Increasing Barrier to Entry (Self-Regulation)
November 15, 2015
Having been involved in our industry in some capacity since January 2007 (Merchant Services direct sales from 01/2007 – 04/2009 and alternative financing from 11/2009 – 09/2015), it has always been amazing to me to see just how low the barrier to entry is into our space, due mainly to companies relying heavily on the highly profitable Mom and Pop Network.
I have made reference before to The Mom and Pop Network that exists in our industry, which is just a group of random brokers who will resell for free (they cover their own expenses on all commission). A funder might have a Mom and Pop Network of 3,000 brokers that bring in on average of 10 applications a year (30,000 apps), with 35% getting approved (10,500) and 30% closing (3,150), with an average funding per client of $30,000. This is close to $95 million in annual funding volume that comes in very profitable and in a lot of ways, very “risk-free” in terms of new client acquisition ROI.
PROBLEMS WITH THE MOM AND POP NETWORK
Companies in our space relying heavily on The Mom and Pop Network, is why the barrier to entry is so low, as the major players want to continue benefiting from free marketing/advertising by recruiting hundreds to thousands of random, inexperienced, experienced, ethical, or unethical agents/brokers, who are willing to work for free (100% commission) and cover their own expenses, all for the rah-rah sales dream of striking it big.
The reality however, is that The Mom and Pop Network creates a number of problems for our industry which cause merchants to lose faith in all agent/brokers in the space, as well as causing somewhat decent funders, lenders and merchant processors to end up on RipoffReports and other negative review sites. These problems include but are not limited to:
- Merchants being the victim of rogue agents/brokers ripping them off, stealing from them, flat out lying to them, forging signatures, doing bait and switch pricing tactics, and other measures.
- Merchants being the victim to an inexperienced agent/broker providing the wrong information on pricing, terms, conditions, and other aspects which leave Merchants in a bad position long after the “close” of the sale.
- Merchants being the victim to the flat out unprofessionalism on behalf of these rogue and inexperienced agents/brokers.
THE MOM AND POP NETWORK IS THE LAZY WAY TO BUILD A SALES FORCE
The reality is that The Mom and Pop Network is a lazy way of making a profit in the professional Sales game. Instead of actually developing a quality in-house training program that creates a high quality professional Sales Team backed with knowledge, competency, market research, etc., most companies in our space would just rather hire a bunch of random people with a pulse, feed them the rah rah sales motivational dream speech, throw them against a wall and pick off what sticks.
The vast majority of the individual agents/brokers listed in the Mom and Pop Network do not make enough money directly from the activity to make a living, but as a collective whole, the company gains new clients in one of the most profitable and risk-free manners possible.
But in return for that profitable and risk-free procedure, a ton of damage is done to the industry that’s irreplaceable, continuing the threat of government regulation coming in and totally changing the way we all do business for the worse.
RECOMMENDATIONS TO CLEAN UP THE MOM AND POP NETWORK (SELF-REGULATION)
Funders, lenders and merchant processors surely won’t take my advice to end The Mom and Pop Network tomorrow, because it’s simply too profitable, so instead how about we take the following steps to create a more quality Mom and Pop Network?
To clean this up, every funder, lender and merchant processor should require extensive personal and professional background checks on every agent, broker and reseller that they bring on board externally, just as they would do internally with direct employees they would hire on W-2. Just because someone is a 1099 independent contractor, does not mean you might not still be named to a major lawsuit, held liable, etc., for their rogue and inexperienced actions to Merchants in the marketplace.
For Personal Background Checks:
- Pull their credit: If their credit is bad and they can’t provide some type of reasonable explanation, I wouldn’t approve them to begin reselling your services. Think about it, we are in the financial services industry where the rep is going out to “consult” a merchant on a financial manner, when they can’t even do something as simple as pay minimum payments on a credit card every month? Or pay their taxes on time to avoid getting tax liens? Either they are horrible at managing their finances or they just have bad character, neither of which we want to bring into our industry.
- Look for any previous criminal record history: If you have a felony for any reason, you shouldn’t be allowed to come in and resell services to merchants that give you access to SSNs, DOBs, home addresses, bank accounts, tax returns, financial statements, etc. This should be common sense.
- Look for any previous excessive civil record history: Are they getting sued a lot and if so, what is it for? If it’s something that points to bad judgment or bad character, don’t allow them to resell your services.
For Professional Background Checks:
- Look for any previous sales experience: Our industry is very competitive, so why on Earth would a person without any prior professional sales experience want to run in here and start selling for free (on all commission)? At the very least, look for previous sales experience of at least two years with verified references from the prior employer in terms of performance.
- Look for any type of higher education: I would limit all new entrants only to those who have “some college”. It might just be an associate’s degree or they might have only completed one year of college, but they should have “some college”. College in and of itself might not directly influence a lot of the performance in terms of what makes a good sales professional, but usually a good professional in general in today’s day and age, will have some level of college completed.
