The Pandemic, The Economy, and The Presidential Race
March 20, 2020Note from the Editor: In early February, I asked one of our regular journalists, Paul Sweeney, to look into the economy and the presidential race to size up the coming election season. As he was wrapping up his interviews over the span of a month, things took a startling turn, and COVID-19 came to the forefront and changed everything. This story is an amalgamation of reporting that started one way and quickly morphed into another. In light of how fast the situation is changing, we are publishing it now rather than waiting until early April to release it in print.
Chris Hurn, who heads an Orlando-area financial firm in Florida that specializes in small business lending, says he is witnessing fear and desperation among business owners whose stores, shops and enterprises have been thrown into a tailspin by the coronavirus pandemic.
“We’ve been overwhelmed with telephone calls and e-mails,” says Hurn, chief executive at Fountainhead Commercial Capital, a non-bank Small Business Administration lender which boasts more than $250 million in originations last year. “I’ve fielded over 300 inquiries from borrowers about these loans in just the last few days,” he added. “People are telling me that they’re being harmed and don’t know how they’ll make payroll. The SBA needs to act.”
What Hurn is experiencing in Florida is not just an isolated incident. Thousands of small businesses are under siege nationwide as Americans’ have gone into isolation in response to the pandemic, helping precipitate a full-blown economic crisis. As of March 17, the coronavirus – also known as Covid-19 – had leapfrogged across the globe since appearing in China in December, 2019, infecting people in 100 countries. There are now some 272,000 confirmed Covid-19 cases worldwide and close to 11,300 deaths, according to data compiled by scientists at Johns Hopkins University in Baltimore.
In the U.S., the number of cases has cleared 19,000 as of March 20, the death toll has climbed above 230, and coronavirus cases have been recorded in all 50 states. The Center for Disease Control reports that the number of cases are growing at 25-30% per day. But experts warn that, because of a lack of testing, the actual number of cases is certainly higher.
The outbreak is drawing comparisons to the worldwide influenza pandemic of 1918. Popularly known as the “Spanish Flu,” that virus may have claimed as many as 100 million lives, according to estimates by the World Health Organization. Medical officials say that persons 70 and older and those with underlying medical conditions, such as a weakened immune system, are most at risk in the current pandemic.
“What makes this disease so lethal,” says Rachel Scott, a family physician in Austin, Texas and the author of “Muscle and Blood,” a pathbreaking study of occupational diseases, “is that people in the vulnerable population who come down with the virus are prone to contract severe acute respiratory distress syndrome. In ARDS, the virus destroys the sacs in the lungs, preventing oxygen from being delivered into the blood stream. By the time people with severe ARDS are hospitalized and treated with a ventilator, it may already be too late.”
To blunt the accelerated pace of contagion, governors and mayors are putting restrictions on citizens by curbing gatherings and monitoring interactions. Governors in 44 states have forced restaurants and bars to close shop in an unprecedented regulation of U.S. citizens. Meanwhile, millions of Americans self-quarantined and self-isolated and re-examined how they interact socially, commercially and professionally. Increasingly draconian controls to moderate the trajectory of the outbreak are not only turning cityscapes into ghost towns from coast-to-coast but throwing a giant monkey wrench into the U.S. economy.
Treasury Secretary Steven Mnuchin has reportedly warned Congressional leaders that the unemployment rate could spike to 20%.
Former Labor Secretary Robert Reich has gone Mnuchin one better amid reports that 1.2 Americans had filed for unemployment insurance. In an interview on MSNBC Thursday, Reich said he feared that the unemployment rate is likely to hit that 20% mark in the next two weeks. “Eighty percent of Americans are living paycheck to paycheck,” he declared ominously. “We’re in a national emergency.”
The pandemic and the ensuing economic crisis is also casting a giant shadow over the 2020 presidential election. “It’s a black swan event that wasn’t anticipated by any of the candidates, and the reverberations for the election are going to be huge,” said Richard Murray, a political scientist and elections expert at the University of Houston.
For the past 50 years, political analysts have generally agreed, the condition of the U.S. economy was a key predictor – if not the key predictor – to the outcome of presidential elections. President Jimmy Carter, for example, had the bad fortune to preside over a problematic economy marked by oil-price shocks and energy shortages, mile-long queues at gasoline stations, and sky-high interest rates. There was even a new word — “stagflation” – coined for the phenomenon of stagnant growth and runaway inflation, recalls David Prindle, a government professor and expert on voting behavior at the University of Texas at Austin.
There were, of course, additional negative complications to Carter’s presidency. Most notable was the “Hostage Crisis” in which Iranian students attacked the U.S. Embassy in Teheran in the fall of 1979, held 44 American diplomats and aides captive for more than a year, and made Carter look hapless and helpless. Nonetheless, Ronald Reagan, a former governor of California and longtime matinee idol, hammered Carter mercilessly on the economy, demanding: “Are you better off than you were four years ago?”
Answering that question sent Carter packing to his Georgia peanut business. “In 1980, as in every election, there were multiple causes,” says Prindle, “but the deciding factor was the economy.”
A healthy economy can serve as a mighty bulwark against opponents in a president’s bid for a second term. In the mid-1990s, an expanding economy and relentlessly buoyant stock prices – a Dow Jones Industrial Average so robust in the mid-1990’s that Federal Reserve chairman Alan Greenspan famously admonished investors for their “irrational exuberance” – allowed Bill Clinton to sail to re-election. (The good times also buffered Clinton during the ensuing sex scandal involving White House intern Monica Lewinsky.)
As the election year of 2020 dawned, a decently performing economy seemed to be serving President Donald Trump’s cause. Before the World Health Organization declared the coronavirus outbreak a pandemic in early March, the U.S. economy was coming off 10 full years of job growth and the unemployment rate had sunk to 3.5 percent, its lowest level in 50 years. Wages were also rising by nearly 4 percent per annum, noted Aparna Mathur, a labor economist at the business-backed American Enterprise Institute in Washington, D.C. “The economy is not spectacular,” she said, “but everything is moving in the right direction.”
