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.
Alternative Funding: Over The Top Down Under
September 2, 2015
San Francisco had its gold rush, Oklahoma had its land rush and now Australia is experiencing a rush of alternative funding. After a slow start a few years ago, foreign and domestic companies have been flocking to the market down under in the last 18 months.
As many as 20 new alt-funders are doing business in Australia, but that number could swell to a hundred, said Beau Bertoli, joint CEO of Prospa, a Sydney-based alternative funder. “The market in Australia has been very ripe for alternative finance,” Bertoli, said. “We see an opportunity for the alternative finance segment to be more dominant in Australia than it is in America.”
Recent entrants to the embryotic Australian market include Spotcap, a Berlin-based company partly funded by Germany’s Rocket Internet; Australia’s Kikka Capital, which gets tech backing from U.S.-based Kabbage; America’s Ondeck, which is working with MYOB, a software company; Moula, which began offering funding this year but considers itself ahead of the curve because it formed two years ago; and PayPal, the giant American payments company.
The new entrants are joining ‘pioneers’ that have been around a few years, like Prospa, which has been working for three years with New York-based Strategic Funding Source, and Capify (formerly AUSvance until it was consolidated into the international brand Capify), which came to market in 2008 with merchant cash advances and started offering small-business loans in 2012.
Some don’t take the newcomers that seriously. “There are small players I’ve never heard of,” said John de Bree, managing director of Capify’s Sydney-based office, in a reference to local Australian funders. “The big ones like OnDeck and Kabbage don’t have the local experience.”
But many players view the influx as a good sign. “I think it’s an endorsement of the market,” Bertoli said. “There’s more publicity and more credibility for what we’re doing here in terms of alternative finance.” It’s like the merchant who gets more business when a competing store opens across the street.
Besides, the market remains far from crowded. “I’m not concerned about the arrival of OnDeck and Kabbage because it really does validate our model,” maintained Aris Allegos, who serves as Moula CEO and cofounded the company with Andrew Watt.
The market’s relatively small size – at least compared to the U.S. – doesn’t seem to bother players accustomed to the heavily populated U.S., a development some observers didn’t expect. “I’m very surprised,” de Bree said of the American interest in Australia. “The American market’s 15 times the size of ours.”
Others see nothing but potential in Australia. “This is a market that will evolve over time, and we think the opportunity is enormous,” said Lachlan Heussler, managing director of Spotcap Australia.
Some view the Australian rush to alternative finance not so much as a solitary phenomenon but instead as part of a worldwide explosion of interest in the segment, driven by banks’ reluctance to provide loans since the financial crisis, de Bree said.
Viewed independently or in a larger context, the flurry of activity in Australia is new. “The boom is probably only getting started,” Bertoli maintained in a reference to the Australian market. “Right now, it’s about getting the foundation of the market established.”
To get the business underway in Australia, alternative funders are alerting small-business owners and the media to the fact that alternative funding is becoming available and teaching them how it works, de Bree said. “Half of our job is educating the market,” noted Heussler.
New players are building the track record they need to bring down the cost of funds, according to Allegos. “Our base rate is 2 percent or 3 percent higher than yours,” he said, adding that the cost of funds is more challenging than gearing up the tech side of the business.
Although the alternative-lending business started later in Australia than in the United States and lags behind America in in exposure, it’s maturing rapidly, said de Bree. Aussie funders are benefitting from the lessons their counterparts have learned in the U.S., he said.
But the exchange of information flows both ways. Kabbage, for example, chose to enter the Australian market with a local partner, Kikka. Kabbage learned from its earlier foray into the United Kingdom that it makes sense to work with colleagues who understand the local regulatory system and culture, said Pete Steger, head of business development for Atlanta-based Kabbage.
Such differences mean that risk-assessment platforms that work in the United States or Europe require localization before they can perform effectively in Australia, sources said.
