadily making a name for itself by collaborating with independent and regional banks that utilize its platform to make small business loans under $150,000. In January, the company announced formation of a partnership with Bank of California in which the West Coast bank will use Fundation’s platform to offer a digital line of credit for small businesses on its website.
Fundation lists as many as 20 banks as partners, including most prominently a pair of tech-savvy financial institutions — Citizens Bank in Providence, R.I. and Provident Bank in Iselin, N.J. — which have been featured in the trade press for their enthusiastic embrace of Fundation.
John Kamin, executive vice president at $9.8 billion Provident reports that the bank’s “competency” is making commercial loans in the “millions of dollars” and that it had generally shunned making loans as meager as $150,000, never mind smaller ones. But using Fundation’s platform, which automates and streamlines the loan-approval process, the bank can lend cheaply and quickly to entrepreneurs. “We’re able to do it in a matter of days, not weeks,” he marvels.
Not only can a prospective commercial borrower upload tax returns, bank statements and other paperwork, Kamin says, “but with the advanced technology that’s built in, customers can provide a link to their bank account and we can look at cash flows and do other innovative things so you don’t have to wait around for the mail.”
Provident reserves the right to be selective about which loans it wants to maintain on its books. “We can take the cream of the crop” and leave the remainder with Fundation, the banker explains. “We have the ability to turn that dial.”
The partnership offers additional side benefits. “A lot of folks who have signed up (for loans) are non-customers and now we have the ability to market to them,” he says. “After we get a small business to take out a loan, we hope that we can get deposits and even personal accounts. It gives us someone else to market to.”
As a digital lender, Provident can now contend mano a mano with another well-known competitor: J.P. Morgan Chase. “This is the perfect model for us,” says Kamin, “it gives us scale. You can’t build a program like this from scratch. Now we can compete with the big guys. We can compete with J.P. Morgan.”
For Fundation, which booked a half-billion dollars in small business loans last year, doing business with heavily regulated banks puts its stamp on the company. It means, for example, that Fundation must take pains to conform to the industry’s rigid norms governing compliance and information security. But that also builds trust and can result in client referrals for loans that don’t fit a bank’s profile. “For a bank to outsource operations to us,” Graziano says, “we have to operate like a bank.”
Bankrolled with a $100 million line of credit from Goldman Sachs, Fundation’s interest rate charges are not as steep as many competitors’. “The average cost of our loans is in the mid-to-high teens and that’s one reason why banks are willing to work with us,” Graziano says. “Our loans,” he adds, “are attractively structured with low fees and coupon rates that are not too dramatically different from where banks are. We also don’t take as much risk as many in the (alternative funding) industry.”
Despite its establishment ties, Graziano says, Fundation will not become a public company anytime soon. “Going public is not in our near-term plans,” he told AltFinanceDaily. Doing business as a public company “provides liquidity to shareholders and the ability to use stock as an acquisition tool and for employees’ compensation,” he concedes. “But you’re subject to the relentlessly short-term focus of the market and you’re in the public eye, which can hurt long-term value creation.”
Graziano reports, however, that Fundation will be securitizing portions of its loan portfolio by yearend 2020.
PayPal Working Capital, a division of PayPal Holdings based in San Jose, and Square Inc. of San Francisco, are two Big Fintechs that branched into commercial lending from the payments side of fintech. PayPal began making small business loans in 2013 while Square got into the game in 2014. In just the last half-decade, both companies have leveraged their technological expertise, massive data collections, data-mining skills, and catbird-seat positions in the marketplace to burst on the scene as powerhouse small business lenders.
With somewhat similar business models, the pair have also surfaced as head-to-head competitors, their stock prices and rivalry drawing regular commentary from investors, analysts and journalists. Both have direct access to millions of potential customers. Both have the ability to use “machine learning” to reckon the creditworthiness of business borrowers. Both use algorithms to decide the size and terms of a loan.
Loan approval — or denials — are largely based on a customer’s sales and payments history. Money can appear, sometimes almost magically in minutes, in a borrower’s bank account, debit card or e-wallet. PayPal and Square Capital also deduct repayments directly from a borrower’s credit or debit card sales in “financing structures similar to merchant cash advances,” notes S&P.
At its website, here is how PayPal explains its loan-making process. “The lender reviews your PayPal account history to determine your loan amount. If approved, your maximum loan amount can be up to 35% of the sales your business processed through PayPal in the past 12 months, and no more than $125,000 for your first two loans. After you’ve completed your first two loans, the maximum loan amount increases to $200,000.”
PayPal, which reports having 267 million global accounts, was adroitly positioned when it commenced making small business loans in 2013. But what has really given the Big Fintech a boost, notes Levi King, chief executive and co-founder at Utah-based Nav — an online, credit-data aggregator and financial matchmaker for small businesses – was PayPal’s 2017 acquisition of Swift Financial. The deal not only added 20,000 new business borrowers to its 120,000, reported TechCrunch, but provided PayPal with more sophisticated tools to evaluate borrowers and refine the size and terms of its loans.
“PayPal had already been incredibly successful using transactional data obtained through PayPal accounts,” King told AltFinanceDaily, “but they were limited by not having a broad view of risk.” It was upon the acquisition of Swift, however, that PayPal gained access to a “bigger financial envelope including personal credit, business credit, and checking account information,” King says, adding: “The additional data makes it way easier for PayPal to assess risk and offer not just bigger loans, but multiple types of loans with various payback terms.”
While PayPal used the Swift acquisition to spur growth and build market share, its rival Square — which is best known for its point-of-sale terminals, its smartphone “Cash App,” and its Square Card — has employed a different strategy.
OF A FREIGHT TRAIN
By selling off loans to third-party institutional investors, who snap them up on what Square calls a “forward-flow basis,” the Big Fintech barged into small business lending with the subtlety of a freight train. In just four years, Square originated 650,000 loans worth $4.0 billion, a stunning rise from the modest base of $13.6 million in 2014.
Square’s third-party funding model, moreover, demonstrates the benefits afforded from being deeply immersed in the financial ecosystem. Off-loading the loans “significantly increases the speed with which we can scale services and allows us to mitigate our balance sheet and liquidity risk,” the company reported in its most recent 10K filing.
Square does not publicly disclose the entire roster of its third-party investors. But Kim Sampson, a media relations manager at Square, told AltFinanceDaily that the Canada Pension Plan Investment Board — “a global investment manager with more than CA$300 billion in assets under management and a focus on sustained, long term returns” – is one important loan-purchaser.
Square also offers loans on its “partnership platform” to businesses for whom it does not process payments. And late last year the company introduced an updated version of an old-fashioned department store loan. Known as “Square Installments,” the program allows a merchant to offer customers a monthly payment plan for big-ticket purchases costing between $250 and $10,000.
Which model is superior? PayPal’s — which retains small business loans on its balance sheet — or Square’s third-party investor program? “The short answer,” says UBS analyst Wasserstrom, “is that PayPal retains small business loans on its balance sheet, and therefore benefits from the interest income, but takes the associated credit and funding risk.”
Meanwhile, as PayPal and Square stake out territory in the marketplace, their rivalry poses a formidable challenge to other competitors.