Since then, however, the economy has been slammed as an alarmed country reacted to the pandemic. The NBA and NHL closed down their basketball and hockey seasons. Major League Baseball called a halt to spring training. The NCAA initially declared that “March Madness” would proceed and that hoopsters would perform before empty arenas, but then it pulled the plug. Even professional golf, an outdoor sport, hung up its cleats, announcing that The Masters, played at Augusta (Ga.) National Golf Course in April and the crown jewel of professional golf, would be postponed indefinitely.
Almost overnight, colleges and universities shut down classrooms, emptied their dorms, and opted for online coursework. Some 33 million schoolchildren in 41 states have ceased attending school. Hundreds of companies, including Amazon and Microsoft in Seattle, a city hit hard by the coronavirus, are requiring their employees to “telecommute” by working at home on their laptops.
The CDC at first advised Americans not to cluster in groups of more than 25 people, then cut that figure to 10. Americans are being prodded to engage in “social-distancing” by avoiding shaking hands and separating themselves from others by a separation of three-to-six feet from others. San Francisco has gone still further, grounding cable cars, closing down clubs and bars and restaurants and effectively putting the city on lockdown.
The city of Boston called off its iconic St. Patrick’s Day parade, Broadway theaters dimmed their lights, and Starbucks forbade customers to sit down in its coffee shops. Major events like South by Southwest, the music and cultural festival in Austin, Texas, was canceled, depriving Texas’s capital city of some $350 million in economic activity.
Jilting the festival cuts deeper than the losses to airlines, hotels, bars, restaurants, and music venues, notes Alfred Watkins, a Washington, D.C.-based economist and chairman of the Global Solutions Summit, an international consulting firm. “You have all of these people in Austin who are running events and they’re hiring caterers for sandwiches and refreshments,” he said. “You have independent contractors like videographers and photographers, sound-equipment suppliers, Uber and Lyft drivers, hairstylists, and even freelance entertainment journalists — all of whom are no longer making money. For these entrepreneurs,” he added, “losing this event is a little like retailers missing out on the Christmas season. It’s when they make their money.”
The airline, travel, leisure, and tourism industries are in free-fall. Major cruise lines suspended bookings and cut short voyages after horrific reports of coronavirus outbreaks among passengers trapped at sea, temporarily putting a $38 billion industry in dry dock.
The conventions industry, which has come to a standstill after wholesale cancellations, remains a vastly under-appreciated sector of the U.S. economy, argues George Brennan, former executive vice-president of marketing at Arlington (Va.)-based Interstate Hotels and Resorts, the world’s largest independent hotel management company.
These mass gatherings are an unheralded engine of growth, he says, packing a bigger economic wallop than they get credit for. “Conventions typically draw anywhere from 2,000 to 25,000 people,” he said. “They run 6,000 to 8,000 attendees on average, and most can only be accommodated by the top 10-20 U.S. cities, which include Chicago, San Francisco, Las Vegas, Atlanta, New Orleans and Orlando.
“Conventions are often multi-dimensional,” he added. “Attendees usually spend three to five days in town. They often shop at clothing stores and other retailers. They’ll take in sporting events or, if they’re in New York, a Broadway play. They’ll go to attractions like the San Diego Zoo, or spend an afternoon on a golf course in Florida or California.”
Conventions generate a tremendous amount of commerce and revenues for vendors and exhibitors. As an example, Brennan cites his former employer, the hospitality industry. “At hotel conventions,” he said, “you’ll see people there selling curtains and sheets, soaps and towels.”
In addition, many trade groups – Brennan cites the National Association of Civil Engineers and the American Medical Association as examples – count on the annual convention as an important component of their organization’s annual revenues. “When you pay to attend,” he says, “a significant portion goes back to the association. The convention often covers the yearly salary for a group’s staff.”
Amid the dramatic behavioral changes, the stock market registered several days of panic-selling in March, capped by a record, single-day plunge on March 16: The Dow Jones index plummeted 2,997 points, the third-worst percentage loss in history. After flirting with the level at which the Dow was reading on Inauguration Day Jan. 20, 2017, the market continued see-sawing this week, herky-jerkying between mini-rallies and skids.
Hoping to prevent a coronavirus recession, the U.S. Senate adopted by an overwhelming, 90-8 bipartisan vote a $100 billion bill sent by the Democraticac-led House that expands free testing for the coronavirus, provides for paid sick leave and medical leave for some workers, and an emergency unemployment insurance and food assistance programs. The bill was signed late Wednesday night.
Meanwhile, Congress was taking up a monumental $1 trillion economic rescue plan proposed by the White House on St. Patrick’s Day (March 17) that included a bailout for the hotel and airline industries, help for small businesses, and $500 billion in direct cash payments to Americans households.
“We’re looking at sending checks to Americans immediately,” Treasury Secretary Steve Mnuchin said in a Rose Garden press conference at the White House on St. Patrick’s Day. By immediately, he added, “I’m talking about the next two weeks.”
The Trump Administration’s proposed help for small businesses has a strong supporter in Karen G. Mills, former SBA administrator and senior fellow at Harvard Business School. During her tenure in the Obama Administration, Mills was a troubleshooter in several crises including the Great Recession and Hurricane Sandy. “In a worst-case scenario with this virus contagion, getting loans to people through banks is not going to be fast enough,” she told AltFinanceDaily just before the White House drew up its rescue plan. “They’ll need direct loans to people and other aid. If we lose our small business economy, it will be catastrophic.”
So how will the pandemic and the state of the economy play out politically in the November, 2020 general election between President Trump and former Vice President Joseph Biden, the presumptive Democratic nominee? The result remains shrouded in the fog of the future, of course, but the election’s contours are coming into focus.
Having seen him through numerous scandals, impeachment, and a trial in the U.S. Senate, Trump’s political and electoral following has been put to the test. Yet his backers remain unshakably loyal in a way not seen in 80 years, observed the University of Houston’s Murray. “More people are dug in now than at any time since the 1930s,” he says, as roughly 43% of the electorate is firmly lodged in Trump’s camp. “Trump’s support has been remarkably stable.”