Sydney-based Prospa, for example, got its start three years ago and has been working ever since with New York-based Strategic Funding Source to localize the SFS American risk-assessment platform for Australia, said Bertoli, who shares the company CEO title with Greg Moshal.
Moula, which has headquarters in Melbourne, sees so many differences among markets that it decided to build its own local platform from scratch, according to Allegos.
One key difference between the two markets is that Australia does not have positive credit reporting. “We have nothing that even comes close to a FICO score,” said Allegos. The only credit reporting centers on negative events, he said.
Without credit scores from credit bureaus, funders base their assessments of credit worthiness largely on transaction history. “It’s cash-flow analytics,” said Allegos. “It’s no different from the analysis you’re doing in your part of the world, but it becomes more significant” in the absence of positive credit reporting, he said.
Australia lacks credit scores at least partly because the country’s four main banks control most of the financial sector and choose not to release credit information, sources said. The banks have warded off attacks from all over the world because the regulatory environment supports them and because their management understands how to communicate with and sell to Australian customers, sources said.
The big banks – Commonwealth Bank, Westpac, Australia and New Zealand Banking Group, and National Australia Bank – set their own rules and have kept money tight by requiring secured loans and long waiting periods, Bertoli said. It’s difficult for merchants who don’t fit into a “particular box” to procure funding, he maintained. “It’s almost like an oligarchy,” Allegos said of the banks’ grip on the financial system.
Eventually, the banks may form partnerships with alternative lenders, but that day won’t come soon, in Allegos’ estimation. It could be 12 months or more away, he said.
Even as the financial system evolves, deep-seated differences will remain between Australia and the U.S. Most Americans and Australians speak English and share many views and values, but the cultures of the two countries differ greatly in ways that affect marketing, Bertoli said. “In your face” advertising that can work well with “loud, confident” Americans can offend the more “laid-back” Australian consumers and business owners, he said.
Australians have become tech-savvy and comfortable with online banking, but they guard their privacy and often hesitate to reveal their banking information to a funding company, Allegos said. The entrance of OnDeck and Kabbage should help familiarize potential customers with the practice of sharing data, he predicted.
Cost structures for businesses differ in Australia from the U.S., Bertoli noted. Australian companies pay higher rent and have to pay minimum wages set much higher than in the United States, he said. Published reports set the Australian minimum wage at $13.66 U.S. dollars. The higher costs down under can take a toll on cash flow. “Take an American scorecard and apply it to Australia?” Bertoli asked rhetorically. “You just can’t.”
Distribution’s not the same for commercial enterprises in the two countries, Bertoli maintained. Despite having about the same geographic area as America’s 48 contiguous states, Australia has a population of 23 million, compared with America’s 322 million.
No matter how many people are involved, changing their habits takes time. Australian merchants prefer fixed-term loans or lines of credits instead of merchant cash advances, Bertoli said. In many cases Australian merchants simply aren’t as familiar as Americans are with advances, Allegos said.
Besides, the four big banks in Australia tend to solicit merchants for credit and debit card transactions without the help of the independent sales organizations and sales agents. In the U.S., ISOs and agents play an important role in explaining and promoting advances to merchants, Bertoli said. Advances make sense for merchants because advances adjust to cash flow, and they help funders control risk, but just haven’t caught on in Australia, Bertoli said. Australians resist advances if too many fees are attached, said Allegos.
Pledging a portion of daily card receipts might seem too frequent, too, he said. Besides, advances are limited to merchants who accept debit and credit cards, while any business could conceivably choose to take out a loan, said de Bree.
Advances have to compete with inventory factoring, which has become a massive business in Australia, according to Heussler. The business can become intrusive because funders may have to examine balance sheets and talk to customers, he said.
Australia’s reluctance to turn to advances, leaves most alternative funders promoting loans and lines of credit. Prospa, for example, uses some brokers to that end but also relies on online connections, direct contact with customers, and referrals from companies that buy and sell with small and medium-sized businesses.
“Anyone that touches a small business is a potential partner,” said Heussler, including finance brokers, accountants, lawyers and even credit unions, which have the distribution but not the product.
