Peer-to-Peer Lending Will Meet MCA Financing
December 29, 2013
In 2014 the peer-to-peer lending industry will collide with merchant cash advance and the rest of alternative business lending. Get familiar with these names: Lending Club, Funding Circle, and Prosper. They are brothers and sisters in the business of non-bank financing. They’re also seasoned, tested, and much like the merchant cash advance industry, experiencing phenomenal growth.
The old guard of merchant cash advance companies should take notice. After losing significant ground to Kabbage and OnDeck Capital, a new breed of fighter is about to enter the ring. I hear this phrase too often in response to the threat of competition, “there’s enough opportunity out there for everyone.”
But is there? Aside from the ACH repayment boom, one of the biggest drivers of merchant cash advance industry growth has been stacking. Stacking is the process of issuing an additional advance or loan to a merchant without paying off their existing advances or loans. That puts merchants in the position of having 2, 3, 4, or even 5 daily withdrawals to remain in good standing with all of them.
While the legality and risks of stacking have long been debated, the deeper revelation here is that there may not be as much new opportunity as everyone thinks. There has been an ongoing turf war over land that had already been discovered. It’s caused overall annual funding volume to rise significantly, but there’s not much room for 400%, 500% or 1,000% growth.
Funders like Kabbage came in and conquered the online merchant cash advance space without anyone noticing. Some funders have taken 5 years to double output on a monthly basis. Impressive, yes, but Lending Club on the other hand has more than quadrupled monthly funding volume over just the last 18 months. Not only that, but they’re doing more than OnDeck and CAN Capital (formerly Capital Access Network) combined. That’s massive.
Backed by Google and recently valued at $2.3 Billion, Lending Club is expected to go public in the next 12 months. As they seek to extend their dominance from consumer lending to business lending, funders should seriously ask themselves, is there really enough opportunity out there for everyone?
The Achilles Heel for merchant cash advance companies is money. Regardless of how fast they turn it over, there’s no possible way to experience fast triple digit growth without outside capital. Some funders spend a lot of time and energy trying to raise it. Others are content without it and go chugging along at a moderate pace.
Peer-to-peer lenders on the other hand have a unique advantage, unlimited access to cash. That’s because they source all the money from individuals. The money is crowdsourced from an infinite pool of investors and they just book the deals and service them. Combine this model with a sweet infusion from an IPO and alternative business lending will have its very own behemoth.
I’m not predicting the doom of merchant cash advance at the hands of Lending Club, but quite the opposite. Lending Club will legitimize non-bank business financing once and for all. Merchants will seek capital and investors will seek lucrative returns. Merchant cash advance companies offer a vastly better ROI than what 3-5 year loans can do with regulated interest rates. The top 10 Prosper investors are only earning 15-19%.
Lending Club will carpet bomb businesses across the nation with marketing and likely end up declining 90% of them. If they do indeed stick to their model of 3-5 year loans, they will undoubtedly leave a trail of interested but unfundable merchants. Alternative lenders and merchant cash advance companies will rush in to fill the void.
At the same time, that capital raising problem could fix itself. As everyone jumps on the peer-to-peer/crowdsourcing bandwagon, investors will be thrilled to learn that merchant cash advance is peer-to-peer based as well. Oh you didn’t know? Many funders already crowdsource capital from “syndicates”. Syndication in merchant cash advance is a simplified form of crowdsourcing. ISOs, investors, and account reps can pool funds collectively into deals just as someone could with Prosper or Lending Club.
I first raised this similarity in December 2010 (three years ago!) and even went so far as to make a mock version of Prosper’s site with MCA terminology plastered on it. Eerie isn’t it?
The difference between a company like Lending Club and say a company like RapidAdvance is whether or not funding is meant to be used as working capital or permanent capital.
The consumer lending model is not applicable when it comes to underwriting businesses. Renaud Laplanche, the CEO of Lending Club acknowledged that when he testified before congress a few weeks ago. But is he really ready to experience it for himself?
We shall see in 2014 when the line blurs once and for all. MCA, say hi to your family, P2P.
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Get familiar:
Dear Ami
November 19, 2013I don’t know Ami Kassar personally, but I read the articles in his NY Times blog, a column dedicated to chastising merchant cash advance companies. In it he yearns for the glory days of 10 year loans at 8% interest for local mom and pop shops. Having been a broker for 3 years myself, believe me when I say I wish rates were lower and terms were longer. It’d be an easier sell. But having also been a very senior underwriter and risk manager, I know exactly why the terms are what they are.
The below post was intended to be a comment on Ami’s latest post, Assessing a Kevin O’Leary Investment on Shark Tank, but it shattered the 1,500 character limit so I’m posting it here. As it was intended to be a comment and not its own post, I did not expand or delve into as much as I wanted.