- Look for a business plan: Simply, what is their plan of action to come in and begin turning profit in our highly competitive space? Do they have the proper accounting, legal, market research, business planning, strategic planning, marketing mediums, etc. in place? If they don’t, then why are they here?
SELF-REGULATION IS THE ANSWER
The barrier to entry into our space will be increased when companies using The Mom and Pop Network model (funders, lenders and merchant processors) start conducting more thorough personal and professional background checks on their recruit prospects.
They need to limit their recruiting efforts to individuals who “appear” to be competent, professional, and serious about our industry, rather than just to anybody with a pulse and a heartbeat, without taking into regard their previous criminal history, bad credit, bad character, lack of sales experience and lack of any type of business plan to gain market share.
Grenville Kleiser (personal development author) said, “by constant self-discipline and self-control, you can develop greatness of character.” If we want to eliminate the bad character that’s running rampant in our space, then we are going to have to develop our own forms of “self” control (self-regulation) to produce a better industry, one that’s instead running rampant with great character.
Madden v. Midland Appealed to the US Supreme Court
November 15, 2015The Madden v. Midland decision has been appealed to the US Supreme Court and the future of non-bank lending potentially hangs in the balance. The introductory statement reads as follows:
This case presents a question which is critical to the operation of the national banking system and on which the courts of appeals are in conflict. The National Bank Act authorizes national banks to charge interest at particular rates on loans that they originate, and the Act has long been held to preempt conflicting state usury laws. The question presented here is whether, after a national bank sells or otherwise assigns a loan with a permissible interest rate to another entity, the Act continues to preempt the application of state usury laws to that loan. Put differently, the question presented concerns the extent to which a State may effectively regulate a national bank’s ability to set interest rates by imposing limitations that are triggered as soon as a loan is sold or otherwise assigned.
Several attorneys have said off the record that the likelihood the US Supreme Court would actually hear the case is about 100 to 1, because the issue lacks sex appeal. Gay Marriage, Obamacare, these are the type of things that make their way through the system.
Nevertheless, the petition argues the matter at hand:
The Second Circuit vacated the judgment, holding that the National Bank Act ceased to have preemptive effect once the national bank had assigned the loan to another entity. App., infra, 1a-18a. In so holding, the Second Circuit created a square conflict with the Eighth Circuit, and its reasoning is irreconcilable with that of the Fifth Circuit. The Second Circuit also rode roughshod over decisions of this Court that provide broad protection both for a national bank’s power to set interest rates and for its freedom from indirect regulation. And it cast aside the cardinal rule of usury, dating back centuries, that a loan which is valid when made cannot become usurious by virtue of a subsequent transaction.
The Second Circuit, of course, is home to much of the American financial-services industry. And if the Second Circuit’s decision is allowed to stand, it threatens to inflict catastrophic consequences on secondary markets that are essential to the operation of the national banking system and the availability of consumer credit. The markets have long functioned on the understanding that buyers may freely purchase loans from originators without fear that the loans will become invalid, an understanding uprooted by the Second Circuit’s decision in this case. It is no exaggeration to say that, in light of these practical consequences, this case presents one of the most significant legal issues currently facing the financial-services industry. Because the Second Circuit’s decision creates a conflict on such a vitally important question of federal law, and because there is an urgent need to resolve that conflict, the petition for a writ of certiorari should be granted.
Brian Korn, a partner at Manatt, Phelps and Phillips, told the LendAcademy blog in an interview that the Court could rule on the motion at any time and that it takes 4 out of 9 justices to agree to accept the case.
The plaintiff, Madden, has until December 10, 2015 to file a response to the petition.
Brokers: It’s Okay To Be A Piker
November 5, 2015The Financial Services Industry is famous for coming up with different connotations that are outside of the comprehension level of the general public. Such connotation listings include terms such as: Derivatives, EPS, Diluted EPS, SPO, EBITA, Par Value, among others.
But there’s one word that I wanted to discuss in particular that comes off as a form of “slang” within the Industry, and that’s the word Piker. To be called a piker by someone in our industry, is to be called a person that thinks small, reaches for small goals and doesn’t dream big.
MASS NEW BROKER ENTRANTS HAVE BIG DREAMS
The Merchant Cash Advance Industry is in a major bubble right now, with a large quantity of new broker entrants into the market all with big dreams inspired by the myriad of industry recruiting ads, highlighting that with little-to-no experience, you can jump in and make $20k a month. The “rah rah” sales motivational speeches soon follow with examples on how one guy is making $25k per month, how another guy just sold his MCA firm and cashed out for $5 million, how another guy made $1 million last year alone, and how YOU can do all of this too if you just come on in and start dialing!
So the big dreamers begin to dream……
- “This year I’m what Dave Ramsey calls a Whopper Flopper. I hate working in this crappy Burger King drive-thru, it’s time to start making my dreams come true.”
- “Next year, I will be making $20,000 a month and driving around in a Mercedes-Benz S-Class.”