Both are well capitalized and risk-averse. PayPal, which reported $4.23 billion in revenues in 2018, a 13% increase over the previous year, reports sitting on $3.8 billion in retained earnings. Square, whose 2018 revenues were up 51 percent to $3.3 billion, reported that — despite losses — it held cash and liquid investments of $1.638 billion at the end of December.
King, the Nav executive, observes that Able, Dealstruck, and Bond Street – three once-promising and innovative fintechs that focused on small business lending – were derailed when they could not overcome the double-whammy of high acquisition costs and pricey capital.
“None of them were able to scale up fast enough in the marketplace,” notes King. “The process of institutionalization is pushing out smaller players.”
Tips For Trade Show Success
February 14, 2019
Conference season will soon kick off, but many attendees are at a loss at how to score big at these events. Without a doubt, trade shows and conferences offer participants a prime opportunity to boost brand exposure, make professional connections and increase sales.
But there’s also a lot of behind-the-scenes work required to turn these events into successful business endeavors. While the playbook won’t be the same for every company, here are some tried-and-true tips to help attendees get the most out of conferences.
Start by determining which conferences to attend. With dozens to choose from, it’s not realistic from a budget, time or value perspective to hit every conference, says Jim Larkin, who manages events for OnDeck. Companies should select conferences based on which ones make the most sense for their goals and objectives. Not all conferences will offer the same benefits to every company or industry professional, frequent conference attendees say.
Ideally, management teams should meet early in the year to weigh the pros and cons of each conference, against the backdrop of the company’s budget. Some factors to consider include where and when the conference is being held, which of your competitors, prospects and customers are likely to attend and how many employees it makes sense to send, if any. “Budgets drive everything and you want to be smart with spending money,” says Janene Machado, Director of Events for AltFinanceDaily, whose flagship conference, Broker Fair, is scheduled for May 6 in New York. “You need to be strategic about why you are attending a particular conference,” she says.
It’s essential to plan ahead for each conference to make the most out of the event. This includes carefully combing through the agenda, scheduling meetings ahead of time and getting acquainted with the physical layout of the event space. If more than one company representative is attending, it’s also important to coordinate their activities in advance to avoid duplicating efforts and to maximize productivity.
“You have to make your own luck at these conferences,” Larkin says.
Most events have an online or mobile agenda and networking portal that are open to participants at least a few weeks beforehand. Bookmark the sessions you would like to attend, build your wish-list of people you would like to meet and start requesting meetings as soon as possible, says Peter Renton, co- founder and co-chairman of LendIt Fintech, which has an upcoming conference scheduled for April 8 and 9 in San Francisco. “Last year we helped to enable nearly 2,100 meetings at our USA event, and most of those meetings were organized through our networking portal,” Renton says.
Don’t delay when it comes to setting up advance appointments because schedules can fill up quickly, says Monique Ruff-Bell, event director for Money20/20 USA, which will take place in Las Vegas from Oct. 27 through Oct. 30. “Identifying the right contacts beforehand, reaching out and establishing what you’d like to achieve in a short meeting will make your time much more productive,” she says.
It’s fine for attendees to leave some time in their schedule for impromptu meetings as well; just be sure to fill those slots, says Ken Peng, head of business development and marketing at Elevate Funding. “No one should ever be asking, ‘what are we doing next?’ You should know,” he says.
It’s also a good idea to plan ahead for a dedicated meeting space so you’ll have a convenient, comfortable and quiet space to conduct meetings, seasoned conference attendees say. This can be especially important at big conferences where thousands congregate. For those who don’t want, or can’t afford, to pay for a meeting room, it’s a good idea to find a quiet restaurant or coffee shop outside the busy convention center area where you can have quiet, uninterrupted, productive conversations in a relaxed environment, says Larkin of OnDeck. Don’t choose the heavily frequented coffee shop next to the hotel where meetings are sure to be disrupted by heavy foot traffic, he says. “Get away from the noise, the hustle, the chaos. Quiet is king.”
Conferences can be expensive, so it’s important to make the right decisions with the available budget. For instance, companies don’t have to miss out on promotional opportunities just because the highest level of sponsorship is out of reach for their budget. Instead, look for creative ways to make an impact without breaking the bank, says Stephanie Schlesinger, director of marketing for LEND360.
Schlesinger suggests that would-be sponsors have an open conversation with conference organizers about what they can afford to spend and what they hope to reap in return for their marketing dollars. She offers the examples of companies that have sponsored popcorn breaks, pens and pads of paper, badges, lanyards and other marketing materials. “There could be opportunities to do something very unique. By brainstorming together we can think of outside-the-box opportunities to really make an impact for your brand,” she says.
Another cost consideration is where to stay. Though it can be tempting to save a few bucks by bunking off-site, that’s not always the most prudent decision, frequent conference attendees say.
“Time is really valuable at these shows and events. If you’re staying off-site you have to battle everybody for the cab line, and the increased expense of commuting can offset any cost savings,” says Sheri Chin, chief marketing officer at BFS Capital. Also, staying on-site “gives you more flexibility when unscheduled things come up,” she says.
If staying on premises isn’t an option, conference attendees should make extra efforts to spend considerable time in the bar or lobby of the conference site, says Jeffrey Bumbales, marketing director at Credibly. People will come in and go and it’s an easy way to start conversations, he says.
Conferences typically consume a lot of energy, so Eden Amirav, chief executive and co-founder of Lending Express, recommends participants try to catch people well before they are running on empty. As the conference goes on, it becomes harder to engage people because they also get drained, he says. Typically conference doors open a few hours before the first sessions begin, and this can be an especially effective time to network, Amirav says.
Arriving early also allows participants to find their way around. Ruff-Bell of Money20/20 USA recommends participants walk through the entire event space upon arrival to get their bearings. “Many of these large conferences can be overwhelming, and knowing where to go will help with your time management,” she says.
Bumbales of Credibly also recommends conference attendees pack their schedule tightly—even though it might mean activities extend late into the evening. Instead of calling it quits at 6 p.m. he recommends conference attendees plow through and host evening meetings over dinner or drinks. Even though a participant may be tired, it’s best not to miss these important networking opportunities, he says.
The proper conference mindset includes knowing there’s a good chance sleep won’t be plentiful. To accommodate, Bumbales tries to ensure he’s well-rested before a conference. He also makes sure to pack protein bars and non-perishable snacks for replacement meals as needed throughout the conference in case he needs to eat on the go. The goal is to hit the ground running and be able to focus entirely on conference-related business, he says.
Although numerous social opportunities abound at conferences, not everyone takes advantage. Certainly not everyone is as comfortable approaching strangers. But it’s important for conference- goers to try to break out of their shell whenever possible, industry professionals say. When he first started going to conferences, Gary Lockwood, vice president of business development at 6th Avenue Capital, says he found it difficult to strike up conversations with strangers because it took him out of his “comfort zone.” But he forced himself to make the extra effort, and it has served him well. He says that some of the best connections he’s made have come from these chance meetings at breakfast, lunch or during random breaks.