Moula finds that most of its business comes from well-established companies and that loans average just over $27,000 in U.S. currency and they offer loans of up to more than $77,000 U.S. The company offers straight-line, six- to 12-month amortizing loans.
Using a model that differs from what’s common in the U.S., Moula charges 1 percent every two weeks, collects payments every two weeks and charges no additional fees, Allegos said. A $10,000 (Australian) loan for six months would accrue $714 (Australian) in interest, he noted.
Spotcap Australia offers a three-month unsecured line of credit and doesn’t charge customers for setting it up, Heussler said. If the business owner decided to draw down, it turns into a six-month amortizing business loan for up to $100,000 Australian. Rates vary according to risk, starting at half a percent per month but averaging 1.5% per month.
If companies have all of the necessary information at hand, they can complete an application in 10 minutes, Allegos said. Moula has to research some applications offline if the company’s structure deviates too greatly from the usual examples – much the same as in the U.S., he maintained. The latter requires strong customer-service departments, he said.
Kikka uses a platform based on the Kabbage model, which gives 95 percent of customers a 100-percent automated experience, Steger said. “It goes to show the power of our automation, our algorithms and our platform,” he maintained.
Spotcap prefers to deal with businesses that have been operating for at least six months, Heusler said. The funder examines records for Australia’s value-added tax and other financials, and it likes to connect with the merchant’s bank account. Spotcap can usually gain access to the account information through cloud-based accounting systems and thus doesn’t require most companies to download a lot of financial documents, he noted.
Despite the differences between the two countries, banking regulations bear similarities in Australia and the United States, sources said. In both nations the government tries harder to protect consumers than businesses because they assume business owners are more financially savvy. For consumers, regulators scrutinize length of term and pricing, sources said, and on the commercial side the government is concerned about money laundering and privacy.
Regulation of commercial funding will probably intensify, however, to ward off predatory lending, Bertoli said. Government will consult with businesses before imposing rules, he said. A couple of alternative business funders aren’t transparent with their pricing and they charge several fees – that sort of behavior will encourage regulation, Allegos said.
“I know they’re watching us – and watching us very closely,” he added.
In general, however, the Australian government supports alternative finance, Bertoli said, because they want there to be options other than the four big banks and wants small business to have access to capital. Small businesses account for 46 percent of economic activity in Australia and employ 70 percent of the workforce, he noted, saying that “if small businesses are doing badly, the economy is doing badly.”
Hence the need, many in the industry would say, for more alternative funding options in Australia.
Should Alternative Lenders Reconsider IPOs?
August 31, 2015
OnDeck has gotten very quiet over the past month as the stock hovers near its all time low, and down more than 50% from its IPO price. The only updates related to them on the news wire lately are reminders from law firms to join in on the existing class action lawsuit. One has to wonder if they regret going public.
To make the things murkier, the Madden v. Midland decision effectively makes it illegal in a handful of states for alternative lenders to rely on chartered banks to originate loans for them at interest rates that violate state usury laws. In states such as New York, that’s a big problem for OnDeck, but fortunately for them and other lenders like them, they can still fall back on a choice of law provision to still be able to make the loans.
Combine that landmark ruling with the Treasury RFI, The Dodd Frank Section 1071 Reg B rule that everyone wants enforced all of the sudden, and a chorus of lenders calling for regulatory action, and we don’t exactly have an ideal environment for other alternative lenders considering an IPO.
But does an IPO really matter?
I am reminded of a long email that Elon Musk sent to employees of SpaceX two years ago regarding their aspirations to go public so that they could monetize their stock options and get rich.
“Some at SpaceX who have not been through a public company experience may think that being public is desirable. This is not so.”
“Another thing that happens to public companies is that you become a target of the trial lawyers who create a class action lawsuit by getting someone to buy a few hundred shares and then pretending to sue the company on behalf of all investors for any drop in the stock price.”