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Ami,
We get it. You don’t think expensive capital is right or moral and in a perfect world where small businesses have perfect credit and a 0% likelihood of delinquency or default, there probably wouldn’t be a merchant cash advance industry.
Unfortunately, the reality is that many small businesses are high risk borrowers for one reason or another. This isn’t because a bank says so but because there is substantial data that shows there is a high likelihood of delinquency or default. Almost all of the small businesses that existed in my neighborhood 25 years ago are gone. They were replaced by new businesses, which were replaced by new businesses, which were replaced by new businesses. To say that a store with 2 years in business and 700 credit in my neighborhood is a safe long term investment would be a huge mistake. Residents tired of eating the same food, local bars lost their cool factor, the CD store got replaced by digital downloading, the supermarket got replaced by one that only sold organic food, and Blockbuster Video is gone. The Exxon became Shell which turned into Gulf which got torn down and rebuilt as a bank. New extensions to a mall 3 miles away damaged 40+ retail businesses on Main Street. A failed health inspection killed a restaurant, bad Yelp reviews killed the bowling alley, and the 78 year old master tailor didn’t relate to the new generation of residents. A flood closed a clothing store for 2 months, a fire killed a coffee shop, and a hurricane wiped away a strip mall.
Shall I keep going? Partners had a falling out, a son ran his father’s cafe into the ground, development killed a farm stand, and increasing rent put a barbershop over the edge.
I’m not knocking small business, just acknowledging that it’s one of the toughest things in this country to manage. God bless the people that try and especially the ones that last decades.
You know what else happens with a lot of small businesses? They declare losses for tax purposes and make organizing financial documents secondary to all else. To a lender, there is a layer of risk built upon a mountain of risk.
You cited IOU Central as a shining example of rate fairness, but failed to acknowledge that they are wildly unprofitable and have teetered on the brink of insolvency for a year. IOU Central is a publicly traded company and I mean them no disrespect, but check out their books. Lending isn’t supposed to be charity.
SBA loans and defaults are synonymous with each other. It’s great for businesses, but the poor economics of them fall on the taxpayers.
There is this belief that merchant cash advance companies are predatory, but the rates they charge are what the market has priced as sustainable for both parties. There’s more than a hundred funding companies offering the same product. You want to know why the competition hasn’t dropped rates to 10% APR yet? It’s because they’d all be out of business. Rates have come down a little bit, but there is only so far they can drop. Small business is risky business.
As a broker out on the street shaking the wary hands of shop owners, I understand your frustration with the high cost. Believe me, the merchant cash advance companies wish they could lower the prices too. Some have done so at their own peril and closed up shop. Others are on their way to that point now. Would you rather only a tiny fraction of small businesses get non-bank financing at a rate in line with your comfort level and let the rest burn? Small businesses of all credit types and financial standings for years have cried, “HEY, WHAT ABOUT US?!” and in response, private companies made access to capital possible. Often times the money is expensive, very expensive. You are concerned that small business owners are making a mistake when they enter into these agreements yet you admittedly lock them into these deals yourself. It seems as though some of your clients would rather have the opportunity to do something positive with expensive money than have no opportunity at all.
I can think of few things tougher than running a small business. The way my old neighborhood looks today is proof of that. I barely recognize the place. You know what wasn’t around 25 years ago? Merchant cash advance companies. Who knows what would’ve happened if they all had access to capital despite a less than stellar credit rating. Some of those stores may have grew, evolved with the changing times, or become franchises. Things might’ve been different. We all want lower rates, sincerely we do. Competition will drive it down as far as it can go and there’s plenty of that today. Once we hit the floor, if we’re not there already, you will have to ask yourself this question. Are you living in a perfect world or the real one? Let the small businesses decide if the opportunity they’re given is one they want to take.
News from the Space
November 18, 2013
American Express recently teamed up with Heartland Payment Systems to provide split-processing loans tied to all card transactions rather than just American Express exclusively. The max loan size is $750,000. Prior to this deal American Express and other merchant cash advance companies rarely competed head-to-head. Unless a small business was processing substantial AMEX, they weren’t a candidate for American Express Merchant Financing. I expect them to make similar deals with other card processors.
Lending Club got a valuation boost with a $57 million investment from Yuri Milner’s DST Global and Coatue Management LLC. They’re now worth about $2.3 billion. They are expected to go public in 2014 which will be especially significant given their plans to enter the small business lending space as early as January. Today, alternative small business lenders worth tens of millions or hundreds of millions of dollars are the big shots in the industry. Expect major disruption if Lending Club achieves an IPO valuation in the tens of billions.
Zazma put their own spin on lending by financing the purchases small businesses make. Funds are actually wired directly to the suppliers instead of to the borrower. For now they are only doing up to $5,000 at one time, which is typically the minimum sized deal for the merchant cash advance industry.
ISO&Agent published a great article about merchant cash advance titled, Taming the Wild Frontier.