The guy joins the new rolls of rookie/new broker entrants on web based predictive dialers calling merchants about a “UCC” they filed 3- 12 months ago. He will start out with about 150 merchants to call on Monday about this UCC filing, and by the time he calls those merchants on Monday, they would have already been called by 15 – 30 other companies over the previous two weeks alone.
In other words, they will all slam the telephone down in his face after he literally mentions the fact that he’s calling from any “capital or funding” company, without him even being able to get a word in.
DREAM KILLED (REALITY SETS IN)
The reality is that success in our industry is mainly due to leveraged resources, rather than actual superior “selling” capabilities. What happens is that 20% of the brokers in the market remain profitable and sustain a good career/operations going forward, where as 80% of brokers don’t last more than 3 – 6 months, mainly because the 20% has access to resources that the other 80% don’t have access to, that provides them a significant market competitive advantage. These resources include:
- Having Strategic Partnerships with Banks, Credit Unions, Processors and Other Associations
- Having Access To Financing (Debt and Equity) Allowing For A Much Higher Marketing Budget
- Having Access To Better Base Pricing
- Having Access To Better Quality Data
- Having Access To Better SEO Positioning
- Having Access To Better Marketing Channels
Mr. New Broker, you were hired to be a part of what I call The Mom and Pop Network, which is just a group of random brokers who will resell for free (you pay for all of your expenses). So they might maintain a Mom and Pop Network of 2,000 brokers that bring in on average of 10 applications a year (20,000 apps) with 35% getting approved (7,000) and 30% closing (2,100) with an average funding per client of $30,000. This is $63 million in annual funding volume for the firm from this source alone.
A DIFFERENT APPROACH: THE PIKER APPROACH
So Mr. New Broker, how about instead of following the “rah rah” sales crowd, how about you join me over here on the Piker side and we set some goals on being solidly in the middle class instead?
- Going based on individual income, you are considered middle class in the US for the most part if from staying in an low/average cost of living area, you make over $40k a year (lower middle class), $50k – $60k a year (the middle of the middle class) or $70k – $85k (higher middle class).
- $50k – $60k a year in a low cost of living area will still allow you to live in a great quality Suburb, if you strategically manage your expenses with efficient budgeting and tax reduction strategies.
- You also want to be putting away let’s say $7,500 a year into your retirement/investment accounts. If you do this for 40 years from 25 – 65, with just a conservative 5% per year return, you will have over $1 million at age 65. At 65 you could put that $1 million principal into a long term CD paying let’s say 3% per year, opt to receive the interest every month, and get $30,000 a year. Then when you add in your Social Security payments of let’s say $20,000 a year, this now gives you $50,000 a year in spending power without even touching the $1 million principal.
IMPLEMENTING THE PIKER APPROACH
The first thing you want to do is make sure you stay in a low cost of living area, so if you are in a high cost of living area like NYC or LA, I would move immediately. Secondly, you would setup your virtual office (in the cloud) to include your telephone line, fax line, website, etc. Thirdly, you want to focus on doing market research on various market niche challenges where you can come in and creatively solve outstanding problems, for example, you might do some of the following:
- Find new solutions for niche industries that don’t qualify for most MCAs, but would like an MCA.
- Find new solutions for start-up companies seeking working capital.
- Analyze big data sources to find merchants in particular situations that you could address.
Map out a complete strategic business plan with sales forecast estimates, ROI estimates, and partner with companies that have the infrastructure to help deliver the solutions you laid out. Keep your credit clean and use No Interest Credit Card Promo Deals to creatively finance your marketing efforts.
FINAL WORD – AM I DREAMING TOO SMALL?
Am I dreaming too small? Shouldn’t I be up all night focused on how to be the next CAN Capital?
My issue with the “rah rah” sales speech is that they preach from the TOP of the ladder in terms of the extravagant income estimates ( $250k – $1 million per year), without providing any information to New Brokers on actual strategies, competencies, networks, and resources needed to ACTUALLY amass such levels of annual income. It doesn’t make any sense.
So my advice for all New Brokers is to be a PIKER, which is to establish yourself solidly in the middle class first, then once that’s done, you can look at ways to expand on your competencies, resources and networks to grow into the six figure income range.
Lenders Subject to Section 1071 of Dodd-Frank May Find Silver Lining in CFPB’s Roll Out of New HMDA Rules
October 23, 2015
Last week, the CFPB finalized its update to the reporting requirements of the Home Mortgage Disclosure Act (HMDA) regulations. Under the new rules, the CFPB expects that the number of non-depository institutions that will be required to report may increase by as much as 40 percent. This will lead to a sizable increase in the total number of records reported.
Given the breadth of the new rules and the additional compliance efforts they will require, the CFPB has set January 1, 2018 as the effective date of the new regulations. Given that the Bureau could have chosen January 1, 2017 as the effective date, the longer lead time is welcome news for many in the mortgage industry.