The business community is a key demographic in the pro-Trump cohort, notes Ray Keating, chief economist at the Small Business & Entrepreneurship Council, a Washington, D.C. advocacy group claiming 100,000 members. “We have not polled our membership,” Keating says, “but when you look at the data they overwhelmingly vote Republican. We find that support for Donald Trump is clear and substantial.”
Richard Yukes, a Las Vegas-based oilman and longtime entrepreneur who votes his pocketbook, will be pulling the lever for Trump in the November election. The reason? Trump not only presided over a robust economy for the past several years, Yukes says, but the president slashed Obama-era regulations imposed on his industry. “Government regulation and bureaucratic regulation often get mishandled and misdirected by federal bureaucrats and Trump is for less regulation,” Yukes says. “I think America works best with less regulation.”
The owner and operator of oil wells in Wyoming, Yukes benefited handsomely last year when Trump’s Environmental Protection Agency relaxed rules governing methane leaks. The oilman reckons that complying with the regulations had been costing him an extra $1,500 per well each year.
No matter how well the economy has performed in the past three years, however, the pandemic economy promises to be a “game-changer,” says political scientist Murray, and history shows that voters are likely to take stern measure of the incumbent president’s performance during any a crisis.
Trump’s initial response to the coronavirus reminds Murray of Woodrow Wilson’s reaction to the Spanish Flu pandemic in 1918 while World War I was still raging. “As the U.S. was approaching climactic battles in Europe, President Wilson suppressed the news of the flu and the story didn’t get out though eventually people knew about it,” Murray says.
Wilson’s deceit hurt Democratic candidates who were battered in the 1918 midterm elections, just a few days before the November 11 armistice. Two years later, after Wilson had a stroke, the Democratic presidential candidate got crushed in the 1920 election by Warren G. Harding, a Republican senator from Ohio.
After war and influenza, Americans voted enthusiastically for Harding’s promise of “normalcy.”
Fears of Possible Recession Don’t Phase CRE Lenders
December 16, 2019
Depending on your vantage point, a slowdown is either already in progress, just around the bend or several years away. But some alternative commercial real estate professionals are trying to filter out the noise.
Instead, they are more aggressively forging ahead with growth plans, including trying to grab market share from banks.
The commercial real estate lending market remains highly competitive and alternative lenders say they remain focused on looking for opportunities to expand their business, even as the possibility of recession looms. At present, a number of professionals don’t see an imminent threat of recession, and even if there is one, they say they stand to benefit from picking up business banks don’t want to take on—or can’t—because of increased regulatory controls imposed on them since the last recession.
There are plenty of opportunities for alternative commercial real estate lenders to get ahead, even in this environment, says Chris Hurn, founder and chief executive of Fountainhead Commercial Capital, a Lake Mary FL-based, non-bank direct small business lender in the commercial real estate lending space.
To be sure, alternative commercial real estate lenders say that for the most part, there hasn’t been a major pullback in their space. But due in part to mounting economic concerns and changing business priorities, banks—which had already scaled back from their pre- Great Recession exuberance—have been taking an even more cautious approach to lending. This is especially true in certain regions of the country, or in sectors deemed higher-risk such as hospitality and retail, alternative lenders say. While the pullback hasn’t been broad-based, it’s been enough in some cases to create strategic pockets of opportunity for opportunistic non-bank lenders such as private equity funds, debt funds, crowdfunding portals and others.
For many of these commercial real estate professionals, whether or not a recession is on the horizon is not a guessing game that’s worth playing. And with good reason, given how much disagreement there is among market watchers, investment management professionals and others about where the economy is headed.
Certain economic data continues to be strong, for instance, but political and geopolitical factors such as trade wars continue to raise red flags. Then there’s the fatalistic notion that the economy has been on a tear for so long that it’s due for a pullback at some point. This all translates into a hodgepodge of speculation and indecision about the economy’s direction. The dichotomy is evident from the difference in sentiment expressed in two fund manager surveys from Bank of America Merrill Lynch taken a month apart. October’s survey was decidedly bearish; by November, the bulls were back, muddying the waters even more.
Instead of wavering in indecision, however, some alternative commercial real estate players are hunkering down and highly focused on building their business in a cautiously optimistic and strategic manner.
Hurn of Fountainhead Commercial Capital predicts a number of increased opportunities for alternative commercial real estate lenders due to pullback from banks and a growing need for capital. He cautions alternative lenders against being too pessimistic and losing out on potentially lucrative market opportunities as a result.
“I think we might be going into a period of slightly slower growth, but none of the indicators suggest we’re remotely close to where things were 10 years ago,” Hurn says. “If we’re not careful, we’re going to talk our way into recession. It’s a self-fulfilling prophecy.”
Indeed, even as perplexing questions about the economy’s long-term health persist, some alternative commercial lenders anticipate growth in the coming year. Evan Gentry, chief executive and founder of Money360, a tech-enabled direct lender specializing in commercial real estate, says the company’s loan origination business is on track to close between $650 million and $700 million in 2019. That’s expected to increase to about $1 billion in 2020, fueled by growth in some strategic markets, including Washington DC, Atlanta, Miami and Charlotte, N.C., where the company is seeking to add loan origination personnel. Gentry says the company also continues to experience strength in many of the western markets, including the intermountain west markets of Colorado, Utah and Idaho, where growth is expected to continue.
CommLoan, a commercial real-estate lending marketplace in Scottsdale, Ariz., also sees strategic opportunities to grow in this environment. Mitch Ginsberg, the company’s co-founder and chief executive, predicts 2020 will be a strong growth year for his company, after a several-year beta period. CommLoan has plans, for example, to start hiring account executives to build relationships in additional states. Initially, the focus will be on institutions in the Southwestern U.S., with plans to add lenders in Texas, Utah, Colorado and New Mexico in the early part of 2020, Ginsberg says.
Though certain regions or business lines within commercial real estate may be experiencing some pullback, he says his overall outlook for the economy and commercial real estate remains strong. “There is still an enormous amount of activity,” he says. “If and when a correction does happen, it’s going to be a lot softer and not that deep and not that long because of the fundamentals in the economy.”