The end of the year is coming and Capital Access Network, which is now CAN Capital projects they will finish with $800 million in transactions for 2013. 15 years after they started, they are still the biggest in the business.
Here Comes Lending Club
October 17, 2013
As highlighted in BusinessWeek, Lending Club has finally entered the small business lending market. Some of you might say, “bahh… so what!” but you should be paying attention. Lending Club recently got a valuation of $1.55 billion when Google bought a piece of them back in May. To put that in perspective, that’s about 15x the enterprise valuation that RapidAdvance got in its acquisition by Rockbridge Growth Equity. A monster has entered the ring and it doesn’t matter if it’s peer-to-peer lending, because they’re targeting the same market. What Lending Club does isn’t much different than what the typical merchant cash advance industry does these days anyway. Both thrive on syndication, though one relies on a handful of partners and the other relies on tens of thousands of partners. Both are bank loan alternatives and both can get you funded within days.
Back in 2009, the only short term financing opportunities small businesses had was merchant cash advance. There really wasn’t anything else. There were banks or there was merchant cash advance… and banks weren’t lending. Now there’s a whole spectrum of bank loan alternatives and to say that they operate in markets that don’t compete with each other is crazy.
There was a time when folks said Kabbage was not a competitor in the merchant cash advance space. Now they’re synonymous with merchant cash advance financing, have patents that specifically use the merchant cash advance terminology, and they fund brick and mortar businesses. On Deck Capital supposedly wasn’t a competitor back in 2007 because they did loans with fixed daily ACH. On Deck wanted only the high credit merchants that wouldn’t settle for a cash advance and now they compete head to head with everyone else.
The market is all over the place with pricing and structures. Factors range from 1.09s to 1.50s. Deal terms range from 6 weeks to 24 months. For those already annoyed that there has been downward pressure on rates for high quality clients because of what it has done to margins, you may have more to worry about with Lending Club.
I’ve personally referred consumer loan deals for a commission to Lending Club in the past and they went pretty smoothly. They said if they approve a loan, it will basically fund within days. They don’t have any worry about approved loans not raising enough capital to be funded from syndicates/investors/participants. They said almost every approved loan funds. They also charge between 6.5% and 29.99% APR and make loans with terms of 3-5 years. Try competing against that.
Now I don’t know what repayment time frame will be offered on their business loans, but I do know that they’re used to making loans for very low interest over a much longer term than a merchant cash advance company. Something tells me that they won’t stray too far from that and they’re going to disrupt the market (the premium market anyway) on price and time frame more than a few other companies already have.
Granted, I will admit that Lending Club on the consumer side generally only approved applicants with higher than 680 FICO and a low debt-to-income ratio and I don’t think they’ll change that. That means they won’t be a competitor initially for a large chunk of the market. Lending Club will probably butt heads with On Deck Capital, NewLogic Business Loans, and all the premium 12 month programs floating around out there.
Peer-to-peer lending is part of the broader merchant cash advance industry. Deals fund quickly, the capital is unsecured, there’s little paperwork involved, and the deals are syndicated. Hence, Lending Club is now a competitor.
Being owned by Google also can’t hurt. Lending Club is typically ranked at or near the top of the 1st page for the search query, “unsecured business loans.” Coincidence?
Get ready for Lending Club. They won’t be the last billion dollar plus company to throw their hat in the ring.
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Note 1: An edit was made to correct Rapid’s valuation as an enterprise valuation, which one insider noted can be substantially different than a raw equity valuation. That makes Lending Club likely a lot more valuable in comparison.
Note 2: I initially reported that Lending Club owned Dealstruck.com. This is not correct. Dealstruck.com has previously been reported to be the Lending Club of the small business space in the characteristic way of how they structure deals, but they are not actually part of Lending Club. Thanks to Darrin Ginsberg of Super G Funding for pointing out my mistake.
More on DailyFunder about this topic: http://dailyfunder.com/showthread.php/451-lending-club
Is PayPal’s Working Capital Program a Mistake?
October 5, 2013
A few weeks ago, PayPal announced the launch of their Working Capital program as a way to help small businesses in need. They classify it as a loan but the explanation for how it works is textbook merchant cash advance. A percentage of each PayPal sale is withheld and applied as a reduction to the merchant’s balance. PayPal joining the booming merchant cash advance/alternative lending market is really no surprise. After all, RapidAdvance just got acquired by the same group that owns Quicken Loans. We’re in a new era of alternative finance.
PayPal is respected as a payments company but are they ready for the high risk world of merchant cash advance financing? Critics are not so sure. Industry insiders have watched dozens of funding providers jump into the market with aggressive rates, attempt to undercut the competition, and acquire a lot of marketshare. The results are usually disastrous.