The longer lead time may also be positive news for small business lenders that will be subject to the new Small Business Data Collection rule required by the Dodd-Frank act. Section 1071 of the act requires the CFPB to issue implementing regulations. The Bureau has yet to begin its work on the new rule but some small business lenders have already voiced concerns about the costs of other regulations implemented pursuant to Dodd-Frank. They argue that these costs have already begun to restrict access to small business credit.
A well-timed roll out of the new data collection rule could reduce some of these costs. Having adequate time to develop and implement regulatory compliance procedures in a cost-effective manner will lessen the financial impact to small business lenders. This in turn will allow lenders to minimize the new rule’s impact on credit availability to small businesses.
Once the Small Business Data Collection rule is finalized, small business lenders should be given a sufficient period to adjust to the new requirements, just as the CPFB has done for mortgage lenders with the new HMDA rules. HMDA was enacted in 1975 and lenders have been subject its reporting rules for decades. Yet the increased reporting requirements of the revised rules more than justify a two year lead period.
A similar lead period is just as, if not more important for the small business lenders that will be subject to the new data collection rule. The Dodd-Frank act was enacted just five years ago and requires reporting about small business lending that has never been required before. Lenders will need adequate time to develop the new systems required to meet their reporting obligations.
The CFPB’s conscientious roll out of the HMDA revisions is a rare regulatory silver lining. Let’s hope small business lenders get one too.
Did Your Deal Slip Out The Back Door?
October 22, 2015Gil Zapata found himself in the right place at the right time to catch someone red-handed at backdooring, the practice of stealing an alternative-funding deal and cheating the original ISO or broker out of the commission.
It seems that Zapata, who’s president and CEO of Miami-based Lendinero, was sitting in a client’s office about three years ago when the phone rang. The call came from an employee of a direct funder that had turned down Zapata’s deal to fund the merchant. Now, the employee was offering funding from another source without notifying Zapata. Fortunately, the merchant didn’t accept the surreptitious funding, Zapata said. “There’s a huge loyalty factor with maybe 50 percent of the clients an ISO has under their belt,” he noted.
But many merchants sign up for backdoor deals out of ignorance, callousness or desperation, and the problem seemed to gather momentum in the first quarter of this year, according to Cheryl Tibbs, owner of Douglasville, Ga.-based One Stop Funding LLC.
When Tibbs found herself the victim of backdooring a few months ago, the merchant’s loyalty to the ISO prevailed once again. “Because of the relationship we had with the merchant, he let us know and didn’t go along with it,” she said.
Both cases fall into one of the categories of backdooring. This type usually occurs when an ISO or broker submits a deal and the funder declines it, said John Tucker, managing member of 1st Capital Loans LLC in Troy, Mich. An employee of the funder then takes the file and offers it to other funders, often those that accept higher-risk deals. The funder’s employee conveniently forgets to include the originator in the commission, Tucker said. Meanwhile, the employee’s boss might know nothing of the post-denial goings-on.
In another variety of backdooring, ISOs or brokers deceptively claim that they’re direct funders. They solicit deals in online forums, by email message or over the phone, and then they offer the deals to companies that really do function as direct funders. In many cases, the fake funders pocket the entire commission, Tibbs said.
“I’m bombarded with probably 10 emails every day of the week from a supposedly new lender that wants my business, and they’re really just a broker shop like we are,” she maintained.
To guard against both kinds of backdooring, ISOs and brokers should know their funding sources, everyone interviewed for this article suggested. “What we’ve done is tighten up on how we do submissions,” Tibbs said. “We’re very particular about which lending platforms we use.” Although her company has contracts with 60 to 70 funders, it uses only three or four regularly, she noted. “Shotgunning” deals to lots of potential funders invites backdooring, Tibbs said.
Tibbs also scrutinizes deals to determine which funder would provide the best fit. That way, fewer deals are declined and thus fewer became candidates for backdooring by unscrupulous funder employees. “We have a system. We scrub it. We do the numbers,” she said of her company’s close attention to underwriting, which helps determine what funders would accept the deal.
Her company also keeps a watchful eye on every deal’s progress. “We know exactly where the deal is, and who’s looked at it,” she said. It also helps to insist upon having a dedicated account rep, Tibbs emphasized. That way she can form a relationship that discourages backdooring.
Perhaps the most basic safeguard comes with determining that the company claiming to fund the deal really has the capital to do it and isn’t just shopping the file to real funders. Tucker advised using Internet searches to turn up evidence that the supposed funder really isn’t another ISO or broker. Searches should reveal press releases on equity rounds that direct funders have received, for example. If open-ended Web searches don’t produce satisfying results, check state registrations, he said.
ISOs and brokers can also prevent backdooring by avoiding sub-agent status, Tucker cautioned. “I don’t know why guys would want to be a broker to a broker,” who could steal commissions, he observed. One exception to the sub-agent problem comes with agents who are just entering the business and are receiving training from a broker, Tucker said. In another exception, sub-agents may find another broker has competitive advantages that aren’t easy to duplicate – like a $20,000 monthly marketing budget to generate sales leads, he continued. Or perhaps the other broker gets low base pricing from a funder that allows for reduced factor rates without sacrificing part of the commission.
