To Niche or Not to Niche, That Is the Fintech Question
October 1, 2019
A store that sells only cufflinks. A restaurant that serves nothing but grilled cheese sandwiches. A tiny stand where you buy only artisanal salt. In the not-too-distant past, these kinds of shopping and dining options were almost unheard of. Readers of a certain age will remember that if you wanted cufflinks, you went to an all-in-one department store like Macy’s. If you had a hankering for a grilled cheese sandwich, you ordered one off the kids menu at TGI Fridays. And if you wanted fancy salt, you probably learned how to make it yourself. But as times changed, so did consumer behavior, and industries adapted; these days a consumer can find a singular shopping or dining experience for almost any bespoke want or need (entirely egg-based restaurants—they’re a thing). These specialty places have done well by a) focusing on a niche product or service, b) applying expertise to something they believe in and c) executing and perfecting it daily.
In the past decade, the fintech industry has followed this model to a tee. Whether it was B2B or B2C, fintech startups broke the banking business into narrower segments, offering singular niche services for various finance needs, e.g. credit card refinancing, small business loans, student loans, P2P payments, mortgages and more. From this model, big banks became the TGI Fridays of financial offerings (where you go to experience a full spread of financial services), and fintech platforms became the speciality grilled cheese shops (where you go to get the one thing you really crave).
Fintech Niches Fill Big Gaps
Many startups went niche not only because it was a business model that worked, but because the legacy banking industry model was out of date and there was room for true disruption. With these opportunities, niche fintechs could hone in on services that fulfilled singular needs, and they could do it with a focus, passion and dedicated customer service that most general banks couldn’t provide—and the results of this have been mostly positive. Globally, financial inclusion of unbanked people has improved. According to The World Bank, 69 percent of adults or 3.8 billion people now have an account at a bank or mobile money provider. In the U.S., niche fintechs made it easier for small businesses to get a loan post-recession. A host of online lenders stepped in to fill the gap, understanding that without access to relevant capital, small businesses struggle, which ultimately affects economic growth, jobs and inflation.
Can Fintechs Stand up to Tech Giants?
Tech giants thrive when users treat their platforms/offerings as a one-stop shop, something that is already commonplace in China, where millions of people use Tencent’s WeChat app to do almost everything—pay bills, book medical appointments, chat, play games, read news and pay for meals. Although this is not at the same level of activity in the U.S., it is a trend likely to continue.
The winds have been shifting as fintech companies question whether it makes sense to stay true to their niche or offer additional services as a path to scalability and profitability. By taking the latter path, former niche startups are now either a) building out and offering more financial services or b) partnering with more established companies/banks. Some recent examples include eBay and Square Capital, Venmo and Uber and KeyBank and HelloWallet. These partnerships seem to be a win-win—for the niche companies hoping to solve for scale and revenue stream issues, and for the established companies looking to offer complimentary services their core customers already use—but they also have fintech startups standing at a crossroads. Will working a niche be sustainable in 2020 and beyond, or is becoming a jack of all trades the only means of survival?
Beware of Diluting the Brand
For starters, the only means of survival for any fintech company is to solidly define what the company brand is and what it stands for. For example, many small business lenders are deeply passionate about fueling the American dream through helping business owners unlock their financial potential. Supporting small business is key to our country’s economic fabric. Dynamism and the ability to recover from an economic downturn are both dependent on startups’ ability to grow quickly, and in most cases, the only way for them to do so is through access to capital. For a fintech lender to become a trusted brand to small business owners, it must remain devoted to them as a company that has the financial wellbeing and vitality of small businesses in mind. This means facilitating the right loan for them, right when they need it.
The key for fintech companies is to be careful about diluting the brand. When companies stray too far from what they are passionate about, their core audiences suffer. Tech giants enter new spaces every day, whether from R&D or acquisitions. A strong brand (and the loyalty its customers have to it) will not only insulate a fintech company from the tech giant threat, but make its mission and voice stronger by comparison. Think about this the next time you are eating at In-N-Out Burger (sorry, East Coasters!). The humble hamburger shop became a cultural phenomenon through its razor-sharp focus on simplicity, quality and consistency.
Always Consider the Human Factor
Innovation and automation are both critical to survival in the fintech space. But how much tech can a fintech leverage in its solutions to avoid becoming too niche? The answer lies in understanding the core customers’ needs and how much technology can be used to fulfill those needs. For an e-wallet app, the key needs of customers are frictionless payments and transfers happening in real time; it is not a solution (when it’s working) that needs a lot of human interaction. A fintech company such as this can use technology and machine learning to automate most of its services.
Conversely, the human factor is still a huge part of the equation in some fintech services. For example, a person’s livelihood is at stake when a small business takes on a loan or another capital solution for its growth needs. This is a very personal and consequential decision for a business owner. In fact, in the majority of cases, they don’t want to rely solely on a technology-powered platform to deliver the most appropriate loan options for their needs, not to mention address their specific concerns and questions. A fintech lender can leverage technology at every touchpoint to optimize the application and loan approval process; but ultimately, many business owners will desire interaction with a live representative, not a chatbot. The human factor is crucial in business lending, and something that could become lost as a result of brand dilution. While scalability is important, customer service is equally so.
In the end, the decision to offer niche services or to go wide will depend on what’s at the core of a fintech company. Indeed, the pressures to scale, grow and earn returns for investors are huge for any business, but decision-makers must keep their perspective on the market they serve and the problems they solve best. If expanded offerings and partnerships with other service providers enhance your brand and what it stands for, then this approach makes sense for growth and customer satisfaction. If not, then serving up the best grilled cheese sandwiches around, to the folks who really crave them, may well be the best path.
Snapshot On Australia: Growth In The Making
August 30, 2019
The Australian alternative lending market continues to gain momentum, bolstered in part by increased awareness, heightened competition and growing dissatisfaction with the status quo.
Indeed, there’s been significant growth in the few years since AltFinanceDaily first wrote about the nascent alternative lending business down under. Notably, Australia’s alternative funding volume surpassed $1.14 billion in 2017, up 88 percent from $609.59 million in 2016, according to the latest data available from KPMG research. It’s the largest country in terms of total alternative finance market volume in the Asia Pacific region, excluding China, according to KPMG.
To be sure, the Australian market is still relatively small—at least compared with the U.S. Digging deeper, the largest share of market volume in 2017—the latest data available—came from balance sheet business lending, accounting for more than $574 million, according to KPMG. P2P marketplace consumer lending had the second largest market volume at $256 million. Invoice trading was the next largest segment of the Australian alternative finance market, accounting for $142.65 million, according to the KPMG report.
Its small size notwithstanding, what makes the Australian market particularly interesting is the potential promise it holds for the companies already established there and the opportunities it may offer to new entrants that find ways to successfully compete in the market.
Certainly alternative lending opportunities in Australia are growing, as awareness increases and the desire by consumers and businesses for favorable rates and faster service intensifies. The Australian alternative lending market is similar to Canada in that a small number of large banks dominate the market both in terms of consumer lending and small business lending. But, like in Canada, alternative lenders are gaining ground amid a changing customer mindset that values speed, favorable rates and a digital experience.
Equifax estimates that alternative finance volume in Australia is now growing at about 10 percent to 15 percent per year; that compares to a decline of approximately 20 percent for some major traditional lenders in terms of credit growth, says Moses Samaha, executive general manager for Equifax in Sydney. This presents an opportunity for alternative lenders to serve parts of the market the banks don’t want and those that are more attuned to a digital experience.