For years, journalists believed that the high cost of capital provided by non-bank lenders was fueled by the desire for immense profit. They didn’t understand the risks involved or realize that some funding providers weren’t even turning a profit at all. Last year, Opportunity Fund, a non-profit small business lender revealed that to make loans at 12% APR would fail to even cover costs. The for-profit sector of the industry charges factor rates (different than Annual Percentage Rates) between 1.14 and 1.50, not including fees. I explained this variance once before in The Fork in the Merchant Cash Advance Road.
So did PayPal learn anything from an industry that has been in existence for 15 years? It doesn’t look like it:
Doing some simple math (Total to be repaid / Loan Amount), the factor rates range from 1.04 to 1.12, figures that will probably only make sense if their average client has greater than 720 FICO, many years in business, and is virtually perfect on paper and in reality. Perhaps PayPal knows that and will decline 95% of applications or perhaps they believe their clients will buck the trend. I mean, is it possible that a corporate monster like PayPal could make a boneheaded mistake?
A 1.04 deal? Seriously? This has disaster written all over it. There are some people that believe that the losing proposition is intentional…
You can follow the discussion about this on DailyFunder.
The Search for a Bad Credit Startup Loan
October 1, 2013Are you trying to start a business despite having no income, bad credit, and no collateral? Well I’ve got news for you… and it isn’t good. There isn’t any hope for you to get a loan. None. Call me a pessimist or a sensationalist for saying so. Heck, I dare someone to prove me wrong! If there is something out there that even exists for people in that situation, be sure to also explain why undertaking such risk would be viable. Let me reiterate the circumstances again:
So why this example? Well it just so happens thousands of people per day that face all 3 circumstances at once are applying online for business loans. How do I know this? I’m in the lending business. I’ve experienced it firsthand in sales and have also amassed the data through a venture I operate. First let me applaud the entrepreneurs that are making an effort to do something. Some folks believe that people with no job and bad credit just sit at home all day waiting for an unemployment check to come in. That doesn’t seem to be the case at all, not by a long shot. People want to work and when they can’t find a job, they’re trying to start a business. Thousands, tens of thousands, or perhaps even millions of people are saying “Hey you know what? My situation sucks, so I’m going to try and open that store I’ve always dreamed of. I have nothing else to lose.” And that’s great but that’s also the problem. Someone that has absolutely nothing to lose has absolutely nothing to offer a lender.
There are those that are dreamers who pursue their business idea thinking they’re going to get a $2 million loan at 4% interest. They interpret ads that say business loans UP TO $2 million as something of a borrower’s choice instead of the lender’s cap for the most qualified applicant in the world. Believe me, there are actually people with no income, bad credit, and no collateral that will not settle for less than the $2 million stated loan cap. And there are those that accept their predicament of not being credit worthy and broke and apply for a small loan with a very high rate of interest. There’s a still a flaw in that plan though since you can’t even get a payday loan if you don’t actually have a pay day.
Some applicants see this as a challenge. If they just search the Internet long enough and hard enough then surely someone will give them a loan, even if it’s expensive. My belief is that if there is a lender that is willing to give you a loan when you don’t have a business, don’t have an income, don’t have collateral to offer, and have a history of not repaying debts, then it is likely a scam. They’ll ask you for money upfront to secure getting the loan, a hustle known as an advance fee loan scam.
I partially blame search engines for keeping loan hopes alive for someone that has no income, no collateral, and bad credit. Some merchant cash advance companies tell it like it is though in their advertising and are still overwhelmed by startups that have no shot.
Search engines present links and ads that allude that ANYTHING is possible, but the responders to one search result in a Yahoo Answers question seem to understand reality. One commenter emphasizes that if you got a loan with bad credit, no job, no co-signer, and no checking account, then you’d best get it on film since it would be an act of divine intervention.
But Yahoo Answers is just one result in Google’s endless link options and searchers are likely to disregard it.
If you’re familiar with Google’s knowledge graph and the coming age of Semantic Search, I’d advise they get right to the point to save a lot of people time and energy. I mean if you search for what is a manual imprinter? Google will literally get right to the point and spell it out for you. Notice the authoritative source for this definition below:
Since Google trusts our content so intently, I’d like to add the following to their worldwide library of facts:
Is there an opportunity here?
No one is serving the incomeless, creditless, and assetless loan market… my God is there an opportunity here?! Kind of… but not with loans. There is a lot this massive market could benefit from and that’s guidance. A loan is out of the question, but it doesn’t mean these distressed entrepreneurs can’t get their hands on capital. Crowdfunding is a term that a lot of people throw around but startups shy away from it. I mean… what is crowdfunding really? Sites like Kickstarter and Indiegogo allow people to pitch their ideas to try to raise donations. If enough donations are pledged to meet the entrepreneur’s goal, the money is granted to the entrepreneur. If the donation goal is not reached, the money is returned to the donors.