Although attendees don’t always stay on-site for meals, Peng of Elevate Funding recommends people stick around during these times, if possible. He finds these meals a good opportunity to chat with others in a comfortable setting as opposed to the more strained conversations that can happen when someone approaches him at an exhibitor booth. These informal conversations offer a better chance to build a rapport with someone and learn—in a non- pressured environment—about what the other person does, he says.
Bumbales of Credibly says elevator time offers another opportunity for chance meetings that can turn into business opportunities. Most times, he prefers to take the stairs, but not at conferences. Elevators can be great for short, yet productive conversations. He likes to position himself next to the elevator buttons, which gives him an opening to break the ice. He says he’s had a few business opportunities arise as a result of elevator conversations.
It’s also important not to monopolize anyone’s time says Machado of AltFinanceDaily. Everyone is there to meet as many people as possible, so she recommends keeping conversations quick, meaningful and relevant.
When he’s talking to someone for the first time, Lockwood of 6th Avenue Capital tries to listen more than he speaks. “I want to listen a little more than I talk in the beginning so I can tailor the conversation to what they need.”
While not every exchange will be fruitful, it’s important to recognize that any conversation could lead to future business; even a commercial real estate broker who has no present connection to merchant cash advance can be a potential partner or resource at some point, Lockwood says.
It’s also a good idea to keep your business cards handy at all times. Bumbales says he’s been in several situations when people don’t have them available, which makes exchanging information more awkward. “It’s a lot less awkward to exchange business cards then it is to ask for someone’s cell phone number,” Bumbales says.
Because each day is so jammed- packed with information, it’s a good idea to take notes so you don’t lose track of important details, says Ruff-Bell of Money20/20 USA. Each person will have his own system, but effective note-taking becomes important for recapping the event back in the office and for sending post-event follow-ups to new contacts. “At the end of each day, go through your notes and clean them up, ensuring you’ll understand the key points and important details weeks later,” she says.
Some conference participants fall short when it comes to following up with new connections they’ve made, but this can be a grave mistake. Follow-up emails are most effective when they are personal, says Peng of Elevate Funding. He recommends attendees jot down a few notes on the business card of each person they meet to jog their memory later on about their conversation. Then, weave details of the conversation into the follow-up email, so the correspondence won’t seem cold, generic or canned, he says.
Remember, conference-goers will be meeting hundreds of other people at the conference, Ruff- Bell says. “Ensure your follow-up is prompt, effective, and most importantly, memorable,” she says
Even though the setting is social, conference attendees need to be mindful about maintaining proper decorum at all times. This is a seemingly obvious rule of thumb that people sometimes forget, conference participants say.
“You’re there for work first, play second,” Peng says.
Professionalism also dictates that attendees and exhibitors should be where they are supposed to be at appropriate times. Peng recalls a conference he attended last year where one of the exhibitors left its booth unmanned for most of the conference. There’s no way to know where an interaction at these booths can lead in terms of new business or face-time with existing clients.
“It’s not doing the company any favors” by passing up the opportunity, he says.
Get The Affidavit or Waive It? Examining Confessions of Judgment
February 1, 2019
Caton Hanson, the chief legal officer and co-founder of the online credit-reporting and business-to-business matchmaker Nav, says that his Salt Lake City-based company would not associate with a small-business financier that included “confessions of judgment” in its credit contracts.
“If we understood that any of our merchant cash advance partners were using confessions of judgment as a means to enforce contracts,” Hanson told AltFinanceDaily, “we would view that as abusive and distance ourselves from those partners. As a venture-backed company,” Hanson adds, “we have some significant investors, including Goldman Sachs, and I’m sure they would support us.”
Steve Denis, executive director of the Small Business Finance Association, which represents companies in the merchant cash advance (MCA) industry, says that, as an organization, “We’ve taken a strong stance against confessions of judgment.”
He reports that his Washington, D.C.-based trade group is prepared to work with legislators and policy-makers of any political party, regulators, business groups and the news media “to ban that type of practice.
“We’re fighting against the image that we’re payday lenders for business,” Denis says of the merchant cash advance industry. “We’re trying to figure out internally what we can do to stop that from happening and we have been speaking to members of Congress and their staff.”
“Confessions of judgment,” says Cornelius Hurley, a law professor at Boston University and executive director of the Online Lending Policy Institute, “are to the merchant cash advance industry what mandatory arbitration is to banks. Neither enforcement device reflects well on the firms that use them.”
These are just some of the reactions from members of the alternative lending and financial technology community to a blistering series of articles published by Bloomberg News on the use—and alleged misuse—of confessions of judgment (COJs) by merchant cash advance companies. The series charges the MCA industry with gulling unwary small businesses by not only charging high interest rates for quick cash but of using confession-laden contracts to seize their assets without due process.
The Bloomberg articles also reported that it doesn’t matter in which state the small business debtors reside. By bringing legal action in New York State courts, MCA companies have been able to use enforcement powers granted by the confessions to collect an estimated $1.5 billion from some 25,000 businesses since 2012.
“I don’t think anyone can read that series of articles and honestly say what went on were good practices and in the best interest of small business,” says SBFA’s Denis, noting that none of the companies cited in the Bloomberg series belonged to his trade group. “It’s shocking to see some companies in our space doing things we’d classify as predatory,” he adds. “As an industry we’re becoming more sophisticated, but there are still some bad actors out there.”
A confession of judgment is a hand-me-down to U.S. jurisprudence from old English law. The term’s quaint, almost religious phrasing evokes images of drafty buildings, bleak London fog, and dowdy barristers in powdered wigs and solemn black gowns. (And perhaps debtor prisons as well.)
Yet while the legal provision’s wings have been clipped—the Federal Trade Commission banned the use of confessions of judgment in consumer credit transactions in 1985 and many states prohibit their use outright or in such cases as residential real estate contracts—COJs remain alive and well in many U.S. jurisdictions for commercial credit transactions.
Even so, most states where COJs are in use, such as California and Pennsylvania, have adopted safeguards. Here’s how the San Francisco law firm Stimmel, Stimmel and Smith describes a COJ.
“A confession of judgment is a private admission by the defendant to liability for a debt without having a trial. It is essentially a contract—or a clause with such a provision—in which the defendant agrees to let the plaintiff enter a judgment against him or her. The courts have held that such a process constitutes the defendant’s waiving vital constitutional rights, such as the right to due process, thus (the courts) have imposed strict requirements in order to have the confession of judgment enforceable.”
In California, those “strict requirements” include not only that a written statement be “signed and verified by the defendant under oath,” but that it must be accompanied by an independent attorney’s “declaration.” If no independent attorney signs the declaration or—worse still—the plaintiff’s attorney signs the document, the confession is invalid.
But if the confession is “properly executed,” the plaintiff is entitled to use the full panoply of tools for collection of the judgment, including “writs of execution” and “attachment of wages and assets.”
In Pennsylvania, confessions of judgment are nearly as commonplace as Philadelphia Eagles’ and Pittsburgh Steelers’ fans, particularly in commercial real estate transactions. Says attorney Michael G. Louis, a partner at Philadelphia-area law firm Macelree Harvey, “They may go back to old English law, but if you get a business loan or commercial lease in Pennsylvania, a confession of judgment will be in there. It’s illegal in Pennsylvania for a consumer loan or residential real estate. But unless it’s a national tenant with a ton of bargaining power—a big anchor store and the owner of the shopping center really wants them—95% of commercial leasing contracts have them.