Brokers and ISOs can also protect themselves from backdooring – and just in general – by maintaining their relationships with merchants, even those who’ve been denied funding from four or five sources, Zapata said. An increase in revenue or jump in credit worthiness can qualify them a few months later, and other brokers or funders may be soliciting them in the meantime, he said.
Then there’s the possibility of collective action against backdooring. An association or some other entity representing the industry could compile a database of companies accused of backdooring, Tibbs said. “Just as there’s a black list of merchants that have been red-flagged from getting merchant cash advances, there should be some type of database of funders that frequently backdoor deals – that way, ISOs know to stay away from them,” she maintained.
The database would also prompt owners and managers of direct-funding companies to crack down on employees who use nefarious tactics, Tibbs continued, because the heads of companies would want to stay off the list.
But finding the financial support and staffing for such a database might prove difficult, according to Tucker. He noted that the card brands, such as Visa and MasterCard, maintain a match list of merchants barred from accepting credit cards. But the card brands have vast resources and a keen interest in the list, he said.
Requiring funders to pay to register might discourage ISOs and brokers from posing as funders, Tibbs suggested. But that, too, would require an infrastructure and would demand financial investment, sources said.
Still, everyone interviewed agreed that the industry should police itself with regard to backdooring instead of inviting federal regulators to enter the fray. “The federal government will mess with pricing without understanding every merchant can’t get low factor rates because there’s too much risk on the deal,” Tucker warned.
Perhaps extending the protection period in funding applications would help guard ISOs and brokers, Zapata said. But he cautioned that making the time period too long could interfere with the free market.
Keeping backdooring in perspective also makes sense, Zapata said, noting that merchants often receive multiple funding offers because everyone in the industry is basing phone calls on the same Uniform Commercial Code filings regarding distressed merchants.
Alternative Business Funding’s Decade Club
October 22, 2015
The working capital business is a very different animal now than it was a decade or so ago when many of today’s established players were just starting out.
“At that time, the industry was a bunch of cowboys. It was an opportunistic industry of very small players,” says Andy Reiser, chairman and chief executive of Strategic Funding Source Inc., a New York-based alternative funder that’s been in business since 2006. “The industry has gone from this cottage industry to a professionally managed industry.”
Indeed, the alternative funding industry for small businesses has grown by leaps and bounds over the past decade. To put it in perspective, more than $11 billion out of a total $150 billion in profits is at risk to leave the banking system over the next five plus years to marketplace lenders, according to a March research report by Goldman Sachs. The proliferation of non-bank funders has taken such a huge toll on traditional lenders that in his annual letter to shareholders, J.P. Morgan Chase & Co. chief executive officer Jamie Dimon warned that “Silicon Valley is coming” and that online lenders in particular “are very good at reducing the ‘pain points’ in that they can make loans in minutes, which might take banks weeks.”
The burgeoning growth of alternative providers is certainly driving banks to rethink how they do business. But increased competition is also having a profound effect on more seasoned alternative funders as well. One of the latest threats to their livelihood is from fintech companies, like Lendio and Fundera,for example, that are using technology to drive efficiency and gaining market share with small businesses in the process.
“Established lenders who want to effectively compete against the new entrants will need to automate as much decisioning as possible, diversify acquisition sources and ensure sufficient growth capital as a means to capture as much market share as possible over the next 12 to 18 months,” says Kim Anderson, chief executive of Longitude Partners, a Tampa-based strategy consulting firm for specialty finance firms.
Of course, there is truth to the adage that age breeds wisdom. Established players understand the market, have a proven track record and have years of data to back up their underwriting decisions. At the same time, however, experience isn’t the only factor that can ensure a company will continue to thrive over the long haul.
WORKING TOWARD THE FUTURE
Indeed, established players have a strong understanding of what they are up against—that they can’t afford to live in the glory of the past if they want to survive far into the future.
“With every business you have to reinvent yourself all the time. That’s what a successful business is about,” says Reiser of Strategic Funding. “You see so many businesses over the years that didn’t reinvent themselves, and that’s why they’re not around.”
Strategic Funding has gone through a number of changes since Reiser, a former investment banker, founded it with six employees. The company, which has grown to around 165 employees, now has regional offices in Virginia, Washington and Florida and has funded roughly $1 billion in loans and cash advances for small to mid-sized businesses since its inception.
One of the ways Strategic Funding has tried to distinguish itself is through its Colonial Funding Network, which was launched in early 2009. CFN is Strategic Funding’s secure servicing platform which enables other companies who provide merchant cash advances, business loans and factoring to “white label” Strategic Funding’s technology and reporting systems to operate their businesses.
“When you’re in a commodity-driven business, you have to find something to differentiate yourself,” Reiser says.