FINDING WAYS TO COMPETE MORE EFFECTIVELY WITH BANKS AND OTHERS
Some commercial real estate professionals say they are focusing more attention on sectors, regions and concentrations that the banks aren’t going after so readily.
If an alternative lender can offer more money than a bank on a particular deal or offer more flexible terms, or do deals that traditional lenders simply won’t do, for example, then it’s a boon for them. For a slightly higher price, alternative lenders—especially those whose business model relies heavily on technology—are able to take on slightly riskier deals than a bank might be able to stomach, says Jacob Goldsmith, managing partner of Goldwolf Ventures LLC, a privately held alternative investment and asset management company with offices in Miami and Austin.
“Alternative lenders are a lot more nimble,” says Goldsmith, who keeps close tabs on the commercial real estate lending industry.
Especially given the ambiguous economic climate, there are several areas that could be prime opportunities for savvy alternative commercial real estate lenders to gain a leg up. For instance, some banks of late have shied away from certain special purchase property types like hotels, day care facilities and free-standing restaurants, says Hurn of Fountainhead Commercial Capital. These types of properties are traditionally seen as riskier in the latter part of an economic cycle.
Nonetheless, “there’s opportunity here for non-traditional lenders to step in and fill that gap,” he says. Retail loans are another category where banks have been pulling back. One reason banks are being more cautious is the sentiment that as online shopping becomes more pervasive, there’s less of a need for brick-and-mortar shops. This trend is underscored by the recent announcement of Transform Holdco—the company formed to buy the remaining assets of bankrupt retailer Sears Holdings Corp.—that it would close 96 Sears and Kmart stores by the end of February. Still, some industry watchers aren’t ready to concede retail’s demise.
While these types of announcements fan fears, concern over the death of retail is largely overblown, according to Troy Merkel, a partner and real estate senior analyst at RSM, which provides audit, tax and consulting services. “The banks are being too overly cautious,” he opines.
The opportunity for alternative lenders, he says, is not in funding loans that add to the supply, but rather in funding loans that change the existing supply. While the need for new development may not be as great, there is a growing demand for repurposed properties, he says. This includes upscaling an older mall or turning an existing retail building into a mixed use property, namely a mix of retail stores and multi-family apartment complexes. There is still a real need for these types of developments, Merkel says, and with banks shying away, the door is open for alternative lenders to “make a play,” he says.
Real estate professionals say they also see opportunities for alternative commercial real estate lenders to make loans in areas outside major metro cities, where the competition isn’t as strong.
“There will always be opportunities in the ups and downs, the ebbs and flows of the cycle. You just have to be a lot smarter in this part of the cycle,” says Goldsmith of Goldwolf Ventures.
BECOMING RECESSION-PROOF
Pockets of opportunity notwithstanding, alternative commercial real estate lenders have to play it smart, professionals say. For instance, they should not be overly bullish on a particular sector or throw caution to the wind when it comes to their underwriting practices.
That’s because when the market turns—as it inevitably will at some point—there will likely be more defaults and lenders that haven’t dotted their I’s and crossed their T’s will understandably face stronger headwinds. They need to keep their close eye on expenses as well, which may have ticked upward over the past several years. “People get complacent when times are good. This is probably not the time to be complacent anymore,” says Hurn of Fountainhead Commercial Capital.
Another protective measure against an eventual downturn is to diversify sales channels and property types. “If you put too many eggs in one basket, it’s a problem,” Hurn says.
It’s also important for lenders to have their guards up since higher risk deals can lead to losses if a recession hits. Lenders have to be smart when it comes to taking on risk, says Tim Milazzo, co-founder and chief executive of StackSource, an online marketplace for commercial real estate loans. “They have to have a certain expertise in underwriting these transactions correctly and assessing risk,” Milazzo says.
In light of significant ambiguity about where the economy is heading, Gentry of Money360 says his company is protecting itself by taking an ultra- conservative approach. This means, for instance, only making first-lien position loans secured against income producing properties at a loan-to-value ratio on average of 65 percent, he says. Some alternative lenders are making these loans at a loan-to-value ratio of 80 percent or 85 percent, but Gentry says this is too high a rate for his taste. Also, Money360’s loans are also generally short- term—in the two-to-three-year range, which reduces some of the risk and seems especially prudent at this point in the cycle, he says.
When the market turns—as it inevitably will at some point—there will be more loan defaults, and those that are on the more aggressive end of lending will bear most of the challenges, he says.
He cautions other alternative lenders to avoid taking on excessive risk. “You’ve got to be thinking ahead and planning and lending as if the downturn is right around the corner—because it could be,” he says. Even taking a conservative approach, there are still significant business opportunities, he says.
BE ON THE LOOKOUT FOR RECESSIONARY OPPORTUNITIES
Meanwhile, if a recession does hit, alternative commercial real estate lenders say they will have even more opportunities to gain market share, participate in workout financing and hire key personnel. Alternative lenders that are more steeped in technology may potentially have even more of an upper hand since this can enable them to close deals much more efficiently and quickly and at a lower cost, while at the same time giving borrowers broader access.
“In a tighter market, every reduction in rate and cost will make more of a significant difference to borrowers than it does at the moment,” says Ginsberg of CommLoan, the commercial real-estate lending marketplace.
Although there are a growing number of alternative commercial real estate lenders who are relying more heavily on technology than they did in the past, commercial real estate lending still hasn’t flourished online to the extent personal and small business lending has. One reason is that the loans are larger and human intervention is often seen as beneficial, says Gentry of Money360.
However, online lending within the commercial real estate lending space is still on the horizon, according to Ginsberg of CommLoan. “It’s slow-go, but it’s inevitable,” he says.
The Current State of SME Lending in Canada
December 1, 2019
According to the latest statistics, there were 1.18 million employer businesses in Canada, with the majority of them located in the provinces of Ontario and Quebec.
- 1.15 million (97.9%) represented small businesses
- 21.926 (1.9%) referred to medium-sized ventures
- Only 2.939 (0.2%) accounted for large corporations
Small and medium companies are blooming in Canada: they represent 99.8% of all businesses, and they are the heart of the local economy. However, these businesses are facing extreme challenges when it comes to raising capital – a crucial element of SME growth.