“And any commercial bank in Pennsylvania worth its salt includes them in their commercial loan documents,” Louis adds.
Pennsylvania’s laws governing COJs contain a number of additional safeguards. For example, the confession of judgment is part of the note, guaranty or lease agreement—not a separate document—but must be written in capital letters and highlighted. One of the defenses that used to be raised against COJs, Louis says, was that a contractual document was written in fine print “but we haven’t seen fine print for years.”
Other reforms in Pennsylvania have come about, moreover, as a result of a 1994 case known as “Jordan v. Fox Rothschild.” Says Louis: “It used to be lot worse. You used to be able to file a confession of judgment and levy on a defendant’s bank account before he knew what happened. It was brutal. But after the Fox Rothschild case, they changed the law to prevent taking away a defendant’s right of notice and the opportunity to be heard.”
Because of that case, which takes its name from the Fox Rothschild law firm and involved a dispute between a Philadelphia landlord renting commercial space to Jordan, a tenant, the law governing COJs in Pennsylvania requires, among other things, a 30-day notice before a creditor or landlord can execute on the confession. During that period the defendant has the opportunity to stay the execution or re-open the case for trial.
Defenses against the execution of a COJ can entail arguments that creditors failed to comply with the proper language or procedures in drafting the document. But the most successful argument, Louis says, is a “factual defense.” Louis cites the case of a retail clothing store renting space in a shopping center that has a leaky roof. In the 30-day notice period after the landlord invoked the confession of judgment, the tenant was able to demonstrate to the court that he had asked the landlord “ten times” to fix the roof before spending the rent money on roof repairs. In such a case, the courts will grant the defendant a new trial but, Louis says, the parties typically reach a settlement. “Banks generally will waive a jury trial,” he notes, “because they don’t want to take a chance of getting hammered by a jury.”
A number of states, including Florida and Massachusetts ban the use of confessions of judgment. That’s one big reason that Miami attorney Roger Slade, a partner at Haber Law, advises clients that “there’s no place like home.” In other words: commercial contracts should specify that any legal disputes will be adjudicated in Florida. “It’s like having home field advantage in the NFL playoffs,” Slade remarked to AltFinanceDaily. “You don’t want to play on someone else’s turf.”
He has also been warning Floridians for several years against the way that COJs were treated by New York courts. Writing in the blog, “The Florida Litigator,” Slade—a native New Yorker who is certified to practice law there as well as in Florida counseled in 2012: “If you live in New York, a creditor can have your client sign a confession of judgment and, in the event of a default on a loan, can march directly to the courthouse and have a final judgment entered by the clerk. That’s right—no complaint, no summons, no time to answer, no two-page motion to dismiss. The creditor gets to go right for the jugular.”
In addition, because of the “full faith and credit clause of the U.S. Constitution,” Slade notes in an interview, a contract that’s enforced by the New York courts must be honored in Florida. “Courts in Florida have no choice,” Slade says. “It’s a brutal system and it’s unfortunate.”
In December, two U.S. senators from opposing parties—Ohio Democrat Sherrod Brown and Florida Republican Marco Rubio—introduced bipartisan legislation to amend both the Federal Trade Commission Act and Truth in Lending Act to do away with COJs. Their legislative proposal reads:
“(N)o creditor may directly or indirectly take or receive from a borrower an obligation that constitutes or contains a congnovit or confession of judgment (for purposes other than executory process in the State of Louisiana), warrant of attorney, or other waiver of the right to notice and the opportunity to be heard in the event of suit or process theron.”
But with a dysfunctional and divided federal government, warring power factions in Washington, and an influential financial industry, there’s no telling how the legislation will fare. Meantime, the New York State attorney general’s office announced in December that it will investigate the use of COJs following the Bloomberg series. And New York Governor Andrew Cuomo has declared support for legislation that will, among other things, prohibit the use of confessions in judgment for small business credit contracts under $250,000 and restrict judgments by New York courts to in-state parties.
But if New York State or Congressional legislation are adopted it can have “unintended consequences” to merchant cash advance firms in the Empire State—and to their small business customers as well—asserts the general counsel for one MCA firm. “Losing the confession of judgment will be removing what little safety net there is in a risky industry,” the attorney says, noting that the industry has roughly a 15% default rate.
“It is not as powerful a tool as the Bloomberg news stories would have you believe,” this attorney, who spoke on the condition of anonymity, told AltFinanceDaily. “The suggestion seems to be that the MCAs can use the confession of judgment to get back the total amount of money due—and then some—while leaving a trail of dead bodies behind. But that’s not the case.
“What is much more likely to be the case,” he adds, “is that MCA companies try to get the defaulting merchant back on track. And—probably more than we should and only after we’ve tried to reach out to them and failed—do we then reluctantly use the COJ as a last resort. At which point we hope we can recover some part of our exposure. The numbers vary, but the losses are always in the thousands of dollars. These are not micro-transactions.
“What’s going to happen,” he concludes, “is that It will not make sense for us to work with those merchants most in need of working capital. The unfortunate reality is that businesses who don’t have collateral and can’t get a Small Business Administration product will be left out in the cold.”
All of which prompts BU professor Hurley to argue that the “Swiss cheese” system of financial regulation among the 50 states continues to be a root cause of regulatory confusion. Echoing Miami attorney Slade’s concern about New York courts’ dictating to Florida citizens, Hurley likens the situation governing COJs with the disorderly array of state laws governing usury regulations.
In the 1978 “Marquette” decision, the U.S. Supreme Court ruled that a Nebraska bank, First of Omaha, could issue credit cards in Minnesota and charge interest rates that exceeded the usury rate ceiling in the Gopher State. Since then, usury rates enacted by state legislatures have become virtually unenforceable.
“The problem we’re seeing with confessions of judgment is a subset of the usury situation,” Hurley says. “One state’s disharmony becomes a cancer on the whole system. It’s a throwback to Colonial times with 50 states each having their own jurisdictions—and it doesn’t work.”
Hurley’s Online Lending Policy Institute has joined with the Electronic Transactions Association and recruited a phalanx of “academics, non-banks, law firms and other trade associations as members or affiliates” to form the Fintech Harmonization Task Force. It is monitoring the efforts by the 50 states to align their regulatory oversight of the booming financial technology industry which was recently recommended by a U.S. Treasury report.
Tom Ajamie, who practices law in New York and Houston and has won multimillion-dollar, blockbuster judgments against “dozens of financial institutions” including Wall Street investment firms, also argues for greater regulatory oversight. He urges greater funding and expansion of the powers of the Consumer Financial Protection Bureau to rein in “the anticipatory use” of confessions of judgment in commercial transactions.
However, notes Catherine Brennan, a partner at Hudson Cook in Baltimore, the job of protecting small businesses is outside the agency’s mandate. “The CFPB doesn’t have authority over commercial products as a general rule,” she explained in an interview. “Consumers are viewed as a vulnerable population in need of protections since the 1960’s.” As a society “we want protection for households because the consequences are high. A family could become homeless if they lose a house. Or (they) could lose employment if they lose a car and can’t drive. And there is also unequal bargaining power between lenders and consumers.