What I like to think is different between myself and your average journalist on this topic is that I have been down this road. If you’re wondering who in the world is going to donate funds to launch your startup, project, or product idea, you should know that I have done just that. About a month ago, time expired on an Indiegogo campaign to produce an Ubuntu phone. Ubuntu is a Linux OS distribution. It’s like Mac OS or Windows, except it’s neither of those, it’s Linux. Ubuntu believed there was demand for their distro on the mobile platform. In an iOS and Android world, who says there’s not room for one more? Ubuntu users tend to be passionate about their systems and so Ubuntu called on everyday people to take their product to the mobile level.
$12,814,196 was raised but they fell short of the $32 million goal so the funds were returned to the donors. I was one of those donors.
Now you may only need $5,000 or $10,000 or $20,000 and that’s probably a whole lot easier than $32 million. If your business is really viable in the first place, then pitching it on a crowdfunding site is the best trial run you could possibly hope for. Get people emotionally invested or excited about your business. Go nuts promoting your campaign on social media and on blogs. If you can’t get anyone to care about your campaign through crowdfunding though, then you need to seriously consider how you would somehow make people care about your business once it’s operational. I didn’t donate money to the Ubuntu phone project just because it was posted on the site, I did it because I felt like I couldn’t imagine a world where there wasn’t an Ubuntu phone. I became emotionally invested in it.
Supplementary solutions
In my experience, many individuals applying for a startup loan want to address issues like their bad credit, not being incorporated, and not having a business plan until AFTER they get the money. Not all, but many think these are roadblocks or tricks to get them to shell out money they don’t have. They want a guarantee that if they do X, then they will be approved for Y, but it doesn’t work that way. Sometimes you have get your ducks in a row just to make the case that you are credit worthy even if it’s ultimately decided that you are not. Stinks right? That’s the way it goes though.
No income, bad credit, BUT you have collateral
I may have started my rant by painting an apocalyptic picture for startups faced with 3 terrible circumstances, but there is light in the darkness if you’re shooting only 2 for 3. If you’ve got collateral, that’s awesome. My question is though, what do you have? You might be able to get a title loan with your car or a pawn loan for your valuables. I didn’t say the heavens were opening up with these choices, but the possibilities are. Lenders like Borro will actually let you put your jewelry, artwork, antiques, diamonds, gold, or luxury automobiles up as collateral for a short term loan. The only downside is that they will actually come and pick up the item(s) for safekeeping to make sure you pay. And if you don’t, they’ll sell the item(s) off to make up the difference. But hey, if you fully plan on paying back the loan, then what’s the problem?
You have an income, but you have bad credit
This is a start. Having a steady income just upped your chances of repaying a loan. The bad credit is still a problem though, a big one. Mainstream lenders and mainstream alternative lenders are a long shot because the FICO scoring model predicts with high likelihood that you will become delinquent on your payments. Payday lenders are in reach with an income, but they’re probably not a good source for startup capital. How much can you really do with $500 to $2,000 anyway? Just the act of incorporating can run $500.
You have both income and really good credit
This is the only point where the merchant cash advance industry has a chance to find common ground with startups. People have been asking me for years about what in the heck to do about all the startups that flood their phone lines and mob their websites. First the question was about how to make them go away, then how to sell them products to help get their businesses started, then how to find someone who will lend to them, and the back again to how to make them go away. The consensus is that no one will fund startups. Well, some will say they do but as long as they are in business already and can show documented sales history and bank statements. 99% of startups that apply for a loan in the merchant cash advance arena haven’t gotten that far yet though.
A 600 FICO is not a good credit score. Maybe some folks in the merchant cash advance industry will tell you that it is but in the traditional lending world this score is crap. If you have good credit (700+) and a verifiable income, you can in fact get a loan to start a business. It won’t be a true business loan though, perhaps to the dismay of entrepreneurs that falsely believe they can set up a legal entity to shield them from any liability to guarantee it. It will be a personal loan that is personally guaranteed.
This is the point where a regular journalist would cite a random press release about all the startup loans available to small businesses even though they have no idea what’s involved or how true it is. Much like my personal experience with Indiegogo above, I have personally succeeded in taking applicants with no operational or functional business and helped them get a loan. It hasn’t been a lot of people and there’s very little money to be made in it from a reseller standpoint but startup loans exist. I’ve done it with Prosper and Lending Club, but I should warn you, they are very strict on credit criteria and manually underwrite files like a bank would. The only difference is that it’s faster and there are realistic odds of approval.
I didn’t particularly like my experience with Prosper, mainly because they seemed to harbor ill will towards the merchant cash advance industry. This was communicated to me in my conversations with them and as such the decline rate on applicants I referred to them neared a whopping 99%. My experience with Lending Club was a little bit better, in part perhaps because of their recent backing by Google. The last time I ran the numbers, they had approved 11.1% of my deals. To an entrepreneur this success rate probably sounds horrible, but compare it to the 0% approval rate for a startup loan with a merchant cash advance company.