“Public companies are judged on quarterly performance. Just because some companies are doing well, doesn’t mean that all would. Both of those companies (Tesla in particular) had great first quarter results. SpaceX did not. In fact, financially speaking, we had an awful first quarter. If we were public, the short sellers would be hitting us over the head with a large stick.”
“Public company stocks, particularly if big step changes in technology are involved, go through extreme volatility, both for reasons of internal execution and for reasons that have nothing to do with anything except the economy. This causes people to be distracted by the manic-depressive nature of the stock instead of creating great products.”
“It is important to emphasize that Tesla and SolarCity are public because they didn’t have any choice. Their private capital structure was becoming unwieldy and they needed to raise a lot of equity capital.”
“Those rules, referred to as Sarbanes-Oxley, essentially result in a tax being levied on company execution by requiring detailed reporting right down to how your meal is expensed during travel and you can be penalized even for minor mistakes.”
Any other alternative lenders possibly considering an IPO should strongly evaluate whether or not it’s necessary to go public to carry out their objectives. Surely the folks at OnDeck must be at least a little bit distracted by the manic-depressive nature of their stock price, the class action lawsuit, reactions to their quarterly reports, and the unyielding scrutiny by analysts and pundits. Surely it could be argued that they’ve lost some of their PR mojo in the mix.
It’s not easy running a public company, especially a lender in a post-financial crisis world where Wall Street hatred still runs hot. Hopefully if you are in this industry, you are in it for the long haul and not just for an IPO to cash out and give up…
Are Your Sales Methods Wimpy?
August 24, 2015
Do you remember Wimpy? Some of you probably don’t but those who do remember Wimpy, remember him as being a silent scam artist who promised the famous phrase, “I will gladly pay you Tuesday for a Hamburger today.” He never adhered to that promise. I never ascribed cartoons to real life but we can learn a few things from Wimpy and how we understand business relationships.
Back in the day, there was something called Trust. It was a little thing that was swapped like currency with the people that you interacted with on a daily basis. Today, trust has been traded for the Internet and now we have nothing to stand on. We must work harder to build relationships in any capacity and at the end of the day, you might still question if a developing level of trust is reciprocal.
Take trust and mix it with a sales position in 2015 and you have disaster. The countless nos you must endure to get to the few yeses and the pressure to close those yeses is exacerbated by the fear that a Wimpy or the Internet will come and take them away.
While reading Personal Touch Makes Big Difference in Small-Business Loans on the WSJ this morning, I immediately got a little upset. This is such a “Duh Article.” A “Duh Article” is one of those articles that are true, but so true in the fact that you end up saying, “Duh, I know that!” and wonder why such basic teachings become important when they are finally backed up by a case study. Did anyone really not think that personal relationships help? Or that Wimpy, the borrower you didn’t know, would not really pay you on Tuesday when you relied on just his word? It goes both ways.
Below are a few ways to avoid the Wimpy traits of sales when building a relationship between you and a business owner:
#1 Rule of Sales Relationships: What are you even selling?
You are selling money so it shouldn’t be that hard right? WRONG. Even though everyone could use an influx of capital, you have two factors that impact your sales in the MCA Industry. PRICE and PROMINENCE.
- Price: We are already slandered for putting a hefty price tag on advances and even if you say, “We offer factor rates as low as a 1.08!”, How many 1.08 deals do you really close?
- Prominence: Names, Logos, and Promises. Characterization plays a big part in what you represent. With so many MCA Entities popping up, how do you set yourself apart?
You have to offset the two factors by building the relationship and creating an understanding.
Example: Imagine you are selling a line of ketchup to every hamburger shop in the U.S.
Do they already have ketchup? They will eventually need to reorder. So where do they get it now? Are they content with this outlet or have they never thought to seek out an alternative? This is the same “question scenario” you have to answer when selling. Note: Replace Ketchup with Capital.
- Do they need capital now?
- Will they need more capital soon?
- How do they get capital when they need it?