“Large institutions have lawyers to draft contracts and consumers have to agree on a take it or leave it basis. So there’s not a lot of negotiation and government has decided that consumers need protections, including a (Federal Trade Commission) ban on confessions of judgment.”
But Christopher Odinet, a law professor at the University of Oklahoma and a member of Hurley’s harmonization task force, sees the efforts of the federal government and the states to grapple with confessions of judgment as further recognition that small businesses have more in common with consumers than with big business. The COJ controversy follows on the recent passage of a commercial truth-in-lending bill by the State of California which, for the first time, stipulated that consumer-style disclosures should be included in business loans and financings under $500,000 made by non-bank financial organizations.
He cites the close-to-home example of an accomplished professional who got in over his head in financial dealings. “I recently observed a situation where a family member who is a very successful and affluent medical professional was relying on his own untrained business skills,” Odinet says. “He was about to enter into a sophisticated and complex business partnership relying on his intuition and general sense of confidence in the other party.”
Odinet says that he recommended that his relative hire a lawyer. Which, Odinet says, he did.
MCA Participations and Securities Law: Recognizing and Managing a Looming Threat
December 11, 2018Authors: Gregory J. Nowak and Mark T. Dabertin
Due to the high volume of relevant judicial decisions issued by New York courts over the past two years, the risk that enforceability of a merchant cash advance (MCA) contract1 might be successfully challenged as a disguised usurious loan has received ample attention in law firm white papers and published legal articles, including articles by Pepper Hamilton attorneys.2 Avoiding this risk of “loan re-characterization” is essential if the MCA industry is to achieve wider acceptance as a source of small business financing. But another risk—which we believe is largely unrecognized—could significantly throttle further expansion of MCA financing. This risk is that the funding structures MCA providers rely on to generate funding from third-party investors could be found to involve the issuance of unregistered securities. Unless an exception is available, that would be unlawful and could result in fines, penalties, defense costs and even rescission of the entire transaction, with the “issuer” being required to return investor capital.
Many MCA providers raise new funding by offering “participation interests” in their MCA contracts to third-party investors. These are usually structured in one of two ways. Under a “true participation,” the participant acquires the right to receive payments, and a resulting return on the participant’s investment, exclusively from the MCA provider. To this end, the participant receives no rights to enforce, nor any direct interest in, the underlying MCA contracts. Alternatively, the participation agreement may be structured so as to make each investor a pro rata “co-funder” of the underlying MCA contracts in an agreed-upon percentage (the “participation share”). Under this structure, the MCA provider’s contract with the merchant typically acknowledges the possible existence of “co-funders” in general terms, and does not require the merchant to ratify and accept named co-funders as they come into being. This add-on is usually accomplished through a novation to the MCA contract.
Under either of the above-described participation structures, the nature of the participant’s investment is purely passive, with no possibility for active involvement in the underlying MCA relationships. In fact, the participation agreement likely expressly prohibits such interference. The passive nature of a participant’s investment matters, because the presence of passivity, and the resulting reliance on the efforts of another party (i.e., the party offering the investment) to realize a profitable return, is a key factor for purposes of determining whether a security exists under the federal securities laws.
In SEC v. WJ Howey Co.,3> the U.S. Supreme Court established the following four-factor test for identifying the existence of a security: (1) an investment, (2) in a common enterprise, (3) with a reasonable expectation of profits, (4) to be derived from the entrepreneurial or managerial efforts of others. The facts of Howey concerned investments in an orange grove operation, where the investors were entirely dependent on the efforts of the orange grove manager/promoter to maintain the trees that the investor had invested in. In the case of an MCA participation structured as described above, all four Howey factors are arguably present. An investment is made with the expectation of realizing a profit. In addition, as discussed above, because that investment is passive in nature, its success hinges on the efforts of the MCA provider. Finally, at least one court has opined that the existence of common enterprise is inherent to any participation relationship.4
The Howey test, which seeks to identify the presence of an “investment contract,” is not the sole means for evaluating whether an investment constitutes a security. In Reves v. Ernst & Young, the U.S. Supreme Court recognized that the expansive definition of the term “security” under the Securities Act of 1933 and the Security Exchange Act of 1934 extends to other forms of “notes” besides investment contracts.5 In determining whether the “demand notes” at issue in Reves constituted a security, the court applied what is commonly known as the “close resemblance” test. Under this test, if the note in question bears a close resemblance to a type of note that has been judicially recognized as not involving a security, that note likewise will not be considered a security. For example, on its face, an MCA contract closely resembles “a short-term note secured by a lien on a small business or some of its assets.”6 However, in an MCA contract, the purchased future receivables provide the source of repayment of the advanced funds, as opposed to providing security for a lien.
This distinction is important. because in an MCA, the receivables do not yet exist, so there is nothing to lien. Rather, the MCA involves receivables to be created, presumably using the proceeds of the MCA to do so. Properly drafted MCAs sidestep all “note-like” characteristics, and make it clear that the MCA is a contract to purchase an asset (i.e., receivables) that are yet to be created. There is no sum certain for repayment – unlike a note, if the receivables turn out to be bad, the MCA provider has no recourse back to the merchant that created them. The receivables are not security for a loan; rather, the receivables are the property being forward purchased. MCAs are different in kind and extent from loans.
Notwithstanding the Howey test, and as noted above, it is possible to argue persuasively that an instrument that appears to be a security instead describes the terms of an individually negotiated contractual agreement. In this regard, in Marine Bank v. Weaver,7 the U.S. Supreme Court held that a contract between a bank and a married couple that called for the latter to pledge a certificate of deposit as security for a loan between the bank and an unrelated corporate borrower in exchange for the opportunity to share in the latter’s future profits did not involve a security. In doing so, the court distinguished the note in question from investments that fall within the “ordinary concept of a security. . . [which are offered] to a number of potential investors.”8 In contrast, the Court in Marine Bank found that the contested note created “a unique agreement [that was] negotiated one-on-one by the parties” and was therefore, “not a security.”9
In the absence of an applicable statutory exemption, the public offering of unregistered securities constitutes a criminal violation of the federal securities laws. Because securities can generally only be sold to the public by a registered broker-dealer, people who engage in selling such securities, as well as their related corporate actors, may be subject to monetary penalties for the resulting violations of law. An improperly structured MCA participation presents the risks that: (i) sales of participations made under the flawed structure could be declared void and subject to rescission; and (ii) both the MCA provider and its primary individual actors could be subject to criminal prosecution and resulting monetary penalties. In the remainder of this article, we discuss ways for effectively mitigating these risks.
Structuring the MCA participation so as to make each participant not merely a “co-funder” in name, but an actual party to each underlying MCA contract by means of a contract novation signed by the merchant and naming the individual participants, would arguably eliminate any risk that the structure might be deemed to involve the unlawful issuance of securities. Under this structure, each participant, at least in theory, could enforce the MCA contracts directly against the applicable merchants, without having to rely on the MCA provider. The main flaw with this option is that the MCA participation agreement necessarily prohibits such independent actions by the participant, because those actions could directly conflict with the economic interests of either or both the MCA provider or additional participants. Hence, any actual ability of the participant to be actively engaged in the underlying merchant relationships will be missing. As the number of participants increases to more than a handful, this structure – requiring as it does that the merchant ratify and accept every new participant as each participant is added, is unwieldy and becomes infeasible to administer.