Even so, challenges persist. For instance, digital disruptors are still working on gaining brand awareness, and the market is only so big to be able to accommodate a certain number of alternative players. Time will time whether there will be consolidation among alternative lenders and more bank partnerships, which haven’t been so successful to date. “It doesn’t feel like they are as active as they were announced to be,” Samaha says.
At present, the Australian market consists of a few dozen alternative lenders pitted against four major banks. RateSetter, SocietyOne and Wisr are among the largest alternative players in the consumer lending space. On the small business side, Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap are some of the leading companies. PayPal Working Capital also has a growing presence in the Australian small business lending market.
New lenders continue to eye the Australian market for entry, but it’s not an easy market to crack, according to industry participants. The market consists of mostly home-grown players and that’s not expected to change drastically. (Capify, OnDeck and Berlin-based Spotcap are notable exceptions. Another U.S. major player, Kabbage, previously provided its technology to Australia’s Kikka Capital, but that agreement is no longer in force.)
There can be a steep learning curve when it comes to outsiders doing business in Australia. What’s more, there’s no longer the first-to-market advantage that existed a decade or so ago. It’s also a relatively limited market in terms of size, which can be off-putting. Australia has a population of around 25 million, making it less populated than the state of California, with an estimated 39.9 million residents.
Still, for alternative players that are able to successfully navigate the challenges the Australian market presents, there’s ample opportunity to grab market share away from traditional players—similar to the pattern that’s emerged elsewhere around the globe.
Take consumer lending, for example. The unsecured consumer lending market in Australia sits at about $70 billion, with the large banks occupying maybe a 90 percent share of that, says Mathew Lu, chief operating officer of Wisr (previously known as DirectMoney Limited). Compared with other markets such as U.K. and the U.S., who went through a similar journey around a decade ago, “Australia is probably three or four years into that same journey of growth. It’s shifting and changing,” he says.
Alternative lenders have made strides in undercutting the large banks by offering generally lower rates and typically faster loan times. Unfavorable press related to bank lending practices has also benefited alternative lenders. Lu refers to these conditions as “a perfect storm” for growth.
Wisr, for instance, saw loan origination volume spike 409 percent in fiscal year 2018. The company secured $75 million in loan funding agreements last year and boasts more than 80,000 customers, according to a company presentation.
Marketplace lender, SocietyOne, which in March reached $600 million in loan originations, is another example of an alternative lender that has benefited from the momentum. The company— celebrating its 7th anniversary this summer—is hoping to reach $1 billion in loans by 2020, according to its website.
RateSetter—another major player in this space—has also experienced significant growth since launching in Australia in 2014, and is now funding over $20 million in loans each month, according to its website. In April, the company soared past $500 million in loans funded and in May it saw a record number of new investors register. The company has more than 15,000 registered investors by its own account.
One question for the future is whether the consumer alternative lending space in Australia will ultimately be too crowded amid a spate of new entrants. Wisr’s Lu says “there’s a big question mark” regarding how many alternative lenders the market can sustain. “Will there be a level of consolidation or amalgamation? These are questions ahead of us,” he says.
For its part, alternative lending to small businesses is also a growing force within Australia. As a testament to the development of this market, in June 2018, a group of Australia’s leading online small business lenders released a Code of Lending Practice, a voluntary code designed to promote fair terms and customer protections. Currently, the Code only covers unsecured loans to small businesses. Signatories include Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap.
Capify—an early entrant to Australia—has been pursuing businesses there since 2008. The company, which integrated its U.S. business in 2017 to Strategic Funding Source (now called Kapitus) is now operating only in Australia and the U.K. In Australia, it has executed more than 7,500 business financing transactions for Australian businesses and has more than 50 staff members in its Australian offices.
The company recently closed a deal with Goldman Sachs for a $95 million line of credit for growth in Australia and the U.K., which includes building out its broker program to increase distribution and technology investment.
David Goldin, the company’s chief executive, says Capify is hoping to grow its Australian business between 25 percent and 30 percent in 2019. The company is looking at M&A activity as well as organic growth.
Since Capify has been in the market, he has seen a number of new entrants—some more successful than others. One concern Goldin has is the lack of experience by some of these competitors. Many aren’t pricing the risk properly and not underwriting prudently to be able to weather a downturn, he says. They are so new, he questions whether they have the expertise to be able to survive a downturn given what he characterizes as pricing and underwriting missteps.
“You can’t go out 24 months on a 1.25 factor rate – that’s crazy,” he says, referring to some contracts he’s seen. “I’ve seen this movie in the U.S. before and it doesn’t end well.”
Meanwhile, competition has driven down prices and made moving quickly on potential leads more of a necessity. When leads come in today, if you’re not on the phone in 30 minutes, you could lose it to a competitor, he says.
While the small business market is an enticing one for alternative lenders, raising awareness of their offerings continues to be a challenge.
“The small business market is fragmented and raising awareness is expensive,” says Beau Bertoli, co-founder and co-chief executive of Prospa, another prominent small business lender in Australia. “There hasn’t been much innovation in small business banking, but many Australians still don’t think of switching from banks and traditional lenders,” he says.
That said, more small businesses are turning to alternative lenders and these companies say they expect growth to increase over time. Recent research commissioned by OnDeck found that 22 percent of small and medium-sized businesses would consider an online lender, up from 11 percent in the past. This could be buoyed further by the introduction of Open Banking in Australia, which was set to be introduced in Australia in 2019, but this was pushed back to early 2020.
“We look forward to the introduction of Open Banking in Australia as it should allow lenders to use incremental data points to improve risk modeling, and increase competition in the SME lending space, ultimately providing SMEs with improved access to cashflow solutions to grow and run their businesses,” says Cameron Poolman, chief executive of OnDeck in Australia.
Bertoli of Prospa, which recently listed on the Australian Stock Exchange, says the Australian alternative lending market will also benefit from strong support from industry and government to increase competition and improve consumer and small business outcomes. The government recently established a $2 billion Australian Business Securitisation Fund, which is a huge win for small business, he says, that will ultimately make the finance available to small business owners more affordable by lowering the wholesale cost of funds for alternative lenders. “We expect this will boost credibility and consideration of alternative lenders among small business owners,” he says.
Declining property values is another factor helping alternative lending. “In November 2018 we saw the largest annual fall in property prices in Australia since the global financial crisis in 2009,” says Simon Keast, managing director of Spotcap Australia and New Zealand.
“As property prices decline, business owners find it more difficult to use their home as loan security and as such, turn to alternative lenders such as Spotcap that can provide them with unsecured loans for their business,” he says. What’s more, the SME Growth Index in March showed for the first time that business owners are almost as likely to turn to an alternative lender as they are to their main bank to fund growth, says.
Overall, the market opportunity for alternative lending to small businesses is compelling, says Bertoli of Prospa. “We estimate the potential market for small business lending in Australia is more than $20 billion per annum and we’ve penetrated only about 2 percent of the market so far. There are 2.3 million small businesses in Australia, and they’re crying out for capital,” he says.
Keast of Spotcap says he expects to see more banks and non-financial enterprises looking to leverage the technology fintech lenders have built to provide swift and digital lending products to small businesses. He offers the example of a partnership Spotcap, a German-based company, has with an Austrian Bank to provide same-day finance to SMEs in Austria as an example of the types of partnerships the company could also seek in Australia. “We have already partnered with an Austrian Bank that is leveraging our lending platform to provide same-day finance to SMEs in Austria, and there is plenty of interest for similar partnerships on the ground here,” he says.