- How can I deliver all of the above and be their new preferred choice?
If the answer to the first question is no, that’s okay, move on to the next question. You are more likely to close double the sales when you answer the second and third one. Either way, one of those will have an answer.
#2 Rule of Sales Relationships: Understand the Market you are Targeting
Who is your target market and do you understand them? This is one of those situations where I feel offering a factor to a manufacturing company that is based on invoices is just plain dumb. There are many alternative financing options that are more mainstream than you think and it all boils down to the top 3 things:
- Industry: Do you understand the industry you are selling to? You will connect better with your merchant if you understand the inner workings, schedule, and the ways they obtain their receivables. Their Industry is their passion. If you don’t connect with their passion (unless there is a dire need for emergency capital) you will not be taken seriously or remembered. Ask yourself, “how can I demonstrate an understanding of the way the business makes money or works with different vendors to get paid?”
- Credit: Don’t promise a low rate to a business that you know has a credit score below 600. Research the different tier programs PROVIDED to you by most Direct Funders. Categorize your tier sales structure and request examples of similar past funded industries from the Funders you work with.
- NEED:If they do need capital now, what is it for? This is a great conversation starter. Whether it’s a seasonal need, equipment-related, or plain ol’ working capital, probe the conversation by finding out their goals so you can better represent the merchant and fit them to a better funding program.
#3 Rule of Sales Relationships: The Follow up
This may go far beyond the basic sales guidelines, but categorize your prospects!
Example: Say you have a book of restaurants that you have connected with before and you know they are going to start gearing up for the holidays. Let them know you UNDERSTAND this time of year and how you can assist! Personalize the need of capital with something they base their business on. This is where direct marketing comes into play. If you remind them of who you are and that you are to assist them to manage the most stressful money making times of the year, they will think of you as their go-to when they NEED it.
Alternative Lending Becoming Less Alternative
August 23, 2015
Alternative funders are looking a little more like bankers these days, but that’s not to say they’re developing a taste for pinstriped three-piece suits and pocket watches on gold chains. They’re promoting bank loans, applying for California lending licenses and contemplating the unlikely possibility that one day they’ll obtain their own bank charters.
“It’s what everybody’s talking about,” said Isaac Stern, CEO of Yellowstone Capital LLC, a New York- based funder. “If it’s not in their current plans, it’s in their longer-term plans over the next three to five years.”
Funders promote bank loans to drive down the cost of capital, sell a wider variety of products, offer longer terms and bask in the prestige of a bank’s approval, said Jared Weitz, CEO of United Capital Source.
Loans allow for much more customization than is possible with merchant cash advances, noted Glenn Goldman, CEO of Credibly, which was called RetailCapital until a little less than a year ago. The name changed as the company began offering loans in addition to it original advance business. It’s now working with three banks.
While the terms don’t vary much with advances, borrowers can pay back loans daily, weekly, semi-monthly or monthly, Goldman said. Loans can also include lines of credit that borrowers draw down only when they choose. Interest rates on loans can vary, too, he said, and loans can come due after differing periods of time.
Besides that flexibility, loans also offer familiarity among merchants and sales partners – unlike the sometimes baffling advances, Goldman said, adding that “everybody knows what a loan is, right?”
Loans have so many advantages over advances that Credibly expects its loan business to grow more quickly than its advance business, said Goldman, who was formerly CEO of CAN Capital.
Those advantages are also encouraging other advance companies to form partnerships with banks to provide merchants with loans that aren’t subject to state commercial usury laws, said Robert Cook, a partner at Hudson Cook LLC, a Hanover, Md.-based financial services law firm.
The advance company markets the loan to the customer, the bank makes the loan, and the advance company buys it back and services it at the rate the bank is allowed under federal law, Cook said. The bank doesn’t lose any capital, it takes on virtually no risk and it profits by collecting a few days’ interest or a fee, he noted.