One could also argue that including a requirement in the MCA participation agreements that the participant must evaluate independently the quality of each MCA contract before the purchase of the participation share precludes the existence of a common enterprise. However, unless each participant has its own series of MCAs, this distinction is unlikely to be of significance, because all participants are participating in the same MCA. Also, notwithstanding the obligation to conduct independent reviews, the MCA participant must still rely on the MCA provider to source qualified merchants. In addition, as noted above, the investor also must depend on the MCA provider’s success in collecting payments from merchants, which will determine whether a profitable return is achieved. Finally, where a pool of investors all share in the risks and benefits of a particular business enterprise (known in securities law as “horizontal commonality”), the resulting presumption of a common enterprise is extremely difficult to disprove.
In view of the above, we suggest that the best way to manage the risk that the participation structure might be viewed as involving the unauthorized issuance of securities is to embrace the substance, if not the precise letter, of the federal securities laws. Specifically, by structuring the participation in a manner that complies with the safe harbor from the requirement to register securities described in Section 506 of the SEC rules under the Securities Act of 1933. This entails: (i) only selling participations to accredited investors; (ii) describing the applicable risks (i.e., the risk factors) and potential conflicts of interest in an addendum to the participation agreement; (iii) making sure that all sales of participants are made on a one-to-one basis, with no general solicitation or marketing; and (iv) advising participants that the resale of their participation share may be subject to a one-year minimum holding period. (Of course, if the MCA pays off before the one year period and extinguishes the MCA, that is not an issue under this rule.)
We caution that the securities laws are both difficult to navigate and prone to divergent interpretations. The consequences of misinterpretation can be severe and could result in the rescission of existing participations and monetary penalties. Hence, this is not a DIY proposition.
Pepper Points
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The risk that an MCA participation structure could be found by a regulator or court to constitute the unlawful issuance of securities is under appreciated, and has serious consequences that could throttle the availability and growth of MCA financing.
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Although legal arguments can be made in support of the position that the most commonly used MCA participation structures do not involve the unlawful issuance of unregistered securities, none of those arguments is sufficiently persuasive to preclude the need for additional risk mitigation efforts.
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Mitigation plans for managing the risk that a given MCA participation structure involves should incorporate complying with the substance, and the precise letter, of the federal securities laws.
The federal securities laws are difficult to navigate and prone to divergent interpretations. The consequences of misinterpretation are severe and could include the rescission of existing participations and assessments of monetary penalties, including against individual actors.
Endnotes
1 An MCA is a business financing option that involves the advance of funds to a merchant, typically to assist the merchant in managing its short-term cash flow needs, in exchange for the sale of a specified percentage of the merchant’s future receivables at a sizeable discount. It is a relatively new offshoot of “factoring,” which likewise involves the purchase and sale of receivables at a discount in exchange for an advance of funds to a business, with the primary difference being that the receivables in the case of MCA financing are not yet extant. An MCA contract might be deemed a disguised usurious loan for many reasons, including the inclusion of a set term within which the advance must be repaid in full to avoid default. The most critical factor in this regard is whether the MCA provider is looking to the purchased receivables for repayment, or to the merchant itself or its individual owner(s); e.g., in the form of a financial guarantee given by the owner(s).
2 For a broader discussion of MCA financing, and the risk of re-characterization as a usurious loan, see: https://www.pepperlaw.com/publications/recent-litigation-illustrates-why-merchant-cash-advances-are-not-loans-2017-04-20/.
3 328 U.S. 293 (1946).
4 Provident National Bank v. Frankfort Trust Co., 468 F. Supp. 448, 454 (E.D. Pa. 1979) (By its “very nature” any participation involves a common enterprise.).
5 494 U.S. 56, 64 (1990) (“The demand notes here may well not be ‘investment contracts,’ but that does not mean they are ‘notes.’ To hold that a ‘note’ is not a ‘security’ unless it meets a test designed for an entirely different variety of instrument ‘would make the Acts’ enumeration of many types of instruments superfluous’ Landreth Timber, 471 U.S. at 692, and would be inconsistent with Congress’ intent to regulate the entire body of instruments sold as investments, see supra at 60-62”.).
6 Id. at 65.
7 455 U.S. 551 (1982).
8 Id. at 552.
9 Id.at 560. In Vorrius v. Harvey, 570 F. Supp. 537, 541 (S.D.N.Y. 1983), the court followed Marine Bank in finding that a contested loan participation agreement involved an individually negotiated contract versus a security. A key factor in that case, however, was the existence of a comprehensive federal regulatory scheme apart from the federal securities laws in the form of banking laws and regulations, which made application of the former unnecessary for purposes of protecting the interest of investors. No such alternative regulatory scheme exists in the case of the MCA industry, which is generally unregulated.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
GOING NATIONAL: How David Gilbert Built One of the Largest Small Business Lenders in the Country
October 17, 2018
When Ty Austin, who owns a florist shop in West Palm Beach, secured a $5,000 loan from National Funding last year, he was happy to have working capital and could build inventory for mini-gardens and landscaping,
The experience, moreover, was surprisingly pleasant. “The guy I worked with was really cool,” Austin says, referring to the sales representative at the San Diego-based financial technology firm. “It turned out that he was getting married and I ended up giving him and his fiancé advice on floral arrangements.”
The borrowing worked out so well that the Floridian, who is 46 and the sole proprietor of Austintatious Designs, re-upped for a second loan of $12,000 to help purchase a commercial van. The van will be used to transport flowers, plants and tools while doubling as a billboard-on-wheels. “It gives me more ‘street cred,’” he jokes.
To register his approval with National Funding, Austin went online to TrustPilot and posted a rave review of the sales rep: “James Johnson Rocks!”
Pam, a Texas wellness coach who provides clients with an array of holistic health therapies, needed extra money to buy an infrared sauna to add to her portfolio of services. But her credit rating was “poor,” she told AltFinanceDaily in an e-mail interview, “from when I changed careers and lost my health and struggled to make my credit card and student loan payments on time.”
Like Austin, Pam — who asks to be identified by her first name —found National Funding through an online search. And she too secured $5,000, although her transaction was structured as a merchant cash advance, rather than a loan. The terms of the MCA require a daily debit from her bank account. She reckons that the total cost of the MCA to be roughly $1,500.
Pam pronounces herself satisfied with the deal and mightily impressed with the way National Funding treated her. The process took about three days — and would have gone even quicker if she’d located her professional licenses sooner. Best of all, she says, the agent at the company tailored the financing to suit her circumstances. “They were great as far as getting my questions answered, even listening to my past situation, which others may not have cared about,” she says.
“They really wanted to get me an option that they knew I’d be able to repay,” Pam adds. “They said they were in the business of helping small businesses grow rather than putting them in a hard financial situation.”