The Canadian banking sphere, dominated by five large banks, often overlooks these businesses. Banks in Canada typically require 32 articles of information when applying for a loan and still 78% of applications from SMEs are rejected. It is especially stressful for startups: you can’t get a loan unless you have customers, but you can’t start your business and get customers without a loan. Cash flow, on the whole, is a complex concept that may be confusing for small business owners, and this kind of financial exclusion only makes it worse. The problem is global, but this Catch-22 has given the green light to alternative lenders worldwide.
THE ALTERNATIVE
One of the alternative funding options for SMEs to bypass the banks and find the right level of capital that they need is called a merchant cash advance (MCA). MCAs aren’t loans. Instead, they represent the sale of a business’s future revenues in exchange for quick cash — the majority of applications are approved within 2 days. This way, a funder provides a lump sum payment with a predetermined percentage (the factor rate) of a merchant’s future credit or debit card sales — cash and check sales typically don’t qualify to be counted. The process goes on until the contractual terms are satisfied. The MCA industry is growing on Canadian soil, but since it is a relatively new domain, the sector remains heavily influenced by American providers, especially when it comes to business models and pricing. But domestic providers don’t see it as a threat. Bruce Marshall, VP of British Columbia-based Company Capital told AltFinanceDaily in 2016 that “We are happy that some of the bigger US players are coming up here and they are spending millions of dollars on advertising. These companies raise awareness of the industry to a higher level and with us being a smaller company, we can ride on their coattails.”
The question of raising awareness of new technology is vital. In comparison to American SME owners, their Canadian colleagues are slower to adopt technology — for instance, only 27% say they currently use technology to analyze customer data. Another study by BDC claims that only 19% of Canadian businesses are digitally advanced.
On the other side, those established companies find the Canadian alternative lending market to be “a very manageable extension of the US market.” However, it’s a smaller market, and Canada’s geographical position (the majority of businesses are located in four main provinces out of thirteen) and regional differences play their part as well. For instance, because of the restrictions that require businesses to advertise and produce marketing materials in French, the majority of alternative lenders from the US don’t operate in Quebec.
RATES, COSTS, AND FIGURES
All in all, MCAs are slowly becoming a financing option for Canadian SMEs looking for quick cash. That “slowness” comes from a lack of understanding about how exactly merchant cash advances work. Some alternative funders take advantage of their non-bank status to neglect regulations that require clarity resulting in somewhat unethical lending practices. Because of this, a certain number of business owners still hesitate to take a chance on a merchant cash advance program.
MCAs in Canada are generally available to businesses that have a steady volume of credit card sales, such as retail stores or restaurants. The amount of personal and business information required when applying for an MCA is much lower in comparison to a regular bank loan application: the documentation generally includes proof of identity, bank statements, and business tax returns. Merchant cash advance rates and costs differ from provider to provider. As MCAs aren’t loans, there are no fixed amounts for repayment installments and no fixed terms either. Typically, the percentage of credit card sales taken to enable the transaction ranges from 5 to 10%. Some companies in Canada charge premiums on their cash advances (which can be as high as 30% or even more.)
THE CHALLENGE
The main challenge for Canadian MCA providers is the absence of reliable data necessary for making underwriting decisions. As previously mentioned, only a small group of large financial institutions dominate the market, so the data is available solely to a handful of businesses. The information obtained from credit bureaus doesn’t help either: in most cases, it isn’t complete for making a wise credit decision. “The availability and access to government and financial data are scarce in Canada compared to other markets,” said Jeff Mitelman, the former CEO of Thinking Capital in an interview with AltFinanceDaily in a past interview. “Most of the data relationships that fintech companies rely on, need to be developed on a one-to-one basis and is often proprietary information.”
When it comes to the process of underwriting, the availability of data presented in the proper format is a crucial factor. It provides the full picture and saves an enormous amount of time for risk officers. “We pay a lot of attention to our underwriting and decision-making process because if we make a mistake, we can lose a lot of money,” Andrew D’Souza, the CEO of Clearbanc, told TechCrunch.
At the moment, the financial data available to Canadian alternative lenders is meager and needs improvement. Another issue is the legislation that varies with each province. Many alternative lenders find the Canadian rules and regulations that govern the industry rather unclear. However, those challenges are associated with a growing market and emerging ecosystem. One way or another, the business loan landscape has changed for good, and alternative financing methods have captured much attention, with giants like PayPal stepping in the game.
THE NEXT STEP
As the industry is new, and has lots of challenges, the banking sphere and fintechs are turning to partnerships accelerating online lending to small business members. It makes perfect sense to MCA providers to license their automated platforms, banks, and credit unions. Traditional players are familiar with regulations and have data for fine-tuned underwriting, while fintech providers bring innovative technology and customer experience. “We saw that Canada is ripe for technology but the differences in regulation among other things made us go the partner route,” said Peter Steger, the head of business development at Kabbage, to AltFinanceDaily – a perfect illustration of the growing partnership trend. These mutual interests create a lot of business opportunities, and that’s a good sign for all parties involved.
When small business owners need financing, timing is essential. Small and medium businesses are vital to the Canadian economy, so for them, the proper financial support means fast and convenient access to credit. In the new fintech-driven reality, applications should be completed within thirty minutes, decisions made within hours, and funds deposited in the applicant’s bank account within days. Canadian small businesses contribute around 30% of the total GDP, so the need for simple finance is acute. The technology has already made small business lending more accessible, and over time, financing alternatives such as MCA will become mainstream.
Factoring for Freelancers
November 8, 2019
The number of freelancers in America is quickly growing year on year, with a recent study indicating the percentage of full-time freelancers has increased from 17% of the workforce in 2014 to 28% in 2019. Representing a host of fields, from writing and photography to marketing and programming, the incomes and needs of such workers vary as much as their roles do, however a commonality between them is their difficulties with financing.
Being infamous for the difficulties involved in getting paid, freelancers have historically had trouble with the timings of payments. With 59% of freelancers reporting that they live pay check to pay check, missing a payment or waiting until an untimely employer responds to an invoice may not be possible for many; and beyond payments, banks have yet to catch up with the needs of freelancers.