OnDeck, meanwhile, expects to see a shake-out within the alternative finance sector, which will result in a smaller number of bigger players, with the ability to scale and serve multiple customers with a variety of products, according to Poolman, the company’s chief executive.
For his part, Goldin of Capify is bullish on the Australian small business market, but he cautions others that it’s not a gold rush type of place where everyone who comes in can make money.
“The state of California has more opportunity than the entire continent of Australia,” he says.
Born To Borrow
August 26, 2019
Consumer debt has surpassed $4 trillion for the first time, and it’s continuing its ascent into the stratosphere. It’s getting big enough to trigger the next recession, and financial education isn’t changing the underlying consumer behavior.
Personal loan balances shot up $21 billion last year to close 2018 at a record high of $138 billion, according to a TransUnion Industry Insights Report. The average unsecured personal loan debt per borrower was $8,402 as of the end of last year, TransUnion says.
Much of the increase in consumer debt has emerged with the rise of fintechs— such as Personal Capital, Lending Club, Kabbage and Wealthfront—notes Rutger van Faassen, vice president of consumer lending at a U.S. office of London-based Informa Financial Intelligence, a company that advises financial institutions and operates offices in 43 countries.
In fact, Fintech loans now comprise 38% of all unsecured personal loan balances, a larger market share than any of the more traditional institutions, the TransUnion report notes. Banks’ market share has decreased from 40% in 2013 to 28% today, while credit unions’ share has declined from 31% to 21% during the same time period, TransUnion says.
Fintechs are also gaining at the expense of the home- equity market, van Faassen maintains. “They’re eating away at some of the balance that maybe historically was in home-equity loans,” he says. While total debt is increasing, the amount that’s in home equity loans is actually shrinking, he notes.
What’s more, fintechs are changing the way Americans think about credit, van Faassen continues. Until recently, consumers experienced a two step process. First, they identified a need or desire, like a washer and dryer or home renovation. Realizing they didn’t have the cash to fund those dreams, they took the second step by approaching a financial institution for a loan.
If consumers chose a home equity line of credit to procure the cash, they had to wait for something like 40 days from the beginning of the application process to the time they got the money, van Faassen says. “You really had to be sure you wanted something,” or the process wasn’t worth the effort, he says.
Fintechs have removed a lot of the “pain” from that process, van Faassen says. With algorithms helping to assess the risk that an applicant can’t or won’t repay a debt and digitization easing access to financial records, fintechs can quickly evaluate and make a decision on an application. Tech also helps assess applicants with thin or nonexistent credit files, which broadens the clientele while also contributing to total consumer debt.
Meanwhile, mimicking an age old process in the car business, merchants are beginning to make credit available at the point of sale. Walmart, for example, recently signed a deal with Affirm, a Silicon Valley lender, to provide point-of-sale loans of three, six or 12 months to finance purchases ranging from $150 to $2,000. Shoppers apply for the loans by providing basic information on their mobile phones and don’t have to talk to anyone in person about their finances. Affirm’s CEO Max Levchin has called the underwriting process ‘basically instant.”
If that convenience comes at too high a cost, it doesn’t matter much because borrowers can later find another finance vehicle with better terms, van Faassen says. “So if I get the money at the point of sale, which might have been zero for six months and then it steps up to 20-plus percent, there is no problem with refinancing that debt,” he says.
But there’s a downside to the ease of borrowing, van Faassen cautions. It could trigger the next recession, even though unemployment remains low. Despite modest recent gains, wages have remained nearly stagnant for years. That means an increase in interest rates could lessen consumers’ ability to pay off their debts, he says.
Meanwhile, at least some large mortgage lenders have begun running into problems, a situation that bears an eerie resemblance to the beginning of the Great Recession that struck near the end of 2007, notes a report in luckbox magazine, a publication for investors. Stearns Holding, the parent of Sterns Lending, the nation’s 20th largest mortgage lender, filed for bankruptcy protection just after the July 4 holiday, the luckbox article says.
Another worrisome sign with regard to the possibility of recession is emerging as institutional investors buy into the peer to peer lending market. Institutional investors bought batches of sliced and diced home mortgage securities that helped bring about the Great Depression.
Then there’s the nagging notion that the country and the world are becoming ripe for recession simply because no downturns have occurred for a while. Talk to that effect was circulating at the recent LendIt Conference, van Faassen observes. Fintech executives often come from the banking world and thus still find themselves haunted by the specter of the Great Recession. That’s why they’re already beginning to tighten underwriting for consumer credit van Faassen says.
One difference this time around lies in the fact that nothing about the increase in consumer debt appears to be hidden from public view, van Faassen says. Before, investors fell victim to the mistaken impression that risky mortgage-backed securities were rated AAA when they weren’t.
Plus, the increase in peer-to-peer lending could keep the economy going even if big financial institutions freeze the way they did during the Great Recession, van Faassen notes. “Hopefully, with the new structures that are out there, we can keep liquidity going,” he says. That raises key questions for the alternative small- business funding community. The industry came into being partly as a response to banks’ tightened lending policies during the Great Recession, so perhaps a downturn isn’t such a bad thing for the sector. But a downturn for the economy in general could cripple merchants’ ability to pay off debt.
But all bets are off during hard times. In the last recession the conventional wisdom that consumers make their mortgage payment before paying other bills was turned on its head. Instead of making the house payment—because foreclosure would take several months—people were choosing to make their car payments so they could get to work. Nobody really knows ahead of time what will happen in a recession, van Faassen notes.
After all, economics relies to at least some degree upon the often-irrational financial decisions of the general public. And science demonstrates that it’s no easy task to convince consumers to handle their cash, credit and debt responsibly, says Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and Co-Director of the Common Cents Lab (CCL), which works to improve the financial behavior of low- to moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” says Beasley. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influenced lower-income people even less.
Lots of other factors influence financial behavior, Beasley notes. How much a person saves, for example, depends upon how much they make, what their bank tells them and what practices they encountered at home as children, she says. The CCL has been finding out some other things, too.
In one example of its findings, it discovered that putting an amount for a minimum payment on a credit card decreases how much consumers pay. That happens because listing a minimum payment amount creates an anchor, and borrowers adjust their payment upward from there, Beasley says. If the card carrier doesn’t specify a minimum, consumers tend to adjust downward from the full amount they owe. “It turns out to be incredibly powerful,” she contends.
It’s the kind of problem that shows financial institutions haven’t devised many systems to reduce consumer debt by speeding up repayment, Beasley maintains. In this example, suggesting higher payments would prompt some consumers to pay off their debt more quickly.
In an exception to standard practice, a credit card company called Petal does exactly that by placing a slider on its website to help borrowers determine the amount of their payment, she notes.
Meanwhile, people tend to base financial decisions on the examples they see other people set, Beasley says. Problems arise with that tendency because they may see one neighbor spending money freely to dine in restaurants but don’t see any of the many neighbors eating at home to save money. They see a neighbor driving a new car but don’t know how much that neighbor is setting aside for retirement.
That’s why most people overestimate how much others spend to dine out in restaurants, Beasley says. When shown the error, most reduce their own spending in restaurants, she notes, but within two weeks their behavior returns to its original level, their newfound knowledge “drowned out by the noise in the world,” she says.
That’s not good for consumers or small businesses, but help is on the way, according to John Thompson, chief program officer of the Financial Health Network, a national nonprofit research and consulting firm that works with financial institutions and other companies to improve consumer financial health.