The positive experiences that Austin and Pam had with National Funding are not isolated instances. Rather, they are representative of clients’ dealings with the company. Witness its online reviews from business borrowers at TrustPilot which go back three years, run for 36 pages, and merit National Funding a 9.4 rating on a scale of 10. That’s a straight-A grade on any report card. Although there’s the occasional naysayer — four percent assert that their experience was “poor” or “bad” (and some negative comments can be blistering) — the weight of the reviews is almost embarrassingly positive.
Typical postings find that National Funding and its agents win kudos for, among other things, being “prompt and professional,” providing service that is “hassle free and about as friendly as you can be,” and even being “accommodating and gracious.” A man named Al McCullough spoke for many when he declared: “My experience was great. Professional and on time. Couldn’t ask for more.”
All of which helps account for why National Funding — its 230 employees working out of a sleek suburban office building guarded by a tall stand of palm trees in San Diego — is a rising star in the world of alternative business lending and financial technology. In 2017, the company raked in $94.5 million in revenues, a 24.8 percent bounce over the $75.7 million recorded a year earlier and nearly fourfold the $26.7 million posted in 2013.
In recognition of the company’s three-year growth rate of 142%, Inc. magazine included National Funding in its current list of the country’s 5,000 fastest-growing companies, the lender’s sixth straight appearance on the coveted roster. Since its inception in 1999, National Funding reports that it has originated more than $2 billion in loans to some 35,000 borrowers.
The company’s impressive performance has similarly merited accolades for David Gilbert, the 43-year-old chief executive who started the company on little more than a shoestring and whom employees regularly describe as “visionary.” Among Gilbert’s trophies: Accounting firm Ernst & Young recently presented him with its “Entrepreneur of the Year 2017 Award” for San Diego finance.
At first glance, the San Diego financier doesn’t look too much different from its cohorts. The company proffers unsecured loans of $5,000 to $500,000 to a mélange of small businesses in all 50 states and across multiple industries, including retail stores, auto repair shops, truckers, construction companies, heating-and plumbing contractors, spas and beauty salons, cafes and restaurants, waste management, medical and dental clinics, and insurance agencies.
To qualify for financing, a prospective borrower should have been in business for a year, have at least $100,000 in revenues, and boast a personal credit score of at least 500. While there’s no collateral required for loans, National Funding insists on a personal guarantee. The website reviewer NerdWallet cautions borrowers that this “puts your personal assets and credit at risk if you fail to repay the loan.”
Along with unsecured loans, National Funding offers equipment leasing – usually for heavy trucks and construction equipment – as well as merchant cash advances. The equipment lease is secured by the machinery. As in the case of Pam, the wellness coach cited above, MCAs are debited daily, the money automatically withdrawn from bank accounts.
There are a number of businesses that National Funding disdains, no matter how stellar their credit. “We won’t finance casinos, strip bars, tobacco, or firearms,” Gilbert says. “We’re not going to support industries like that.”
For CEO Gilbert, doing business ethically is a signature feature of the company. Among other things, National Funding presses its salespeople to steer clear of putting people into dodgy loans that are likely to default. “We’re lending capital,” Gilbert says, “and one of our core values is the way we support our customers. Are we placing people with the right product to meet their needs or are we being selfish? The best way to be customer oriented is to get a better understanding of what capital will do for them.”
That corporate ethos, coupled with the company’s remarkable performance, has raised its profile while earning it a measure of esteem among industry peers. “What I do know about National Funding,” says Douglas Rovello, senior managing partner at Fund Simple, a lender and broker in the Tampa area, “is that they have five or six different programs and set their rates high but competitively. They’re known for fitting their products to a client’s needs,” he adds. “And in a business that has its share of bad actors, they have a reputation as a company with a conscience.”
A company with a conscience. Customers come first. And yet National Funding turns heads with its sales production of roughly 1,000 financings a month and triple-digit growth rate. So how do they it? A good place to start is with Gilbert, whose leadership skills, business acumen, and second-to-none work ethic “set the tone,” says Kevin Bryla, the company’s 52-year-old chief marketing officer.
For his part, Gilbert credits his family background and an upbringing in which education and academic achievement were strongly encouraged. The fifth of six children, he’s the only one who opted for a business career. “There are three doctors, two lawyers – and me,” Gilbert says.
The son of a prominent physician, his mother a homemaker and volunteer docent at the nearby Nixon Library for the past 25 years, Gilbert grew up in Yorba Linda. He attributes his keen interest in business to observing how his father, a pathologist, operated his own laboratory, which employed 60 people. “It was the business side of medicine that fascinated me,” he asserts.
Even so, his two closest friends at the University of Southern California — fraternity brothers Marc Newburger and Sean Swerdlow– tell a somewhat different story. They remember Gilbert as someone who found his true calling, his métier, during his college years. Enrolled initially in pre-med courses, he was a diligent student but, his friends assert, manifestly unsuited for a career in medicine.
“Formative,” says Swerdlow, the older of the two fraternity brothers and now a management consultant based in Southern California, “would be a very good word” to characterize that period during which Gilbert abandoned medicine in favor of the world of commerce. In 1997, he earned a bachelor’s degree in business administration “with an emphasis in entrepreneurship.”
But it was fraternity life just as much as the classroom, his friends agree, that shaped him and foreshadowed his future. “It wasn’t ‘Animal House,’” Swerdlow says of Alpha Epsilon Pi. “We boasted the highest GPA (grade point average) on fraternity row.”
Nonetheless, Gilbert took to the social life and camaraderie that the fraternity offered with gusto, and his friendship with the colorful Newburger was especially fateful. A freewheeling entrepreneur today, Newburger takes a measure of credit — Gilbert’s disapproving parents might have preferred the word “blame” — for contributing to his fraternity brother’s metamorphosis. “Dave hated all of his pre-med classes,” Newburger insists. “He had zero stomach for it. He was so much like I was: a natural people person and a born entrepreneur.”
Newburger is the quintessential soldier of fortune. After college, he tried his hand as an actor, supporting himself by playing poker and getting paid to be a contestant on TV game shows including “The Dating Game,” “Card Sharks,” and “3’s A Crowd.” He’s now the co-president and co-inventor of Drop Stop, a patented device that “minds the gap” between a car’s front seat and the console and prevents coins, keys, glasses, and mobile phones from disappearing down that rabbit hole. (Drop Stop really took off after Newburger and his business partner appeared on the television show “Shark Tank” and scored a $300,000 capital injection from celebrity-investor Lori Greiner who took a 30% stake in the company and slapped her name on the brand.)
Back at the frat house, Newburger and Gilbert collaborated on business ventures. The pair once sold T-shirts sporting an off-color message about USC’s archrival, the University of California at Los Angeles. “The (anti-UCLA) message was pure hatred,” Newburger recalls. “But it was just for the day of the football game and it was all in fun.”
At first, sales at the stadium were lackluster. USC students kept trying to bid down the price or importune them to throw in an extra tee. As for the game itself, USC’s chances for victory looked equally unpromising. As time ran out, however, the Trojan quarterback completed a Hail Mary pass and USC won. The two fraternity brothers grabbed the bundle of shirts and sprang into action. “We got to the exit just in time and sold out in a matter of seconds,” Newburger recalls.