“There’s this great big area in between consumer banking and business banking that freelancers fall into and the big banks aren’t dealing with that,” George Kurtyka of Joust explained. “They have strategies but it’s not really something they know how to do.”
Kurtyka, after a period of jumping between phone services, payments, and the fintech end of banking, is now COO and Co-founder of Joust, a financial services company occupied with providing for those freelancers ill-suited to traditional banking, which has been operating since 2017.
How are they going about it? Following a conversation Kurtyka had with a friend who told him over half of freelancers don’t separate their business and personal finances, he figured the best place to start was with bank accounts, which became the first product available from Joust. Next was the issue of non-payment, a problem his team thought was suited to underwriting. Offering guaranteed payment within 30 days for 1% of the invoice or instant payment for 6%, factoring, via its PayArmour product has become a large part of Joust’s business model.
“It feels almost like an insurance product,” Kurtyka observed. “When you send an invoice, we’re doing risk assessment on you, we’ve onboarded you and given you a bank account so we know about you.”
And so, after an early partnership with the Freelancers Union, Joust has been offering its cocktail of banking, invoicing, and alternative financing services to freelancers and self-owned businesspeople across America, with eyes on expanding its products further down the line.
“As you can imagine, we can start with just invoice factoring, but we can move into working capital and lines of credit … We’ve heard stories of freelancers losing houses and apartments because they were paid late. The next step is income smoothing. If you can predict how much you’re going to earn, we can smooth your income and then work with one of our bank partners to prequalify you for a loan. We’re obviously not a chartered institution but we work with a host of chartered banks and payments companies and we sit on top of them and the great news is we work with a lot of partners who want access to this burgeoning market of freelancers who may not qualify for a FICO score because their income is like this … Down the line we’d love to offer loans and mortgages. We think the underwriting models we’re building could be like the next FICOs for freelancers.”
The FTC Wants To Police Small Business Finance
October 22, 2019
On May 23, the Federal Trade Commission launched an investigation into unfair or deceptive practices in the small business financing industry, including by merchant cash advance providers.
The agency is looking into, among other things, whether both financial technology companies and merchant cash advance firms are making misrepresentations in their marketing and advertising to small businesses, whether they employ brokers and lead-generators who make false and misleading claims, and whether they engage in legal chicanery and misconduct in structuring contracts and debt-servicing.
Evan Zullow, senior attorney at the FTC’s consumer protection division, told AltFinanceDaily that the FTC is, moreover, investigating whether fintechs and MCAs employ “problematic,” “egregious” and “abusive” tactics in collecting debts. He cited such bullying actions as “making false threats of the consequences of not paying a debt,” as well as pressuring debtors with warnings that they could face jail time, that authorities would be notified of their “criminal” behavior, contacting third-parties like employers, colleagues, or family members, and even issuing physical threats.
“Broadly,” Zullow said in a telephone interview, “our work and authority reaches the full life cycle of the financing arrangement.” He added: “We’re looking closely at the conduct (of firms) in this industry and, if there’s unlawful conduct, we’ll take law enforcement action.”
Zullow declined to identify any targets of the FTC inquiry. “I can’t comment on nonpublic investigative work,” he said.
The FTC investigation is one of several regulatory, legislative and law enforcement actions facing the merchant cash advance industry, which was triggered by a Bloomberg exposé last winter alleging sharp practices by some MCA firms.
The Bloomberg series told of high-cost financings, of MCA firms’ draining debtors’ bank accounts, and of controversial collections practices in which debtors signed contracts that included “confessions of judgment.”
The FTC long ago outlawed the use of COJs in consumer loan contracts and several states have banned their use in commercial transactions. In September, Governor Andrew Cuomo signed legislation prohibiting the use of COJs in New York State courts for out-of-state residents. And there is a bipartisan bill pending in the U.S. Senate authored by Florida Republican Marco Rubio and Ohio Democrat Sherrod Brown to outlaw COJs nationwide.
Mark Dabertin, a senior attorney at Pepper Hamilton, described the FTC’s investigation of small business financing as a “significant development.” But he also said that the agency’s “expansive reading of the FTC Act arguably presents the bigger news.” Writing in a legal memorandum to clients, Dabertin added: “It opens the door to introducing federal consumer protection laws into all manner of business-to-business conduct.”
FTC attorney Zullow told AltFinanceDaily, “We don’t think it’s new or that we’re in uncharted waters.”
The FTC inquiry into alternative small business financing is not the only investigation into the MCA industry. Citing unnamed sources, The Washington Post reported in June that the Manhattan district attorney is pursuing a criminal investigation of “a group of cash advance executives” and that the New York State attorney general’s office is conducting a separate civil probe.
The FTC’s investigation follows hard on the heels of a May 8 forum on small business financing. Labeled “Strictly Business,” the proceedings commenced with a brief address by FTC Commissioner Rohit Chopra, who paid homage to the vital role that small business plays in the U.S. economy. “Hard work and the creativity of entrepreneurs and new small businesses helped us grow,” he said.
But he expressed concern that entrepreneurship and small business formation in the U.S. was in decline. According to census data analyzed by the Kaufmann Foundation and the Brookings Institution, the commissioner noted, the number of new companies as a share of U.S. businesses has declined by 44 percent from 1978 to 2012.
“It’s getting harder and harder for entrepreneurs to launch new businesses,” Chopra declared. “Since the 1980s, new business formation began its long steady decline. A decade ago births of new firms started to be eclipsed by deaths of firms.”
Chopra singled out one-sided, unjust contracts as a particularly concerning phenomenon. “One of the most powerful weapons wielded by firms over new businesses is the take-it-or-leave-it contract,” he said, adding: “Contracts are ways that we put promises on paper. When it comes to commerce, arm’s length dealing codified through contracts is a prerequisite for prosperity. “But when a market structure requires small businesses to be dependent on a small set of dominant firms — or firms that don’t engage in scrupulous business practices — these incumbents can impose contract terms that cement dominance, extract rents, and make it harder for new businesses to emerge and thrive.”