Where the bank’s located can make a big difference. A bank based in New York, for example, can charge only 25 percent interest no matter where the customer resides, while New Jersey allows banks to collect unlimited interest anywhere in the country, Cook said.
But the partnerships funders are forming with banks could face a threat. The United States Court of Appeals for the Second Circuit ruled in May in Madden v. Midland Funding LLC that a non-bank that buys a loan cannot charge interest set where the bank is located but must instead charge interest according to the laws of the state where the consumer is located, Cook noted. That could mean a lower rate.
In Cook’s view the case was poorly argued, the decision was wrong and the ruling may be reversed, “but it has to trouble someone who is thinking about starting up a bank partnership,” he said.
The court was asked whether the rules that apply to a national bank also apply to the non-bank that bought the loan, Cook maintained. That’s not the question, he asserted. The argument should have been that the idea of “valid when made” should take precedence. It states that a transaction that’s not usurious when it’s made doesn’t become usurious if a party takes action later – like reassigning the note, Cook said.
Meanwhile, offering bank loans isn’t the only way alternative funders are coming to resemble banks. Some are obtaining what’s formally called a California Finance Lenders License that enables them to make loans in that state.
California began requiring the license in response to lawsuits over the cost of advances. The state has published a licensee rulebook that’s about the size of an old-school New York phone book – the kind kids sat on to reach the dining room table, according to Yellowstone’s Stern, who completed the licensing process three years ago.
Getting the license took 15 or 16 months and required lots of help from the legal team at Hudson Cook, Stern said. The state investigated his back- ground and fingerprinted him. The cost, including lawyers’ fees came to about $60,000, he recalled.
“Man, it was like pulling teeth to get that license,” Stern said. Keeping it’s not easy, either. “We guard that thing fiercely,” he maintained. “They’ll take away your license if you even sneeze the wrong way.”
The hassles have paid off, though, because Yellowstone now deals directly with California customers instead of sharing the profits with other companies licensed to operate there. What’s more, companies that don’t have licenses are sending business Yellowstone’s way.
Retaining the profits from loans is also prompting some funders to contemplate applying for their own bank charters. But Cook, the attorney from Hudson Cook, sees little or no chance of that happening.
Federal bank regulators are reluctant to grant charters to mono-line banks – institutions that perform only one financial-services function, Cook said. “It’s risky to put all your eggs into one basket,” he maintained.
Regulations make forming or acquiring a bank so difficult for businesses that want to make small loans at high rates, Cook said. “If that’s going to be their business plan, they’re not going to get a bank.” A state charter requires the approval of the Federal Deposit Insurance Corp., which isn’t likely, he noted.
Utah industrial banks and Utah industrial loan companies are insured by the Federal Deposit Insurance Corp. but aren’t considered bank holding companies, Cook said. However, that’s a regulatory loophole that may have closed and thus may no longer offer a way of becoming a bank, he noted.
Clearly, the complications surrounding bank loans, lending licenses and bank charters mean that becoming more bank-like requires more than a pinstriped suit.
Second Guessing Alternative Lending
August 21, 2015The best case scenario for the alternative lending industry is that every startup’s model is pure genius and all the founders’ assumptions are correct. To an extent, it kind of feels that way right now, that everyone’s riding this unstoppable growth train. I can barely go a half hour without getting an email alert telling me that yet another fintech player has raised millions to disrupt lending. The steady drumbeat of news validates ideas, concepts, and investments, and puts pressure on others to jump on board and join the party.
Meanwhile, industry conferences become self-reinforcing loops of assurance. They’re great places to hear what you already thought.
No, you’re brilliant!
No, you’re the brilliant one!
It’s incredibly easy to get caught up in it all. I am guilty of it myself sometimes. I know this because my pedestrian friends outside the industry have reacted to the investment opportunities in it with extreme skepticism.
“But isn’t this brilliant?!,” I ask them. Most are amused, but I’ve never convinced a pedestrian to invest in marketplace loans. They see flaws and risk all over it, and sometimes for reasons I hadn’t even considered. I compared these responses in my head with responses I’ve heard from industry professionals. Was the contrast in feelings reflective of differing philosophies? And do industry professionals just have more knowledge to think the way they do?