Newburger takes credit too for introducing his friend to Las Vegas’ gaming tables. Gilbert, his friend says, immediately demonstrated a knack for counting cards, handling money, and taking risks. “It was typically blackjack,” recalls Swerdlow, who sometimes accompanied them. “We didn’t have much money then. But there were moments when Dave would bet a big pile of chips. He’s willing to make a bet and live with the consequences.”
Sports are another of Gilbert’s enthusiasms. His friends say that, whether he’s returning serve at ping pong or standing over a putt — he plays to an 11 handicap at golf – he wants to win. Remarks Newburger: “He’s competitive to the point that — when he beats you — he wants the Goodyear blimp flying overhead to announce his victory.”
Gilbert, who is married with two children, is legendarily loyal to friends and family. While most members of a college fraternity might keep up with old companions after graduation by exchanging greeting cards and attending college reunions, Gilbert goes the extra mile.
He once footed the bill for Swerdlow to travel with the USC football team to an away game, arranging it so that his fraternity brother could view the action from field-level. After Newburger had a recent health scare (no worries, he’s O.K.), Gilbert rounded up a couple of dozen fraternity brothers and their wives (or companions), and put together a four-day bash in his buddy’s honor. The event was held at Cabo, the Mexican beach resort in Baja California, and Gilbert underwrote a fair amount of the cost. “He shares his success with his friends,” Newburger says, adding: “I don’t know anybody who works harder on friendships.”
Many of the personality traits described by friends and colleagues — tenacity and competitiveness, self confidence and leadership — played a key role in the development and success of National Funding, which Gilbert founded just two years out of college with $10,000 borrowed from his uncle, Howard Kaiman, of Omaha.
He’d worked a couple of quick jobs right after college, including a stint at small-business lender Balboa Capital, but he was always destined to be his own boss. Gilbert’s start-up was called Five Point Capital and, at first, it was located in the affluent Chatsworth section of Los Angeles and concentrated on equipment leasing.
“The first two years we were a cold-calling company and then we got into direct mail and saw some success and then we moved to San Diego and started to scale up the company,” Gilbert says. The decampment, he explains, was “for the quality of life, but we also felt we could hire from a better talent pool than L.A. We wanted to set ourselves apart.”
By 2007, Five Point was cranking up operations, revenues shot to $28 million and its headcount totaled 210 employees. “Then the Great Recession hit” in 2008-2009, Gilbert says. The company was forced to furlough 140 employees, two-thirds of its workforce. Yet even as it retrenched, the company managed to branch out. It began making merchant cash advances, Gilbert says, and, also in 2007, it linked up with CAN Capital to do broker financings. “We were pretty well known and they were looking for partners for factoring and leasing,” Gilbert explains.
It took time to recover after the financial crisis. But by 2013 – the year that Gilbert re-branded his company “National Funding” – the company was able to hire back as many as 15% of its laid-off employees (most had found other jobs, in many cases relocating to Silicon Valley, Gilbert reports). By then, the company had secured a $25 million credit facility from Wells Fargo Bank, which allowed it to move up the food chain to “become a balance-sheet lender,” Gilbert says, and offer a wider selection of financing options.
Key to driving the company’s phenomenal growth has been its flood-the-zone marketing and sales strategies. The company spends $16 million annually on marketing using a full panoply of channels and media, both online and offline. These include direct mail and targeted marketing, paid advertising, search-engine optimization or SEO, and sports sponsorships. “We try to build a whole range of marketing mechanisms,” explains marketing chief Bryla, “and when you get the mix right, they all help each other.”
Gilbert is a big believer in the benefits of sports marketing, the company’s website featuring the logos of the San Diego Padres (baseball), and Anaheim Ducks and Los Angeles Kings (hockey). Ever the faithful alumnus, Gilbert and his company back USC football as well. During the 2015 2016 college football season, the company paid for naming rights for what became, for one night, the “National Funding Holiday Bowl” at Qualcomm Stadium.
Janet Fink, department chair at the McCormack School of Sports Management located at the University of Massachusetts-Amherst, told AltFinanceDaily that sponsorship programs can easily cost a million dollars or more. “It’s not cheap,” she says. “When a company sponsors a team, they get a number of benefits. One is that they get to put the team’s logo on their website. The idea is that fans are passionate or have an affinity for the team and that it will rub off on a sponsor.
“Sports enthusiasts,” Fink adds, “often make good customers. When you have enough disposable income to go to these sporting events, you’re probably a good prospect for a loan.”
The sponsorships — which include civic involvement such as offering Holiday Bowl tickets to members of San Diego’s large military contingent as well as to company employees — also build good will in the community and team spirit among the workforce. (National Funding also makes an effort to hire veterans, says Bryla.)
Gilbert believes in the old adage that you have to spend money to make money. The company spends $14 million rewarding its network of outside brokers. Inside the company, high-performing salespeople are compensated with commissions, bonuses and an assortment of rewards, including resort trips.
But sales representatives’ must conform to company guidelines. Justin Thompson, National Funding’s sales chief, explains that the “customer comes first” philosophy is not just a slogan but a core value. “We’re not a factory spitting out widgets,” Thompson says. “We’re here to build relationships and sell a repeatable product. We want that customer to come back to us. Every loan is customized. Six of ten customers who pay off their loans come back for a second financing. Whether your business is dog grooming or you’re an asphalt company,” he adds, “people will do business with people they like and trust.”
Using the software program “customer relationship management” (CRM), National Funding expends a lot of effort gathering data on its business customers and extrapolating the information for use in credit evaluations. But the use of technology only goes so far.
Gilbert reckons that the art of the deal involves about “70 percent algorithm and 30 percent people.” He adds, “You still need the people component to look at credit profiles. The algorithm spits out a recommendation but we still need the human element.”
If there’s a fly in the National Funding ointment, it’s that the company’s fees can be more expensive than a bank loan.
But borrowers who have been denied loans at a bank or other lender are likely to overlook those costs. Austin, the florist in West Palm Beach, for example, came to National Funding when his bank, North Carolina-based BB&T Bank, gave him the cold shoulder despite the $15,000 in deposits that he averages each month. “I’ve been with them for six years,” he fretted, “and they treated me shabbily.”
Even more grateful was Jimmy Frisco, of Annapolis, who is co-owner with his wife of Lisa’s Luncheonette, a business that includes a food trailer and several cafeterias located in the city’s office buildings. They employ about a dozen people.
Frisco had taken a nasty spill and was laid up for seven months. Health insurance covered the $18,000 in medical costs but he and Lisa fell behind in their bills and needed working capital to pay for food purchases and other business expenses. By the time a flyer from National Funding popped up in his mailbox, he and his wife “had been turned down by several other lenders, including banks,” he says, adding: “Things happen in life and we don’t have the best of credit.”
Getting that loan for $25,000 from National Funding took just three days. Frisco’s health is much improved and business is back to normal. He won’t discuss the terms of the financing, other than to say “it was reasonable.”
He adds: “There were no problems with National Funding, no hassle with the paperwork. They’re great people to work with.”