As the panel discussions unfolded, representatives of the financial technology industry (Kabbage, Square Capital and the Electronic Transactions Association) as well as executives in the merchant cash advance industry (Kapitus, Everest Business Financing, and United Capital Source) sought to emphasize the beneficial role that alternative commercial financiers were playing in fostering the growth of small businesses by filling a void left by banks.
The fintechs went first. In general, they stressed the speed and convenience of their loans and lines of credit, and the pioneering innovations in technology that allowed them to do deeper dives into companies seeking credit, and to tailor their products to the borrower’s needs. Panelists cited the “SMART Box” devised by Kabbage and OnDeck as examples of transparency. (Accompanying those companies’ loan offers, the SMART Box is modeled on the uniform terms contained in credit card offerings, which are mandated by the Truth in Lending Act. TILA does not pertain to commercial debt transactions.)
Sam Taussig, head of global policy at Kabbage, explained that his company typically provides loans to borrowers with five to seven employees — “truly Main Street American small businesses” — that are seeking out “project-based financing” or “working capital.”
“The average small business according to our research only has about 27 days of cash flow on hand,” Taussig told the fintech panel, FTC moderators and audience members. “So if you as a small business owner need to seize an opportunity to expand your revenue or (have) a one-off event — such as the freezer in your ice cream store breaks — it’s very difficult to access that capital quickly to get back to business or grow your business.”
Taussig contrasted the purpose of a commercial loan with consumer loans taken out to consolidate existing debt or purchase a consumer product that’s “a depreciating asset.” Fintechs, which typically supply lightning-quick loans to entrepreneurs to purchase equipment, meet payrolls, or build inventory, should be judged by a different standard.
A florist needs to purchase roses and carnations for Mother’s Day, an ice-cream store must replenish inventory over the summer, an Irish pub has to stock up on beer and add bartenders at St. Patrick’s Day.
The session was a snapshot of not just the fintech industry but of the state of small business. Lewis Goodwin, the head of banking services at Square Capital, noted that small businesses account for 48% of the U.S. workforce. Yet, he said, Square’s surveys show that 70% of them “are not able to get what they want” when they seek financing.
Square, he said, has made 700,000 loans for $4.5 billion in just the past few years, the platform’s average loan is between $6,000 and $7,000, and it never charges borrowers more than 15% of a business’s daily receipts. The No. 1 alternative for small businesses in need of capital is “friends and family,” Goodwin said, “and that’s a tough bank to go back to.”
Panelist Gwendy Brown, vice-president of research and policy at the Opportunity Fund, a non-profit microfinance organization, provided the fintechs with their most rocky moment when she declared that small businesses turning up at her fund were typically paying an annual percentage rate of 94 percent for fintech loans. And while most small business owners were knowledgeable about their businesses — the florists “know flowers in and out,” for example — they are often bewildered by the “landscape” of financial product offerings.
“Sophistication as a business owner,” Brown said, “does not necessarily equate into sophistication in being able to assess finance options.”
Panelist Claire Kramer Mills, vice-president of the Federal Reserve Bank of New York, reported that the country’s banks have made a dramatic exit from small business lending over the past ten years. A graphic would show that bank loans of more than $1 million have risen dramatically over the past decade but, she said, “When you look at the small loans, they’ve remained relatively flat and are not back to pre-crisis levels.”
Mills also said that 50% of small businesses in the Federal Reserve’s surveys “tell us that they have a funding shortfall of some sort or another. It’s more stark when you look at women-owned business, black or African-American owned businesses, and Latino-owned businesses.”
On the merchant cash advance panel there was less opportunity to dazzle the regulators and audience members with accounts of state-of-the-art technology and the ability to aggregate mountains of data to make online loans in as few as seven minutes, as Kabbage’s Taussig noted the fintech is wont to do.
Instead, industry panelists endeavored to explain to an audience — which included skeptical regulators, journalists, lawyers and critics — the precarious, high-risk nature of an MCA or factoring product, how it differs from a loan, and the upside to a merchant opting for a cash advance. (To their credit, one attendee told AltFinanceDaily, the audience also included members of the MCA industry interested in compliance with federal law.)
A merchant cash advance is “a purchase of future receipts,” Kate Fisher, an attorney at Hudson Cook in Baltimore, explained. “The business promises to deliver a percentage of its revenue only to the extent as that revenue is created. If sales go down,” she explained, “then the business has a contractual right to pay less. If sales go up, the business may have to pay more.”
As for the major difference between a loan and a merchant cash advance: the borrower promises to repay the lender for the loan, Fisher noted, but for a cash advance “there’s no absolute obligation to repay.”
Scott Crockett, chief executive at Everest Business Funding, related two anecdotes, both involving cash advances to seasonal businesses. In the first instance, a summer resort in Georgia relied on Everest’s cash advances to tide it over during the off-season.
When the resort owner didn’t call back after two seasonal advances, Crockett said, Everest wanted to know the reason. The answer? The resort had been sold to Marriott Corporation. Thanking Everest, Crockett said, the former resort-owners reported that without the MCA, he would likely have sold off a share of his business to a private equity fund or an investor.
By providing a cash advance Everest acted “more like a temporary equity partner,” Crockett remarked.
In the second instance, a restaurant in the Florida Keys that relied on a cash advance from Everest to get through the slow summer season was destroyed by Hurricane Irma. “Thank God no one was hurt,” Crockett said, “but the business owner didn’t owe us anything. We had purchased future revenues that never materialized.”
The outsized risk borne by the MCA industry is not confined entirely to the firm making the advance, asserted Jared Weitz, chief executive at United Capital Service, a consultancy and broker based in Great Neck, N.Y. It also extends to the broker. Weitz reported that a big difference between the MCA industry and other funding sources, such as a bank loan backed by the Small Business Administration, is that ”you are responsible to give that commission back if that merchant does not perform or goes into an actual default up to 90 days in.
“I think that’s important,” Weitz added, “because on (both) the broker side and on the funding side, we really are taking a ride with the merchant to make sure that the business succeeds.”