I had an epiphany when a colleague sent me a link to a short puzzle published on the NY Times website to see if I would arrive at the same conclusion that she did. I didn’t.
For the sake of fun and knowing what I’m talking about, you can take it here.
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According to a sample, a mere 9 percent heard at least three nos — even though there is no penalty or cost for being told no. 78 percent never even got one no before they guessed the answer. “It’s a lot more pleasant to hear ‘yes’,” the research claims. “This disappointment is a version of what psychologists and economists call confirmation bias. Not only are people more likely to believe information that fits their pre-existing beliefs, but they’re also more likely to go looking for such information.”
The Times article is well…timely, because it’s possible there’s a running case of confirmation bias right here in the alternative lending industry. Nothing makes this more obvious than by the way Todd Baker ripped the industry to shreds in his August 17th article for American Banker. In Marketplace Lenders Are a Systemic Risk, he opens by writing, “Once again the markets have fallen in love with a group of young, aggressive and not very regulated lenders.”
The sobering viewpoint was immediately met with criticism, most notably by Mike Cagney, the CEO of SoFi. Cagney issued a direct response to Baker in own American Banker piece. Of Baker, he wrote, “While his intentions are good, his rationale is flawed.”
But whether or not you agree or disagree with what Baker wrote, he’s done the industry an enormous favor. He looked at it all and said “no.” According to the Times, “We’re much more likely to think about positive situations than negative ones, about why something might go right than wrong and about questions to which the answer is yes, not no.”
Keep that in mind when Baker wrote, “If an [Marketplace Lender] MPL can’t issue new loans — which will happen any time investors refuse to buy loans in the MPL marketplace — the transaction fees that are the MPLs’ main source of revenue and cash will instantly disappear, while expenses continue to mount. An MPL has to keep issuing loans to survive.”
Few people like to think about what would happen when or if investors refuse to buy loans. And when Cagney responds directly to this by saying, “The scenario he describes can’t happen,” one has to wonder if his rationale might be subject to confirmation bias. “If there is no buyer, MPLs simply stop lending,” he explained.
Rather than rebut Baker’s argument, he seems to confirm it. Without being able to issue loans, an MPL’s revenue will disappear, and therefore an MPL indeed has to keep issuing loans to survive. How else does an MPL stay in business if it stops lending?
Baker reminds us all that we have been here before. “When sentiment changes, the MPL investors’ rush to the exits will be no less swift than it was for traditional finance companies in 2007-8 or in the Russian and Asian debt crises of the late 1990s,” he writes. He alludes that large swaths of industry professionals have convinced themselves that things will be different this time even though history continues to repeat itself.
“There is too much money to be made before the inevitable blow-up,” he laments.
Baker’s opinion is one of the best pieces I have read about alternative lending this year, mainly because he was unabashed in his criticism. I’ve always believed that the best way to feel good about your decision is to hear a lot of reasons first about why you shouldn’t do something. Coincidentally, in the Times puzzle, I got nine nos before I felt confident about the game’s rule and successfully solved it. Only 9 percent of participants got three nos or more.
Nos are healthy and should be considered a welcome concept in this industry. Those working on credit models should remember that it’s not just about confirming your theories, but also about disproving them. Build your model and then try to destroy it. Test things that you think won’t work in addition to the things you think will work. Go out there and break things. Run worst case scenarios. Fund money to a deal that you think will go bad. See what happens.
“Often, people never even think about asking questions that would produce a negative answer when trying to solve a problem — like this one. They instead restrict the universe of possible questions to those that might potentially yield a ‘yes’,” says the Times. This flawed approach could lead to catastrophe.
In The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, odd scenarios not accounted for in computerized trading models led to disastrous losses. At times, the quants’ computers refused to acknowledge events that were actually happening because the built-in models believed they were too statistically impossible.