FINDING WAYS TO BE DIFFERENT
That’s exactly what Stephen Sheinbaum, founder of Bizfi (formerly Merchant Cash and Capital) in New York, has tried to do over the years. When the company was founded in 2005, it was solely a funding business. But over the years, it has grown to around 170 employees and has become multi-faceted, adding a greater amount of technology and a direct sales force. Since inception, the Bizfi family of companies has originated more than $1.2 billion in funding to about 24,000 business owners.
Earlier this year, the company launched Bizfi, a connected online marketplace designed specifically to help small businesses compare funding options from different sources of capital and get funded within days. Current lenders on the platform include Fundation, OnDeck, Funding Circle, CAN Capital, SBA lender SmartBiz, as well as financing from Bizfi itself. Financing options on the platform include short-term funding, equipment financing, A/R financing, SBA loans and medium term loans.
Sheinbaum credits newer entrants for continually coming up with new technology that’s better and faster and keeping more established funders on their toes.
“If you don’t adapt, you die,” he says. “Change is the one constant that you face as a business owner.”
David Goldin, chief executive of Capify, a New York-based funder, has a similar outlook, noting that the moment his company comes out with a new idea, it has to come up with another one. “If you’re not constantly innovating you’re in trouble,” he says. “It’s a 24/7 global job.”
Capify, which was known as AmeriMerchant until July, was founded by Goldin in 2002 as a credit card processing ISO. In 2003, the company began focusing all of its efforts on merchant cash advances. Four years later, the company made its first international foray by opening an office in Toronto. The company continued to expand its international presence by opening up offices in the United Kingdom and Australia in 2008. The company now has more than 200 employees globally and hopes to be around 300 or more in the next 12 months, Goldin says. The company has funded about $500 million in business loans and MCAs to date, adjusted for currency rates.
THE CULTURE OF CHANGE
Five or six years ago, Capify’s main competitors were other MCA companies. Now the competition primarily comes from fintech players, and to keep pace Capify has made certain changes in the way it operates. From a human resources standpoint, for instance, Capify switched from business casual attire to casual dress in the office. The company has also been doing more employee-bonding events to make sure morale remains high as new people join the ranks. “We’ve been in hyper-growth mode,” he says.
CAN Capital in New York, another player in the alternative small business finance space with many years of experience under its belt, has also grown significantly (and changed its name several times) since its inception in 1998. The company which began with a handful of employees now has about 450 and has offices in NYC, Georgia, Salt Lake City and Costa Rica. For the first 13 years, the company focused mostly on MCA. Now its business loan product accounts for a larger chunk of its origination dollars.
This year, the company reached the significant milestone of providing small businesses with access to more than $5 billion of working capital, more than any other company in the space. To date, CAN Capital has facilitated the funding of more than 160,000 small businesses in more than 540 unique industries.
Throughout its metamorphosis to what it is today, the company has put into place more formalized processes and procedures. At the same time, the company has tried very hard to maintain its entrepreneurial spirit, says Daniel DeMeo, chief executive of CAN Capital.
One of the challenges established companies face as they grow is to not become so rule-driven that they lose their ability to be flexible. After all, you still need to take calculated risk in order to realize your full potential, he explains. “It’s about accepting failure and stretching and testing enough that there are more wins than there are losses,” says DeMeo who joined the company in March 2010.
ADVICE FOR NEWCOMERS
As the industry continues to grow and new alternative funders enter the marketplace, experience provides a comfort level for many established players.
“The benefit we have that newcomers don’t have is 10 years of data and an understanding of what works and what doesn’t work,” says Reiser of Strategic Funding. With the benefit of experience, Reiser says his company is in a better position to make smarter underwriting decisions. “There are many industries we funded years back that we wouldn’t touch today for a variety of reasons,” he says.
Experienced players like to see themselves as role models for new entrants and say newcomers can learn a lot from their collective experiences, both good and bad. Noting the power of hindsight, Reiser of Strategic Funding strongly advises newcomers to look at what made others in the business successful and internalize these best practices.
One of the dangers he sees is with new companies who think their technology is the key to long-term survival. “Technology alone won’t do it because that too will become a commodity in time,” he says.
Over the years Strategic Funding has learned that as important as technology is, the human touch is also a crucial element in the underwriting process. For example, the last but critical step of the underwriting process at Strategic Funding is a recorded funding call. All of the data may point to the idea that a particular would-be borrower should be financed. But on the call, Strategic Funding’s underwriting team may get a bad vibe and therefore decide not to go forward.
“We look at the data as a tool to help us make decisions. But it’s not the absolute answer,” Reiser says. “We are a combination of human insight and technology. I think in business you need human insight.”
Seasoned alternative funding companies also say that newbies need to implement strong underwritingcontrols that will enable them to weather both up and down markets.