As part of that mission, the Network has formulated procedures to assess the financial health of individuals and small businesses, Thompson says. It’s too early to say whether the tool will help with loan underwriting, he notes, but financial wellness determines the ability to pay back debt, he notes.
The Network also publishes the U.S. Financial Health Pulse, which recently pronounced just 28% of Americans financially healthy, meaning that they have sufficient income, savings and planning to handle an unexpected expense and act on the decisions they make. About 55% are relegated to various stages of coping, and 17% find themselves in a vulnerable state.
So Americans aren’t feeling financially secure, and they’ve borrowed $4 trillion to reach that unenviable state. They’re borrowing more and learning virtually nothing useful about their financial errors. Thompson has a way of summing up the situation. “It’s crazy,” he says.
Jamie Dimon Among 181 CEOs Pledging to Look Beyond Investors
August 22, 2019
This week, JPMorgan Chase CEO Jamie Dimon along with 180 other CEOs published a statement committing themselves to rethinking corporate priorities and their responsibilities as leaders of business.
The majority of the Business Roundtable (BRT), a corporate lobbying group comprised of 200 CEOs that once was described as Obama’s “closest ally in the business community,” signed off on the statement, which outlines a number of vague commitments. Included are goals to deliver “value to our customers” by furthering “the tradition of American companies leading the way in meeting or exceeding customer expectations”; to deal “fairly and ethically with our suppliers”; to support “the communities in which we work” through “embracing sustainable practices across our businesses”; to compensate “[employees] fairly and [provide] important benefits”; and to generate “long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate.”
Such promises are in opposition to shareholder primacy, the belief that the purpose of a business is to create profit for stakeholders and the leading corporate philosophy in American capitalism, and are in in direct contradiction to the BRT’s 1997 statement which praised the shareholder-centric approach.
“We looked at this thing that was written in 1997 and we didn’t agree with it,” said Dimon following the statement’s release. “It didn’t fairly describe what we think our jobs are.”
Such a view is reminiscent of Dimon’s 2019 letter to JPMorgan Chase shareholders, which opened with “The American Dream is alive – but fraying for many,” and closed with “CEOs: Your country needs you!” Just as it is linked to fellow BRT member Larry Fink’s similar letter which discusses the growing trend of CEOs having political and social responsibilities. And topping these associations off is Amazon’s Jeff Bezos, another signatory of the statement, who in 2018 took an unexpectedly patriotic turn when he criticized other firms, such as Google, that pulled out of military contracts, saying, “If big tech companies are going to turn their back on the US Department of Defense, this country is going to be in trouble.”
More and more CEOs are stepping up to explain the moral vision of their companies’. Harvard Business School Historian Nancy Koehn says that this specific case of such espousing is a “response to something in the zeitgeist. They perceive that business-as-usual is no longer acceptable.” The reasons for such a change in approach could be changing trends amongst younger workers, such as employees’ demand that their employer believe in something beyond profit, the increasing number of consumers who factor a business’s social purpose into their purchasing decisions, and the constant threat of social media backlash.
CEO of Johnson & Johnson Alex Gorsky, who drafted the language of the statement, echoed this concept of CEO’s having a social vision when he noted that “there were times when I felt like Thomas Jefferson.” Standing in for the Founding Fathers in Gorsky’s vision are Pepsi, Walmart, Apple, and General Motors.
Reactions to the statement have been skeptical, with many critics calling into question whether any action will come from such words. “The bottom line is, I don’t think much is going to change,” commented Dick Bove, a Wall Street analyst. While Walter Olson, a Senior Fellow at the Cato Institute, said that “It’s not really clear whether they’re intending to replace any part of the system or do the same things as before, but … smile more.”
Bernie Sanders was more pointed in his reaction to the statement. “I don’t believe what they’re saying for a moment. If they were sincere, they would talk about raising the minimum wage in this country to a living wage, the need for the rich and powerful to pay their fair share of taxes.” Fellow primary candidate Elizabeth Warren also weighed in, saying that it was “a welcome change,” but “without real action, it’s meaningless … These big corporations can start following through on their words by paying workers more instead of spending billions on buybacks.”
The Council of Institutional Investors (CII), a group that promotes the interests of investors and shareholders, responded with concern, saying that “The statement undercuts notions of managerial accountability to shareholders.” “Accountability to everyone means accountability to no one … It is government, not companies, that should shoulder the responsibility of defining and addressing societal objectives with limited or no connection to long-term shareholder value.”
Canada’s Alternative Financing Market Is Taking Off
May 20, 2019
Canadians have been slow out of the gate when it comes to mass adoption of alternative financing, but times are changing, presenting opportunities and challenges for those who focus on this growing market.
Historically, the Canadian credit market has traditionally been dominated by a few main banks; consumers or businesses that weren’t approved for funding through them didn’t have a multitude of options. The door, however, is starting to unlock, as awareness increases about financing alternatives and speed and convenience become more important, especially to younger Canadians.
Indeed, the Canada alternative finance market experienced considerable growth in 2017—the latest period for which data is available. Market volume reached $867.6 million, up 159 percent from $334.5 million in 2016, according to a report by the Cambridge Centre for Alternative Finance and the Ivey Business School at Western University. Balance sheet business lending makes up the largest proportion of Canadian alternative finance, accounting for 57 percent of the market; overall, this model grew 378 percent to $494 million in 2017, according to the report.
Industry participants say the growth trajectory in Canada is continuing. It’s being driven by a number of factors, including tightening credit standards by banks, growing market demand for quick and easy funding and broader awareness of alternative financing products.
To meet this growing demand, new alternative financing companies are coming to the market all the time, says Vlad Sherbatov, president and co-founder of Smarter Loans, which works with about three dozen of Canada’s top financing companies. He predicts that over time more players will enter the market—from within Canada and also from the U.S.—and that product types will continue to grow as demand and understanding of the benefits of alternative finance become more well-known. Notably, 42 percent of firms that reported volumes in Canada were primarily headquartered in the U.S., according to the Cambridge report.
To be sure, the Canadian market is much smaller than the U.S. and alternative finance isn’t ever expected to overtake it in size or scope. That’s because while the country is huge from a geographic standpoint, it’s not as densely populated as the U.S., and businesses are clustered primarily in a few key regions.
To put things in perspective, Canada has an estimated population of around 37 million compared with the U.S.’s roughly 327 million. On the business front, Canada is similar to California in terms of the size and scope of its small business market, estimates Paul Pitcher, managing partner at SharpShooter, a Toronto-based funder, who also operates First Down Funding in Annapolis, Md.
Nonetheless, alternative lenders and funders in Canada are becoming more of a force to be reckoned with by a number of measures. Indeed, a majority of Canadians now look to online lenders as a viable alternative to traditional financial institutions, according to the 2018 State of Alternative Lending in Canada, a study conducted by online comparison service Smarter Loans.
Of the 1,160 Canadians surveyed about the loan products they have recently received, only 29 percent sought funding from a traditional financial institution, such as a bank, the study found. At the same time, interest in alternative loans has been on an upward trajectory since 2013. Twenty-four percent of respondents indicated they sought their first loan with an alternative lender in 2018. Overall, nearly 54 percent of respondents submitted their first application with a non-traditional lender within the past three years, according to the report.
Like in the U.S., there’s a mix of alternative financing companies in Canada. A number of companies offer factoring and invoicing and payday loans. But there’s a growing number focused on consumer and business lending as well as merchant cash advance.