So when SoFi’s Cagney says, “the scenario [Baker] describes can’t happen,” in regards to the potential of an MPL failing because there are too few loan buyers, it should be taken with a grain of salt. Of course it can happen.
But it should also be mentioned that SoFi is now worth about $4 billion. That means that in a room full of alleged geniuses, Cagney is a certifiable genius. But there’s no way someone in his position would raise a fresh billion dollar round of capital and then concede to American Banker that the whole system could be torn to shreds at any moment.
The danger is that others will point to Cagney as validation that their own lending aspirations are viable even when their own models and market positioning are substantially weaker. Not every new lending startup CEO is Mike Cagney. And there is plenty of truth in Baker’s opening line, “Once again the markets have fallen in love with a group of young, aggressive and not very regulated lenders.”
A lot of arguments have been put forth about why everything is different this time, that it is impossible to fail, but we may find out just as we have countless times before that this isn’t the case.
It’s refreshing to hear someone second guess the whole industry. Hopefully if you’re a player in this space, you’ve thought of reasons why your business might be flawed. If you’re like 78% of the population that’s too scared to even get one no before committing to an answer, you’re probably in big trouble…
OnDeck vs. IOU Financial: Are one of these lenders mispriced?
August 12, 2015
Has OnDeck’s stock price dropped so much that it’s now a buying opportunity? You’ll probably want to read this before you decide.
OnDeck’s IPO market cap was $1.3 billion. They funded $1.2 billion worth of loans in 2014. OnDeck’s stock has since dropped though, bringing its market cap down to around $650 million. The company is often compared to Lending Club despite their business models being completely different. But since there has been seemingly no one else to make comparisons with, the two have become star crossed lovers in a new FinTech Lending category of the market.
Everyone seems to have ignored the fact that one of OnDeck’s direct competitors is also a public company and I don’t mean a subsidiary of a giant conglomerate for which no individual comparison would be logical, but a standalone entity that is a serious player.
Kennesaw, GA-based IOU Financial (formerly IOU Central) is actually a public company in Canada, even though its only operational activities are small business loans in the U.S. The company is not a fly-by-night me-too business lender, as they funded more than $100 million in 2014 and earned a spot on the AltFinanceDaily leaderboard for being one of the biggest in the industry.
OnDeck out-loaned IOU in 2014 at a ratio of 12 to 1, but here’s the kicker, OnDeck’s market cap is more than 34x the size of IOU. When converting to USD, IOU’s market cap is only slightly above $18 million.
$18 million…
That for a company that loaned $100 million last year. It’s no wonder that the perceived low market value has invited a hostile takeover bid from Russian venture capitalists. The tender offer of $15 million, presumably in Canadian dollars, would’ve acquired 55.9% of the company’s outstanding shares. The company is currently waiting for its shareholders to vote on the offer.
Meanwhile, another competitor, Kabbage, was recently valued at $875 million on loan volume last year of $400 million.
Ignoring all other factors that comprise a lender’s worth
- Kabbage was valued at more than twice its annual loan volume
- OnDeck’s IPO value was about equal to its annual loan volume, but their current market cap is almost half its annual loan volume
- IOU Financial’s current market cap is less than 20% its annual loan volume.
On these stats alone, IOU Financial seems to be incredibly undervalued, especially for a company whose spokesperson is celebrity investor and TV personality Kevin O’Leary.
OnDeck touts OnDeck marketplace as a way to sell off loans and generate income but IOU also regularly sells off its loan receivables while retaining the servicing rights just like OnDeck does.
Kabbage out-loaned IOU last year by a ratio of only 4 to 1, yet is valued almost 50x higher than IOU.
Every company has strengths, weaknesses, and reasons why they stand apart from their peers even if they look very much like them. However, given the mind blowing disparity in valuations for lenders that compete for the same customer with similar products, there surely has to be a buying or selling opportunity in here somewhere.
I think the Russian nuclear scientists are on to something…