The vast majority of newcomers have never experienced a downturn like the 2008 Financial Crisis, which is where seasoned alternative financing companies say they have a leg up. Until you’ve lived through down cycles, you’re not as focused as protecting against the next one, notes Sheinbaum of Bizfi. “Every 10 years or 15 years or so, there seems to be a systemic crisis. It passes. You just have to be ready for it,” he says.
Goldin of Capify believes that many of today’s start-ups don’t understand underwriting and are throwing money at every business that comes their way instead of taking a more cautious approach. As a funder that has lived through a down market cycle, he’s more circumspect about long-term risk.
One of the biggest problems he sees is funders who write paper that goes two or three years out. His company is only willing to go out a maximum of 15 months for its loan product, which he believes is s a more prudent approach. He questions what will happen when the economy turns south—as it eventually will—and funders are stuck with long dated receivables. “You’re done. You’re dead. You can’t save those boats. They are too far out to sea,” Goldin says.
Having a solid capital base is also a key to long-term success, according to veteran funders. Many of the upstarts don’t have an established track record and need to raise equity capital just to stay afloat—an obstacle many long-time funders have already overcome.
Goldin of Capify believes that over time consolidation will swallow up many of the newbies who don’t have a good handle on their business. Hethinks these companies will eventually be shuttered by margin compression and defaults. “It can’t last like this forever,” he says.
In the meantime, competition for small business customers continues to be fierce, which in turn helps keep seasoned players focused on being at the top of their game. Getting too comfortable or complacent isn’t the answer, notes DeMeo of CAN Capital. Instead, established funders should seek to better understand the competition and hopefully surpass it. “Competition should make you stronger if you react to it properly,” he says.
For Lending, It Might as Well be 1997
October 9, 2015
If you did any business with OnDeck between 2008 and 2014, you probably spoke with or at least knew of Sherif Hassan. His last position with the company before he left in May, 2014 was the Vice President of Major Markets. About six months later OnDeck went public and Hassan, one of the company’s earliest employees, was not there to celebrate it.
That’s because Hassan was busy working on something new, Herio Capital, a provider of working capital to small businesses that just recently surpassed more than $10 million in funding since inception.
Herio teamed up with Orchard on Thursday evening, September 8th to present The Future of Credit 2015.
“This is e-commerce in 1997 right now for lending,” said Jason Jones, a partner in Lend Academy who moderated the event’s panel. And Hassan, who is now easily considered an industry veteran, explained what set his new company apart.
It’s apparently not all algorithms when it comes to small business either. “We’re using our data to do all the heavy lifting and we’re using our people to do all the thinking,” Hassan said. And while they can take a deal from start to finish in four hours, they still have a human credit committee process. Other industry leaders have reported using similar approaches. “I like eyes on a deal,” said Orion First Financial CEO David Schaefer back in June at the AltLend conference. But for Herio, APIs and data allow the company to do a lot of filtering before anyone even touches the deal. Yodlee’s bank verification product reportedly plays a big role in being able to do that and Terry McKeown, Yodlee’s Data Practice Manager was coincidentally also on the panel.
Next to Hassan sat Matt Burton, the CEO of Orchard Platform, who was previously the 7th employee of Admeld, a company that was acquired by Google in 2011 for $400 million. His co-founder, Angela Ceresnie, is a former VP of Risk Management at Citibank and Director of Risk Management at American Express.
Speaking on the availability of decisioning tools, Burton said “there’s never been a better time to enter the space.” That may seem counter-intuitive since the frenzy of M&A activity and capital raising over the last couple years has had some players worried there’s a bubble brewing, but studies show they may just be filling a growing gap. Small business lending is actually shrinking in the traditional banking sector in part because of Dodd-Frank.
“Community banks are being destroyed,” said Burton. “All the products they used to be able to provide have been taken away.” That’s not just his opinion either. Three weeks ago, the heads of the Independent Community Bankers of America and National Association of Federal Credit Unions offered testimony to the House Small Business Committee that demonstrated the carnage that regulations were having on their industry. During that hearing, Subcommittee Chairman Tom Rice said, “the burdens created by Dodd-Frank are causing many small financial institutions to merge with larger entities or shut their doors completely, resulting in far fewer options where there were already not many options to choose from.”
So today’s online lending industry might seem really big but it’s relatively small when compared to the shoes they’re trying to fill. Case in point, nearly 10% of the 104 companies that responded to the Treasury RFI on marketplace lending attended Herio & Orchard’s three hour event in New York City. That was determined by a quick show of hands from the audience when asked by Manatt Phelps and Phillips attorney Brian Korn. The industry didn’t seem so big all the sudden.
Korn, making a lawyer joke, likened the Treasury RFI to the first discovery request in a lawsuit, but argued the Treasury Department is not really in a position to be the regulator in this space. He believed their motivation came down to, are we doing enough for small business and are we doing enough to protect consumers?