Entrepreneurs with really good credit and an income can up the approval rate by trying another channel, the credit card. Just know that even if you get it in the name of the business, it’s going to be personally guaranteed. And how do I know that you can get a business credit card for a startup? There’s that experience thing again… When I was starting a business, I was able to get a business credit card with a decent sized line just because I had good credit and sufficient income. They didn’t care so much about the business itself, so long as I met their other criteria. You will need to be incorporated and have all of your business ducks in a row though to make this happen.
You have a very young operating business
Once you cross the threshold from a startup business with no sales to a startup business with sales, supporting business documents, and bank statements, well then congratulations because you’ve finally entered the realm of being eligible for a merchant cash advance. You’re not guaranteed an approval and there are still minimum criteria to be met depending on where you apply. Credit may or may not be a factor. Sales volume will make a major difference in what you’re eligible for. Most funders require an absolute minimum of $10,000 in monthly gross sales. The rates will be less than ideal and you’ll likely have to settle for less than the lender’s $2 million loan maximum. $10,000 in monthly gross sales might only equate to a $5,000 approval.
If you’re looking for that real shot in the arm, like a million dollars on really low sales volume, then you could always try the equity game and pitch investors like on Shark Tank:
If you had to ask Billionaire Mark Cuban where to get a startup loan, he’d say not to bother with one at all. Good credit? Bad credit? It doesn’t matter. So many startups fail so why would you risk screwing yourself over with debt if things just don’t work out?
I agree with Cuban’s comments in the video that it’s a hell of a risk to a take out a loan when you’re just getting started and lenders look at it the same way… one giant hell of a risk.
That’s why I shake my head when I see applicants out there with no income, bad credit, and no collateral applying for loans on any and every lending website on the Internet. The odds of an approval no matter what the advertisement says is astronomically low. I don’t think startup loans for applicants like that exist and I invite anyone to prove me wrong.
I’m serious about this. E-mail me at Sean@merchantprocessingresource.com
No End in Sight for Alternative Lending
September 17, 2013
Which one of these three isn’t like the other two?
- Quicken Loans
- RapidAdvance
- Cleveland Cavaliers
It’s a trick question because as of September 16, 2013, All three are owned by Rockbridge Growth Equity, a Detroit-based private equity firm. RapidAdvance announced the acquisition over the news wire, shocking many people around the industry. The move opens RapidAdvance to the connections and prowess of Dan Gilbert, the 126th richest man in the United States. Gilbert is worth approximately $3.9 Billion, is the founder of Quicken Loans, and he owns 4 sports teams, including the NBA’s Cleveland Cavaliers.
Compare that to On Deck Capital board member Peter Thiel, who is worth $1.9 Billion and is the 309th richest person in the U.S. You may remember Thiel, the co-founder of PayPal and first investor in Facebook as participating in a series D round for On Deck Capital along with Google Ventures back in May.
These are truly some historic times. Two of the richest people on all of planet Earth have stock in the merchant cash advance industry. Does that tell you anything about the direction things are moving in? Think about that one again… Two of the richest men in the world have invested in the merchant cash advance industry.
Four years ago, an influential friend advised me that this industry would be eradicated by 2010. As told through The Bubble That Wasn’t, some people left the business prematurely fearing the best days of alternative lending were over. At present, it looks as if those best days are still yet to come.
The Rockbridge Growth Equity move comes less than a year after Steven Mandis bought into RapidAdvance. He will reportedly stay on as a shareholder.
On Deck Capital
In other news, On Deck Capital announced that they’ve raised another $130 million in debt financing, leveraging themselves out even further. ISOs in the industry report that they’re ON FIRE with approvals. Rumors about a possible IPO on the horizon are starting to pick up again but my sources tell me that isn’t likely to happen with On Deck for another 2-3 years.
Alternative Lending: People are Finally Getting it
September 12, 2013
Alternative lending is all the rage these days and so much so that BusinessWeek asked the question: What Do Small Businesses Need Banks for Anyway?. They go on to name many companies with ties to the merchant cash advance industry, which is no surprise to us of course. It is interesting however to notice that the mainstream media is not only giving us the time of the day, but starting to treat us like royalty.
Five and a half years ago this very same collective of lenders were referred to as bottom feeding vampires¹. Over the next couple years they upgraded us to a very expensive alternative, then to an acceptable alternative, and now finally to who the hell needs banks when you have these great companies?!. You have to laugh just a little bit at the shift.