Some major players in the Canadian alternative lending or funding landscape include Fairstone Financial (formerly CitiFinancial Canada), an established non-bank lender that recently began offering online personal loans in select provinces; Lendified, an online small business lender; Thinking Capital, an online small business lender and funder; easyfinancial, the business arm of alternative financial company goeasy Ltd. that focuses on lending to non-prime consumers; OnDeck, which offers small business financing loans and lines of credit; and Progressa, which provides consolidation loans to consumers.
By comparison, the merchant cash advance space has fewer players; it is primarily dominated by Thinking Capital and less than a dozen smaller companies, although momentum in the space is increasing, industry participants say.
“The U.S. got there 10 years ago, we’re still catching up,” says Avi Bernstein, chief executive and co-founder of 2M7 Financial Solutions, a Toronto-based merchant cash advance company.
OPPORTUNITIES ABOUND
In terms of opportunities, Canada has a population that is very used to dealing with major banks and who are actively looking for alternative solutions that are faster and more convenient, says Sherbatov of Smarter Loans. This is especially true for the younger population, which is more tech-savvy and prefers to deal with finances on the go, he says.
Because the alternative financing landscape is not as developed in Canada, new and innovative products can really make a significant impact and capture market share. “We think this is one of the key reasons why there’s been such an influx of international companies, from the U.S. and U.K. for example, that are looking to enter the Canadian market,” he says.
Just recently, for example, Funding Circle announced it would establish operations in Canada during the second half of 2019. “Canada’s stable, growing economy coupled with good access to credit data and progressive regulatory environment made it the obvious choice,” said Tom Eilon, managing director of Funding Circle Canada, in a March press release announcing the expansion. “The most important factor [in coming to Canada] though was the clear need for additional funding options among Canadian SMEs,” he said.
OnDeck, meanwhile, recently solidified its existing business in Canada through the purchase of Evolocity Financial Group, a Montreal-based small business funder. The combined firm represents a significantly expanded Canadian footprint for both companies. OnDeck began doing business in Canada in 2014 and has originated more than CAD$200 million in online small business loans there since entering the market. For its part, Evolocity has provided over CAD$240 million of financing to Canadian small businesses since 2010.
“There is an enormous need among underserved Canadian small businesses to access capital quickly and easily online, supported by trusted and knowledgeable customer service experts,” Noah Breslow, OnDeck’s chairman and chief executive, said in a December 2018 press release announcing the firms’ nuptials.
There are also a number of home grown Canadian companies that are benefiting from the growth in the alternative financing market.
2M7 Financial Solutions, which focuses on merchant cash advances, is one of these companies. It was founded in 2008 to meet the growing credit needs within the small and medium-sized business market at a time when businesses were having trouble in this regard.
But only in the past few years has MCA in Canada really started picking up to the point where Bernstein, the chief executive, says the company now receives applications from about 200 to 300 companies a month, which represents more than 50 percent growth from last year.
“We’re seeing more quality businesses, more quality merchants applying and the average funding size has gone up as well,” he says.
NAVIGATING THROUGH CHALLENGES
Despite heightened growth possibilities, there are also significant headwinds facing companies that are seeking to crack the Canadian alternative financing market. For various reasons, some companies have even chosen to pull back or out of Canada and focus their efforts elsewhere. Avant, for example, which offers personal loans in the U.S., is no longer accepting new loan applications in Canada at this time, according to its website. Capify also recently exited the Canadian business it entered in 2007, even as it continues to bulk up in the U.K. and Australia.
One of the challenges alternative lenders face in Canada is distrust of change. Since Canadians are so used to dealing with only a few major financial institutions to handle all their finances, they are skeptical to change this behavior, especially when the customer experience shifts from physical branches to online apps and mobile devices, says Sherbatov of Smarter Loans. He notes that adoption of fintech products in Canada has lagged in recent years, partially because there has been a lack of awareness and trust in new financial products available.
One way Smarter Loans has been working to strengthen this trust is by launching a “Smarter Loans Quality Badge,” which acts as a certification for alternative financing companies on its platform. It is issued to select companies that meet specified quality standards, including transparency in fees, responsible lending practices, customer support and more, he says.
The Canadian Lenders Association, whose members include lenders and merchant cash advance companies, has also been working to promote the growing industry and foster safe and ethical lending practices. For example, it recently began rolling out the SMART Box pricing disclosure model and comparison tool that was introduced to small businesses in the U.S. in 2016.
Another challenge that impacts alternative lenders in the consumer space is having restricted access to alternative data sources. Because of especially strict consumer privacy laws, access is “substantially more limited” than it is in any other geography,” says Jason Mullins, president and chief executive of goeasy, a lending company based in Mississauga, Ontario, that provides consumer leasing, unsecured and secured personal loans and merchant point-of-sale financing.
From a lending perspective, goeasy focuses on the non-prime consumer—generally those with credit scores of under 700. Mullins says the market consists of roughly 7 million Canadians, about a quarter of the population of Canadians with credit scores. The non-prime consumer market is huge and has tremendous potential, he says, but it’s not for the faint of heart.
Another issue facing alternative lenders is the relative difficulty of raising loan capital from institutional lenders, says Ali Pourdad, co-founder and chief executive of Progressa, which recently reached the $100 million milestone in funded loans for underserved Canadian consumers. “The onus is on the alternative lenders to ensure they have good lending practices and are underwriting responsibly,” he says.
What’s more, household debt to income ratios in Canada are getting progressively worse, with Canadians taking on too much debt relative to what they can afford, Pourdad says. As the situation has been deteriorating over time, there is inherently more risk to originators as well as the capital that backs them. “Originators, now more than ever, have to be cautious about their lending practices and ensure their underwriting is sound and that they are being responsible,” he says.
On the small business side of alternative lending, getting the message out to would-be customers can be a challenge in Canada. In U.S. there are thousands of ISOs reaching out to businesses, whereas in Canada, most funders have a direct sales force, with a much smaller portion of their revenue coming from referral partners, says Adam Benaroch, president of CanaCap, a small business funder based in Montreal.
He predicts this will change over time as the business matures and more funders enter the space, giving ISOs the ability to offer a broader array of financing products at competitive rates. “I think we’re going to see pricing go down and more opportunities develop, and as this happens, the business is going to grow, which is exactly what has happened in the U.S,” he says.
Generally speaking, Canadian businesses are still somewhat skeptical of merchant cash advance and require considerable hand-holding to become comfortable with the idea.
“You can’t wait for them to come to you, you have to go to them and explain what the products are,” says Pitcher of SharpShooter, the MCA funding company.
While Pitcher predicts more companies will continue to enter the Canadian alternative financing market, he doesn’t think it will be completely overrun by new entrants—the market simply isn’t big enough, he says. “It’s not for everyone,” he says.
How To Scale Your Broker Shop
May 15, 2019
When it comes to hiring, it’s quality over quantity. That’s what the co-founders of Everlasting Capital Josh Feinberg and Will Murphy told a packed room at AltFinanceDaily’s Broker Fair last week. They presented a panel called “How to Scale Your Broker Shop,” where they shared tips on how to do just that.
“We wanted to scale so badly and throw bodies in seats,” Murphy said.
And that’s what they did until they realized that they were doing just as much volume when they had fewer people.
CEO of National Funding Dave Gilbert, who spoke on a different panel at Broker Fair, said that he’s a fan of small brokers. He later explained to AltFinanceDaily that when brokers get too big, they can get stuck with legacy staff. Instead, he said that when they stay lean and spend money on high quality salespeople, they can be much more effective with five or fewer people than with 10.
“It’s not the amount of bodies in the office, it’s the processes you have in place,” Murphy said.