A more serious issue was the Madden v. Midland decision which has put National Bank Act preemption in uncertain legal limbo. For those still unsure what preemption means, Korn offered an example of a 16-year old obtaining a driver’s license in one state and driving to another state where the minimum driving age is 17. The driver can legally export their home state’s minimum driving age and drive in a state where the age limit is higher. It’s that model which is uncertain now thanks to Madden v. Midland, but with interest rates not with drivers’ licenses.
So what’s the Future of Credit as the event was so aptly named? One could argue that whatever the future is, Orchard and Herio will likely have a place in it. The panelists mostly agreed that while some online lenders might be at risk in the next credit cycle, the online lending concept is here to stay. That’s because the borrowers themselves have changed. Nobody’s going to want to walk into a bank anymore and fill out paperwork after this, they argued.
If Lend Academy’s Jason Jones was right about this being like e-commerce in 1997, then it’s certainly incredible to think that the future of credit is something we can hardly even imagine yet.
Stop Saying Alternative Lending Isn’t Regulated
October 7, 2015
I cringe every time I hear someone say that alternative business lending or merchant cash advances are completely unregulated. It’s true as a generality that there are fewer restrictions on commercial transactions than there are on consumer transactions, but fewer doesn’t mean none. If you are operating your funding business with the impression that it’s all unregulated, then you’re probably doing it wrong and should hire a lawyer (or several) immediately.
Things like interest rates, truth in advertising, and the banking system are already regulated. Who can invest and what has to be disclosed in an investment is regulated. Email marketing and telemarketing are regulated. The ACH network is regulated. Credit card processors and payment networks are regulated. Credit reporting and the process of declining someone for credit is regulated.
As de-banked as merchant cash advances and non-bank loans look, they all go through the traditional banking system and still obviously operate under state and federal laws just like everyone else. That means compliance with the OCC, OFAC, FED, FCC, FTC, SEC, IRS, state regulatory bodies and more. So when critics say there are no regulations in place for these products, one has to wonder what the heck they’re talking about.
In the context of merchant cash advances, there’s a pervasive myth that the process of purchasing future assets is really all just a loophole to charge Annual Percentage Rates (APRs) in excess of state usury caps. I can’t speak on behalf of all purchase agreements in general since every financial company structures theirs differently, but in a true purchase of future assets, it is literally impossible to calculate an APR. It’s not just a matter omitting the word loan from the agreement either, it’s the uncertainty of the seller’s future sales to which the agreement ultimately hinges upon (among other factors), that make such a calculation indeterminate even if one wanted to generate one just for comparison’s sake. These are purely commercial transactions that fall under the umbrella of factoring and they have no basis for comparison with loans. Oh, and they’re not new.
According to wikipedia, “factoring’s origins lie in the financing of trade, particularly international trade. It is said that factoring originated with ancient Mesopotamian culture, with rules of factoring preserved in the Code of Hammurabi [about 4,000 years ago]. Factoring as a fact of business life was underway in England prior to 1400, and it came to America with the Pilgrims, around 1620.”
While the subtle nuances of merchant cash advances may only be a couple decades old, the system on which they’re based precedes the arrival of Jesus. That makes the concept understandably new… if you’re a Stegosaurus.
But here in modern times, the courts in many states have reviewed these agreements and generally respect the arrangements when they are well-defined and compliant with state and federal laws. There’s that regulation thing again…
For funding companies that deal in actual loans, the industry is heavily regulated. The non-bank lenders we hear about on a daily basis have to acquire state licenses where applicable or forge partnerships with chartered banks to create a relationship in which the banks themselves are the ones that actually originate the loans. That means despite the excitement and fanfare of tech-based disruption, many of these lenders are really just servicing loans made by traditional banks. Kind of a bummer, isn’t it?
And when it comes to sales tactics, it’s important to remember that deceptive advertising is already illegal.
The regulation and compliance hurdles in FinTech are cumbersome even if some of the companies involved in the business appear scrappy and amateurish. According to a report that was recently published by accounting firm KPMG, titled Value-Based Compliance: A Marketplace Lending Call to Action, they offer a non-exhaustive list of federal legislation and networks:
- Anti-Money Laundering (AML)
- Bank Secrecy Act (BSA)
- Blue Sky Laws
- Card Act (CARD)
- Dodd-Frank Wall Street Reform and Consumer Protection Act
- Electronic Funds Transfer Act (EFTA)
- Electronic Signatures in Global and National Commerce Act (ESIGN)
- Equal Credit Opportunity Act (ECOA)
- Fair and Accurate Transactions Act (FACTA)
- Fair Credit Reporting Act (FCRA)
- Fair Debt Collection Practices Act (FDCPA)
- Fair Housing Act (FHAct)
- Financial Crimes Enforcement Network (FinCEN)
- Gramm-Leach Bliley Act (GLBA)
- Know Your Customer (KYC)
- Service Member Civil Relief Act (SCRA)
- Truth in Lending Act (TILA)
- Unfair, Deceptive or Abusive Acts or Practices (UDAAP)
- USA Patriot Act
Completely unregulated you say? You are sadly mistaken. =\