It’s easy to call a lender that charges high rates a bad seed when you have no sense of the context. The reality in lending is that a material amount of borrowers don’t make their payments on time or they don’t pay back the loan at all. That causes rates to go up to compensate for the losses. Critics argue that borrowers can’t make the payments or default because the rates were too high to begin with. Some lenders cave to that assumption and position themselves as a fair lender by undercutting the market rates. They eventually learn that defaults are less related to the cost of the loan and more so tied to a borrower’s willingness to repay or ability to repay. Meaning, loans with no interest tacked on to the principle will still be rocked by late payers and defaults. Wait, seriously?
Yes, welcome to America where sometimes borrowers face circumstances beyond their control or they maliciously decide they don’t want to pay. The overwhelming majority are in the former camp, the ones where sudden or gradual hardship is interfering with their ability to make good on their commitment. I admit, even I feel uncomfortable mentioning this. Nobody wants to be seen as picking on borrowers. We’d all rather pretend that lenders are inherently bad and borrowers are inherently innocent. The truth is that most lenders and borrowers are good but some lenders and borrowers are bad. Lending is a two way street and what’s fair for all is somewhere in the middle.
My friends in the commercial banking sector tell me their tolerance for bad debt is less than 1%. Even 1 single loan default over the course of a year could cause their entire portfolio performance to come crumbling down. They do make loans, but they’re often in the tens of millions or hundreds of millions of dollars and only to large established businesses that quite often, don’t even need the capital but would rather not jeopardize their liquidity by spending their own cash. Some of these loans end up getting classified as small business loans even though there’s nothing small business about them.
Mom and pop shops see the statistics and the corresponding rates of say 4% to 10% APR and set that as the bar to shoot for. Then they head down to their local bank and hit a roadblock. The average small retail/food service business is going to have a greater than 1% chance of default no matter how good it looks on paper. I mean think about it, what are the odds that things will go 99% as planned for a restaurant over the next 12 months? Do you think it’s reasonable to assume there is at least a 5% chance that any of the following could happen in the next year even without knowing anything specific? A failed health inspection, bad reviews published online, a revoked liquor license, construction outside impeding pedestrian traffic, internal damage caused by a flood or disaster, extreme weather hurting sales, major job losses in the area leading to people having lower disposable income, key employees quitting, theft, landlord not renewing the lease, competitor opening up in the neighborhood, or declining sales for no single identifiable reason? Lending money to retail businesses is risky, really risky. Suppose the above business owner had a history of late payments and defaults to begin with. At what cost does it begin to make sense to do this deal? And those are just the risks of what could happen to the business itself, so what about the other risks involved?
To a bank, the stereotypical entrepreneur is damaged goods. The hard knock humble beginnings of turning a vision into a successful business usually comes with personal financial sacrifice and in turn a lower credit score. And just as the successful entrepreneur is getting ready to explain his/her high debt to income ratio and story of triumph, they’re already being declined. Banks don’t care about the story. They care about the aggregate mathematics. If there’s just a 5% chance that the business isn’t going to be where it thinks it will be in a year from now, then the deal’s probably a non-starter. Leveraged? Declined. Poor credit? Declined. Business is running smoothly? Who cares, it’s declined already!
Extension on your taxes? Declined. Showing modest profit or a loss for tax purposes ::wink wink:: ? Declined. Didn’t file a tax return? Declined. Co-mingling funds with your personal finances? Declined. Overdrafts or NSFs? Declined. Unaudited financials? Declined. No collateral? Declined. Doing the books with paper and pen? Declined. Have less than 5 employees? Declined. Can’t find a document the bank wants? Declined. Need the money really badly? Declined. Experiencing a downturn? Declined. Have a tax lien? Declined. Have a criminal record? Declined.
Get the picture? If you take a look at Lending Club, an alternative lender, they’re widely known to have a 90% decline rate. Their maximum interest rate is 29.99% APR. Think about that for a second. Some people would say, “WOW, 30% are you kidding me?” but statistically, Lending Club would be losing money on the deal 9 times out of 10 if they approved every single person that applied. Lending Club actually used to be more liberal with their approvals when they first started and what happened is that too many borrowers just didn’t pay. If you believe that Lending Club should approve even more loan applications than they already do, then they would have to compensate for the increased risk and we’d quickly see APRs reach well into the 40s,50s,and 60s.
A critic might argue that once an applicant exceeds the risk of a 30% APR loan, they probably shouldn’t be getting a loan from anyone. That’s not a bad suggestion and what happened is that when the lending world concurred with that 5 years ago, Americans and politicians went up in arms because “Banks weren’t lending.” No loans? Businesses can’t hire. No loans? Businesses can’t grow. No loans? Economy gets stuck in neutral. The nation demanded that capital flow despite the risks presented to the lenders. And so the finance world heeded the call to provide solutions and came up with a smorgasbord of financial products. Merchant Cash Advance financing was already established but had an especially unique characteristic that allowed it to take off. It structured financing as a sale, not a loan. A big problem was that traditional lenders and alternative lenders were at the mercy of state regulated interest rate caps. Once an applicant reached a certain risk threshold, they just couldn’t do the deal anymore. But when financial companies came in to buy future revenues in exchange for a large chunk of cash upfront, the system started to gain some traction.