Processes like hiring, training employees and organizing data, which they said should be as simple as possible. Bigger isn’t better and perfect isn’t realistic, they conveyed.
“Don’t worry about trying to create the perfect website or business card,” Feinberg said.
Instead, he said to think about five elements when trying to scale a brokerage shop:
- Focus on cash flow.
- Know that you will fail.
- Don’t quit before the miracle happens.
- Be different than your competition.
- Think bigger.
Meanwhile, Murphy presented concrete actions to take to grow a broker shop:
- Get customers.
- Build relationships.
- Be transparent.
- Find a mentor.
- Ask questions.
- Specialize in two programs (products)
- Brand yourself / your company
Everlasting Capital, which now has 19 people on staff and is based in New Hampshire, facilitates MCA funding and equipment financing.
On Diversification: Acknowledging that MCAs have an uncertain future, Feinberg said it’s important to diversify. He said that three years ago they were doing exclusively MCA deals and now they do 50% MCA and 50% equipment financing.
On social media marketing: “Be consistent. It’s not about the likes. It’s about [good] content and consistency,” Murphy said.
On broker performance: Brokers are given a six month training program at Everlasting Capital. After the six month period, they’re expected to fund four deals a month.
They also said it’s important to make friends with people in the industry.
So God Made a Farmer, But Who’s Financing The Farms?
May 1, 2019
Most mornings, farmers and ranchers wake up worrying about uncooperative weather and volatile commodity prices. Just the same, they pull themselves out of bed to spend the morning tinkering with crotchety machinery or wrangling uncooperative livestock. When they break for lunch, the kitchen radio alerts them to trade wars with distant countries and the unintended results of federal regulation. As they make their way back outdoors for the afternoon’s work, they can’t help but notice another new house taking shape in the distance as suburban sprawl encroaches on the fields and pastures. By evening, their thoughts have turned to their need for short-term capital and how the local banker seems increasingly wary of providing funds.
It’s that last challenge where the alternative small-business funding industry might be able to help, says Peter Martin, a principal at K-Coe Isom, an accounting and consulting firm focused on the ag industry. “If you as a farmer need operating funds and you can’t get them from a bank, you don’t have a lot of options,” he says. “Historically, nobody outside of banks has had much interest in lending operating money to a farmer.”
The result of that reluctance to provide funding? “I can’t tell you the number of calls I get to say, ‘Hey, I need $100,000 and I need it in a couple of days because of X, Y, Z that’s come up,’” says Martin. “We don’t have a place that we can send those people to. You could make a lot of quick turnaround loans in rural America.” What’s more, it’s a potential clientele that makes a lot of money and prides itself on paying back what they owe.
Martin’s not alone in that assessment. While farmers enjoy abundant long-term credit to buy big-ticket assets, such as land and heavy machinery, they’re struggling to find sources of short-term credit for operating expenses like labor, repairs, fuel, seed, feed, fertilizer, herbicides and pesticides, notes Mike Gunderson, Purdue University professor of agricultural economics.
But remember that nobody’s saying it would be easy for alt funders to break into the agricultural sector. City folks accustomed to the fast-paced rhythms of New York or San Diego would have to learn a whole new seasonal business cycle. Grain farmers, for example, plant corn and soybeans in April, harvest their crops September or October, and may not sell the grain until the following January, says Nick Stokes, managing director of Conterra Asset Management, an alternative-funding company that places and services rural real estate loans.
That seasonality results in revenue droughts punctuated by floods of revenue – a circumstance far-removed from the more-consistent credit card receipt split that launched the alternative small-business funding industry. Alternative funders seeking customers with consistent monthly cash flow won’t find them in the agricultural sector, Stokes cautions.
And while the unfamiliarity of farm life might begin with wild swings in cash flow, it doesn’t end there. Operating in the agricultural sector would require urbanites to learn the somewhat alien culture of The Heartland – a way of life based on hard physical labor, the fickle whims of the weather, and friendly unhurried conversations, even with strangers.
Even so, the task of mastering the agricultural funding market isn’t hopeless, and help’s available. Experts in agricultural economics profess a willingness to help outsiders learn what they need to know to get involved. “Selfishly, the first place I’d love to have them reach out to is me,” Martin says of alternative funders. “I’ve been writing and thinking for years about the importance of getting some non-traditional lenders into agriculture.” He would have “no qualms” about featuring specific prospective funders in a column he writes for one of the nation’s largest farm publications.
It also requires meet-and-greets. During the winter, when farmers aren’t in the fields, funders could make connections at trade shows, Martin advises. “Word would get around rural America really quick,” he predicts. Networking with advisers such as crop insurance agents, agronomists and ag CPS’s – all of whom deal with farmers daily – would also help funders find their way in agriculture, he contends.
Investors who are curious about extending credit in the agricultural sector could rely upon Conterra to help them locate customers and help them service the loans, says Stokes. He can even help acclimate them to the world of agriculture. “If they’re interested in investing in agricultural assets – whether that be equipment, real estate or providing operating capital – we would enjoy the opportunity to visit with them,” he says.
GETTING STARTED
Alt funders could begin their introduction to the agrarian lifestyle by taking to heart a quotation attributed to President John F. Kennedy: “The farmer is the only man in our economy who buys everything at retail, sells everything at wholesale and pays the freight both ways.”
“Agriculture is a very different animal,” Martin notes. He sometimes presents a slide show to compare the difference between a typical farm and a typical manufacturer of the same size. At the factory, revenue ratchets up a bit each year and margins remain about the same over time. On the farm, revenue and margins both fluctuate wildly in huge peaks and valleys from one year to the next.
The volatility makes it difficult to manage the risk of lending, Martin admits, while noting that agriculturally oriented banks still have higher returns than non-ag banks, according to FDIC records. “You have to go back to 2006 to find a time when ag banks didn’t outperform their peers on return on assets,” he says. “What this tells us is that, generally speaking, ag borrowers are better at repaying their loans,” he asserts. Charge-offs and delinquencies in ag portfolios are lower than in other industries, he says.
Many of the nation’s farms have remained in the same family for more than a century – a stretch of time that’s seldom seen in just about any other type of business. Besides making potential creditors comfortable that a particular operation will stay in business, the longevity of farms provides lots of documents to examine – not just tax records but also production history that’s tracked by government agencies. A particular farmer’s crop yields, for example, can be compared with county averages to calculate how good the borrower is at farming.
Debt to asset ratio on the nation’s farms stands at about 14 percent, which Martin views as “insanely low.” But that’s not the case on every farm. Highly leveraged farms have ratios of 60 percent or even 80 percent when farmers have grown their businesses quickly or encountered debt to buy land from their parents, he says. Commodity prices are low now, but farms with 14 percent debt to asset ratios still don’t have a problem, even in hard times. Farmers deeply in debt, however, have little ability to climb out of the hole. The latter are using operating capital to fund losses.
Farmers with debt to asset ratios of 10 percent have little trouble finding credit and aren’t going to pay anything other than bank rates, Martin says. The target audience for non-traditional funding are farmers who are having trouble but will be fine when commodity prices rebound. Another potential client for alternative finance would be farmers who are quickly increasing the size of their operations when opportunities arise to acquire land. Both groups need funders willing to contemplate the future instead of demanding a perfect track record, he maintains.
Farmers generally need loans for operating capital for about 18 months, according to Martin. “Let’s say I borrow that money, get my crop in the ground, harvest that and I may not sell my grain right after harvest,” he says. The whole cycle can easily take 18 months, he says. Shorter-term bridge lending opportunities also arise in situations like needing a little extra cash quickly at harvest time. Farmers usually have something to put up as collateral – like producing 50 titles to vehicles or offering up some real estate, he says.
An unsecured loan – even one with high double-digit interest – could succeed in agriculture because no one is offering that type of funding, Martin says. Small and medium-sized farms would probably benefit from funding of $100,000 or less, while larger farms might sign up for that amount but often require more, he notes.
LAY OF THE LAND
The Farm Credit System, a nationwide quasi-governmental network of borrower-owned lending institutions, provides more than a third of the credit granted in rural America. That comes to more than $304 billion annually in loans, leases and related services to farmers, ranchers, rural homeowners, aquatic producers, timber harvesters, agribusinesses, and agricultural and rural utility cooperatives, according to published reports.
Congress established the Farm Credit System in 1916, and the Farm Credit Administration was established in 1933 to provide regulatory oversight. “All they’re doing is lending money to agriculture,” says Martin.
However, the system can go astray in the eyes of some observers. An arm of the Farm Credit System called CoBank lends to co-operatives and other rural entities. At one point Verizon Wireless became a borrower from CoBank, which angered some observers because the system was supposed to be helping rural America, not corporate America, Martin says.
That anger arises partly because the federal government doesn’t require Farm Credit to pay income tax, which enables it to lend at lower rates, Martin says. “Part of the allure of borrowing from Farm Credit is you can typically borrow cheaper,” he notes. “You’d be very hard pressed to find a farmer who over the years hasn’t had some interaction with Farm Credit.”
Observers sometimes fault the system for what they perceive as a tendency to extend credit only to those who don’t really need it, notes Purdue’s Gunderson. People working for the system believe they’re doing a good job of supporting agriculture, he says, noting that the system is charged with the responsibility of helping new and young farmers.
Another entity, the Federal Agricultural Mortgage Corp., also known as Famer Mac, works with lending institutions to provide credit to the agricultural sector. It’s a publicly traded company that serves as a secondary market in agricultural loans, including mortgages. It purchases loans and sells instruments backed by those loans and was chartered in 1988. Conterra, the alternative-funding company mentioned earlier in this article, -works with Farmer Mac and financial institutions to make real estate loans to farmers and ranchers in financial distress. The loans are designed to help borrowers get back on their feet in three to five years so that they would then qualify for regular bank loans.
Then there are the ag lending divisions at the large banks such as Wells Fargo, Chase and the Bank of the West, Martin says. “Lots of these big national banks are doing at least some ag lending,” he says. “Some, obviously, have bigger ag portfolios than others.”
Some regional banks focus on agriculture, Martin continues. “When you get into the middle of the corn belt, there are going to be some regional banks where traditional ag lending’s a huge part of what they do,” he says. Local banks in small towns get involved, too. “Most small community banks are going to have some kind of ag lending portfolio,” Martin notes. Hometown bankers can provide operating capital to some farmers, but only to those who haven’t experienced recent hiccups in revenue or expenses.
THE NON-BANKS
“Then you get into the non-bank lenders,” Martin observes. “A really good example of this is John Deere,” the tractor and equipment manufacturer. The company provides a tremendous amount of capital to rural America through equipment lending and also through other credit facilities, he says. In fact some observers estimate that John Deere is the largest lender to agriculture. Even so, the company usually doesn’t provide enough non-equipment credit to become the only lender a farmer would use, he says.
The same holds true with other lenders to agriculture, Martin says. Co-operatives, for example, lend money to agriculture even though they’re not banks. Typically, they begin by extending credit for products like seed, fertilizer or pesticides and then start making additional credit available to farms and ranches. In recent years, a large co-operative called CHS loaned hundreds of millions of dollars in addition to selling products on credit. Some large CHS loans went bad caused a ripple effect throughout the cooperative structure, Martin maintains. Other co-ops have looked at CHS and wondered if they’re moving too far outside their core competency. So now many co-ops are tying funding to products they’re selling.
Some other non-bank lenders have shown up in agriculture, and they fall into two categories, Martin says. One group is making real estate loans in agriculture, so their loan programs are geared to farmers looking to buy land or anything that can be secured by land. Conterra and Ag America are examples. Farmer Mac lends a lot of money against farmland, as well. So farmers who have agricultural land have a lot of access to capital and a lot of lenders who want to provide it, he says.
The second group of non-bank lenders is providing operating capital. “That is a very, very small club,” Martin says. “There’s really not anybody doing this on a regular basis – with just one or two exceptions.” Probably the biggest name among the exceptions is Ag Resource Management, usually known as ARM, he continues. ARM places a value on the potential productivity of a famer’s land. Then it looks at the crop insurance the farmer’s able to buy to protect the investment in that crop. ARM then lends part of the value of that crop insurance.
Let’s say a farmer can grow $10 million worth of crops, according to ARM’s projection,” Martin says. “You can get crop insurance to cover 80 percent,” he continues. “For a total crop failure, you will get $8 million for that crop.” Using a formula based on type of crop, location and type of crop insurance, ARM will lend some amount less than $8 million. “Their collateral is pretty rock solid,” Martin observes.
ARM uses a system to make sure farmers use the funds only for expenses related to growing the crop they’re using as collateral. “Their risk of not getting a crop in the ground that qualifies for the insurance is next to nothing,” Martin says. ARM offers differing interest rates, depending upon risk, in at least the high single digits or double digits, and they also charge fees. “So you’re going to be paying a lot, but they are the lender of last resort in agriculture right now,” he says, adding that ARM operates multiple offices has grown quickly.
Through lenders like ARM, the agricultural sector’s becoming familiar with alternative finance. But much remains to be done if alt fin pioneers want to venture into the sector. Those who do will encounter a complicated credit landscape, but one that offers opportunities for anyone willing to learn about unfamiliar business cycles and lifestyles.
Does Your Merchant Cash Advance Company Pass The Scrutiny Test?
April 29, 2019
The merchant cash advance business has come under repeated fire of late from regulators, legislators and customers. “Every aspect of the industry is under scrutiny right now. Syndication agreements, underwriting, and collections are the subject of bills in Congress and across multiple states,” says Steven Zakharyayev, managing attorney for Empire Recovery Services in Manhattan, which offers debt recovery services to financial companies. So how should funders respond amid these obstacles? Here are a few pointers to help funders succeed despite ongoing challenges from a legal, regulatory, business and public relations perspective:
DIFFERENTIATE BETWEEN CASH ADVANCES AND LOANS AND MODEL BUSINESS DEALINGS ACCORDINGLY
In the eyes of the law, merchant cash advances and loans are very different. With a cash advance, a funder advances the merchant cash in exchange for a percentage of future sales, plus a fee. A loan, on the other hand, is a lump sum of cash in exchange for monthly payments over a set time period at an interest rate that can be fixed or variable. While the two types of funding options have certain similarities, funders have to be extremely careful to make appropriate distinctions in their business practices; otherwise legal trouble can easily ensue, experts say.
Most funders know that they are supposed to draw a bright line between merchant cash advance and lending, but it’s critical they put this knowledge into practice. Funders have to ensure the distinction is evident in their business lexicon, says Gregory J. Nowak, a partner in the Philadelphia office of law firm Pepper Hamilton LLP who focuses on securities law.
For example, it’s extraordinarily important that funders don’t refer to merchant cash advances as loans in their business dealings. Business records, emails and other documents can be requested in litigation for discovery purposes. If the funder’s internal documentation refers to cash advances as loans, it’s going to be hard for the company to argue that they aren’t, in reality, loans.