The effective cost of the money got high, very high, yet they weren’t predatory. I say that because despite how expensive it seemed, most of them were getting eaten alive by defaults. From 2008 – 2010, many merchant cash advance companies filed for bankruptcy. One of the main attributes of a predatory lender is for the lender to actually be getting filthy rich. That means layering on interest way in excess of a healthy profit. Losing a lot of money to help borrowers and small businesses when no one else will can hardly describe a predatory lender.
One has to wonder that perhaps there is a better way. If unsecured financing breeds high defaults, then surely things would be different if a risky applicant secures the loan with collateral. Have the borrower put skin in the game and we’d have a different outcome right? Lenders such as Borro publicly describe their default rate as falling between 8-10%. They offer collateralized personal loans and are described as a “pawn shop for the posh” in the below video, though most of their clients are small business owners. This tells me that even in the instance where borrowers have something very valuable to lose, a significant percentage of them will not repay the loan in full regardless.
A look around at what merchant cash advance companies have been willing to admit has put their average bad debt between 2-5%. In my experience in this industry however, 8% – 15% is a lot more realistic. But are these funding companies getting filthy rich or treading water? Anyone can look at the financial statements of IOU Central², a lender that’s part of the broader merchant cash advance industry. Since they’re owned by a publicly traded company in Canada, we get to see firsthand that they’re suffering tremendous losses quarter after quarter. I find that to be perfectly in line with what I suggested about undercutting the market earlier. IOU Central’s allure is that their loans cost less than a traditional merchant cash advance. The end result is that after paying commissions to sales agents, paying interest on their capital, and factoring in bad debt, they’re hurting pretty badly.
On Deck Capital too, a company mentioned in the BusinessWeek article above acknowledges that they are not profitable, though they do not make their financials public to verify how unprofitable they are or if that’s really even the case.
An SBA loan through a bank may cost approximately 5.5% APR, but if the loan goes bad, the SBA covers almost all of the bank’s losses. There is no such security blanket in the real private sector. The market determines the rates based on the risk. Each funder measures risk differently and in 2013, there is no longer a one-size-fits-all cost of unsecured funding much like there was in 2007 with merchant cash advances. Compared to a bank loan, almost all of these alternative options will be perceived as expensive, but if banks don’t approve anyone, then they’re a terrible standard for a comparison.
It’s taken a long time for the public and the media to come to terms with that. Banks are still technically in the game but by proxy. They are financing numerous alternative lenders and merchant cash advance companies. Banks shouldn’t be lending out their client’s deposits to really risky businesses anyway. A bank is supposed to be safe. If they’re lending money to 100 businesses and 15 of them aren’t paying it back, then that’s the opposite of safe.
So what do small businesses need banks for anyway? Checking, payroll, overdraft coverage, debit cards, wires, record keeping, CDs etc. There is a place for banks in 2013 and beyond. Alternative lenders charge more and that’s okay. Ultimately it’s up to the borrowers to decide what they can sustain. It is better to have expensive options than no options at all. There’s endless proof of that when credit dried up five years ago. Small businesses cried foul so the market reacted. And here we are now with Kabbage, On Deck Capital, Business Financial Services, and Capital Access Network being portrayed as the norm, the new standard. Almost everything that would cause a bank to say “no” can be resolved in some way. That’s incredible and how it should be.
People are finally getting it.
– Merchant Processing Resource
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¹ It took 5 years but Forbes has Finally deleted the March 13, 2008 article that haunted the merchant cash advance industry forever. In Look Who’s Making Coin off the Credit Crisis, Maureen Farrell referred to merchant cash advance companies as vampires that were feasting on small businesses and singled out some of the biggest names in the business at the time. It was Global Swift Funding* (GSF), one of the major funders cited by Farrell that exposed this assertion to be blatantly false. Not too long after the article was published, GSF closed their doors and filed for bankruptcy. It would seem that small businesses actually feasted on them by defaulting in record numbers. Back in April of this year, Forbes essentially rebuked that article when Cheryl Conner revisited the industry to note how much good it was doing in ‘Money, Money’ — How Alternative Lending Could Increase Your Company’s Revenue in 2013
*Disclosure: Raharney Capital, LLC the owner of this website currently owns the former domain of Global Swift Funding (GlobalSwiftFunding.com) though the companies did not have and do not have any ties to each other.
² IOU Central is a subsidiary of IOU Financial Inc. Management’s Discussion and Analysis of Financial Condition and Results of Operations as of August 22, 2013 are available at: http://cnsxmarkets.com/Storage/1563/144040_MDA_%282Q2013%29_-_FINAL.pdf