“Most judges want to see consistency of treatment and that includes your vocabulary,” Nowak says. “The word ‘loan’ should be banned from their email and Word files.”
There’s a fair amount of litigation surrounding what is and what isn’t a cash advance. This can be helpful guidance for funders in setting out the criteria they need to follow to be able to defend their activities as cash advances. Even so, the line is somewhat of a moving target and funders need to be stalwart in these efforts given heightened regulatory scrutiny, experts say.
“If it looks like a loan, the law will treat it as a loan—and all the consequences that follow such a determination,” says Christopher K. Odinet, an associate professor of law at the University of Oklahoma College of Law.
BE CAREFUL ABOUT YOUR COLLECTION POLICIES
Obviously companies want to collect their payments. But some funders are too quick to file lawsuits, which could lead to unwanted trouble, says Paul A. Rianda, who heads a law firm in Irvine, Calif.
“The business model of sue first, ask questions later can be a problem,” says Rianda, whose clients include merchant cash advance companies.
The concern is that when funders sue, merchants start talking to attorneys and that could open the MCA firm to other types of lawsuits. The more a funder sues, the more it increases media attention and invites examination by state regulators and others. “You invite class action lawsuits and regulatory scrutiny that you really don’t want. It’s a boomerang thing,” he says.
The issue is especially pertinent now as legislators grapple with how to handle the thorny issue of confessions of judgement, more popularly known as COJs. For instance, since the start of the year, New York courts and county clerks have become much more rigid in processing confessions of judgments.
Certainly, not all funders use COJs. Just recently, for instance, Greenbox Capital suspended the use of COJs indefinitely, in response to the heightened industrywide debate over their use. While there’s no all-encompassing directive to stop using COJs, experts say it is incumbent upon funders to ensure they are used in a responsible and proper manner, especially amid political and regulatory uncertainty.
For instance, it would be irresponsible and potentially actionable to execute on a COJ simply because the merchant doesn’t remit receivables the merchant cash advance company purchased because he didn’t generate receivables, says Catherine M. Brennan, a partner at the law firm Hudson Cook LLP in Hanover, Maryland.
To be lawful, the COJ has to be based on a breach of performance under the agreement. Fraud, for instance, is actionable. But simple failure to remit receivables because the business has failed is not, she says.
“Conflating those two things—breaches of repayment versus performance—leads to a world of hurt,” she says. “MCA transactions do not have repayment as a concept.”
In places like New York, where COJs are more controversial, funders have to be especially careful about using them properly, experts say. Even though COJs are still enforceable under New York law for the time being, funders should understand every county processes them a bit differently, says Zakharyayev of Empire Recovery Services. “If they have a preferred county for filing, they should ensure their COJs are not only compliant with state law, but also complies with local rules,” he says.
What’s more, funders should ensure their COJs are properly notarized under New York law, ensure party names and the amount confessed is accurate, and avoid blanket statements such as naming each and every county in New York as a possible venue for filing, he says.
While some funders have suggested changing their venue provisions to a COJ-friendly state if New York outlaws COJs, Zakharyayev says he recommend New York funders keep their venue in New York regardless since it would still be one of the most efficient states to enforce a judgment. “I’ve filed COJs outside of New York and, even without a COJ, New York is much more efficient in judgment enforcement as New York courts are less restrictive in allowing the judgment creditor to pursue the debtor’s assets,” he says.
BE CAREFUL WHEN RAISING THIRD-PARTY MONEY
Aside from their dealings with merchants, funders also have to be cautious when it comes to interactions with potential investors.
Some companies have ample balance sheets and don’t need money from third parties to fund their operations. But funders that decide for business purposes to solicit money from investors, have to be careful not to run afoul of SEC rules, says Nowak, the attorney with Pepper Hamilton.
He recommends funders treat these fundraising efforts as if they are issuing securities and follow the rules accordingly. Otherwise they risk being the subject of an enforcement action where the SEC alleges they are raising money using unregulated securities. “You need to be very careful here because these rules are unforgiving. You can’t ignore them,” Nowak says.
TACKLE ACCOUNTING CHALLENGES
Accounting is another business challenge many funders face. Some have fancy customer relationship management systems, but the systems aren’t always set up to provide the detailed information the accounting department’s needs to effectively reconcile the firm’s books, says Yoel Wagschal, a certified public accountant in Monroe, New York, who represents a number of funders and serves as chief financial officer at Last Chance Funding, a merchant cash advance provider.
Ideally, a funder’s CRM and accounting systems should be integrated so both sales and accounting receive the relevant data without the need for either department to input duplicate data. The two systems need a way to get information from each other, without someone manually entering the data in both systems, which is inefficient and prone to error, Wagschal says.
DON’T SKIMP ON LEGAL SERVICES
There’s no set standard for funders to follow when it comes to legal advice. Some funders have in-house counsel, some contract with external law firms and some don’t have attorneys at all, which, of course, can be a risky proposition.
Some funders use contracts they’ve poached from a reputable funder online or from a friend in the industry, says Kimberly M. Raphaeli, vice president of legal operations at Accord Business Funding in Houston, Texas. The trouble is what flies in one state may not be legal in another, she says.
Many contracts include things such as jury waivers and class-action waivers or COJs and depending on the state, the rules surrounding the enforcement of these types of clauses may be different. So it’s really important to know the nuances of the state you’re doing business in and even potentially the states where your merchants are located, she says.
Having dedicated legal staff is arguably better. But at the very least, funders should have an attorney on speed dial who can provide advice on contracts, compliance and other areas of their business. Even when a funder has in-house attorneys, Raphaeli says it’s a good idea to tap external counsel to review documents in situations where potential liability exists. Not only does this offer a second set of eyes, it can provide added peace of mind. “A funder should never shy away from paying a little bit of money for long-term business security,” Raphaeli says.
FOLLOW BEST PRACTICES
The Small Business Finance Association, an advocacy group for the non-bank alternative financing industry, has developed a list of best practices for industry participants to follow. These encompass principles of transparency, responsibility, fairness and security.
“It’s a very competitive market and companies are trying to differentiate themselves. I think it’s important to make sure you’re following industry standards,” says Steve Denis, executive director of the association whose members include funders and lenders.
Funders also need to be mindful that best practices can change based on business and competitive realities, so it’s important for funders to review procedures periodically, says Raphaeli, of Accord Business Funding. Because the industry is fast-moving, a good rule of thumb might be for a funder to review the entire set of policies and procedures every 18 months. But more frequent review could be necessary if outside factors such as new case law or regulation demand it, she says.
“Periodically taking a look at your collections techniques, your default procedures, even your funding process down to your funding call – these are all critical components of having a successful MCA funder,” she says.
TAKE PAINS TO AVOID INDUCTION INTO THE PUBLIC HALL OF SHAME
While there is no shortage of unseemly news stories involving MCA, funders need to do their best to avoid negative press. This means being extra careful about the way they present themselves to businesses, at public speaking engagements, at conferences, industry trade shows, brokers and others, says Denis of the Small Business Finance Association.
Denis, a long-time Washington, D.C., resident, recommends funders invoke what he calls the “The Washington Post test,” though it applies broadly to any news outlet. Before sending an email, leaving a voicemail or saying anything publicly, funding company employees need to ask themselves: Am I comfortable with that information being on the front page of the paper? “I think our industry has a big problem with public relations right now,” he says. “The stigma is only as true as our industry allows it to be.”