FTC’s panel moderators prodded the MCA firms to describe a typical factor rate. Jesse Carlson, senior vice-president and general counsel at Kapitus, asserted that the factor rate can vary, but did not provide a rate.
“Our average financing is approximately $50,000, it’s approximately 11-12 months,” he said. “On a $50,000 funding we would be purchasing $65,000 of future revenue of that business.”
The FTC moderator asked how that financing arrangement compared with a “typical” annual percentage rate for a small business financing loan and whether businesses “understand the difference.”
Carlson replied: “There is no interest rate and there is no APR. There is no set repayment period, so there is no term.” He added: “We provide (the) total cost in a very clear disclosure on the first page of all of our contracts.”
Ami Kassar, founder and chief executive of Multifunding, a loan broker that does 70% of its work with the Small Business Administration, emerged as the panelist most critical of the MCA industry. If a small business owner takes an advance of $50,000, Kassar said, the advance is “often quoted as a factor rate of 20%. The merchant thinks about that as a 20% rate. But on a six-month payback, it’s closer to 60-65%.”
He asserted that small businesses would do better to borrow the same amount of money using an SBA loan, pay 8 1/4 percent and take 10 years to pay back. It would take more effort and the wait might be longer, but “the impact on their cash flow is dramatic” — $600 per month versus $600 a day, he said — “compared to some of these other solutions.”
Kassar warned about “enticing” offers from MCA firms on the Internet, particularly for a business owner in a bind. “If you jump on that train and take a short-term amortization, oftentimes the cash flow pressure that creates forces you into a cycle of short-term renewals. As your situation gets tougher and tougher, you get into situations of stacking and stacking.”
On a final panel on, among other matters, whether there is uniformity in the commercial funding business, panelists described a massive muddle of financial products.
Barbara Lipman: project manager in the division of community affairs with the Federal Reserve Board of Governors, said that the central bank rounded up small businesses to do some mystery shopping. The cohort — small businesses that employ fewer than 20 employees and had less than $2 million in revenues — pretended to shop for credit online.
As they sought out information about costs and terms and what the application process was like, she said, “They’re telling us that it’s very difficult to find even some basic information. Some of the lenders are very explicit about costs and fees. Others however require a visitor to go to the website to enter business and personal information before finding even the basics about the products.” That experience, Lipman said, was “problematic.”
She also said that, once they were identified as prospective borrowers on the Internet, the Fed’s shoppers were barraged with a ceaseless spate of online credit offers.
John Arensmeyer, chief executive at Small Business Majority, an advocacy organization, called for greater consistency and transparency in the marketplace. “We hear all the time, ‘Gee, why do we need to worry about this? These are business people,’” he said. “The reality is that unless a business is large enough to have a controller or head of accounting, they are no more sophisticated than the average consumer.
“Even about the question of whether a merchant cash advance is a loan or not,” Arensmeyer added. “To the average small business owner everything is a loan. These legal distinctions are meaningless. It’s pretty much the Wild West.”
In the aftermath of the forum, the question now is: What is the FTC likely to do?
Zullow, the FTC attorney, referred AltFinanceDaily to several recent cases — including actions against Avant and SoFi — in which the agency sanctioned online lenders that engaged in unfair or deceptive practices, or misrepresented their products to consumers.
These included a $3.85 million settlement in April, 2019, with Avant, an online lending company. The FTC had charged that the fintech had made “unauthorized charges on consumers’ accounts” and “unlawfully required consumers to consent to automatic payments from their bank accounts,” the agency said in a statement.
In the settlement with SoFi, the FTC alleged that the online lender, “made prominent false statements about loan refinancing savings in television, print, and internet advertisements.” Under the final order, “SoFi is prohibited from misrepresenting to consumers how much money consumers will save,” according to an FTC press release.
But these are traditional actions against consumer lenders. A more relevant FTC action, says Pepper Hamilton attorney Dabertin, was the FTC’s “Operation Main Street,” a major enforcement action taken in July, 2018 when the agency joined forces with a dozen law enforcement partners to bring civil and criminal charges against 24 alleged scam artists charged with bilking U.S. small businesses for more than $290 million.
In the multi-pronged campaign, which Zullow also cited, the FTC collaborated with two U.S. attorneys’ offices, the attorneys general of eight states, the U.S. Postal Inspection Service, and the Better Business Bureau. According to the FTC, the strike force took action against six types of fraudulent schemes, including:
- Unordered merchandise scams in which the defendants charged consumers for toner, light bulbs, cleaner and other office supplies that they never ordered;
- Imposter scams in which the defendants use deceptive tactics, such as claiming an affiliation with a government or private entity, to trick consumers into paying for corporate materials, filings, registrations, or fees;
- Scams involving unsolicited faxes or robocalls offering business loans and vacation packages.
If there remains any question about whether the FTC believes itself constrained from acting on behalf of small businesses as well as consumers, consider the closing remarks at the May forum made by Andrew Smith, director of the agency’s bureau of consumer protection.
“(O)ur organic statute, the FTC Act, allows us to address unfair and deceptive practices even with respect to businesses,” Smith declared, “And I want to make clear that we believe strongly in the importance of small businesses to the economy, the importance of loans and financing to the economy.
Smith asserted that the agency could be casting a wide net. “The FTC Act gives us broad authority to stop deceptive and unfair practices by nonbank lenders, marketers, brokers, ISOs, servicers, lead generators and collectors.”
As fintechs and MCAs, in particular, await forthcoming actions by the commission, their membership should take pains to comport themselves ethically and responsibly, counsels Hudson Cook attorney Fisher. “I don’t think businesses should be nervous,” she says, “but they should be motivated to improve compliance with the law.”
She recommends that companies make certain that they have a robust vendor-management policy in place, and that they review contracts with ISOs. Companies should also ensure that they have the ability to audit ISOs and monitor any complaints. “Take them seriously and respond,” Fisher says.
Companies would also do well to review advertising on their websites to ascertain that claims are not deceptive, and see to it that customer service and collections are “done in a way that is fair and not deceptive,” she says, adding of the FTC investigation: “This is a wake-up call.”
How Business Financing Has Changed
October 22, 2019
The first thing small business owners think about when deciding to take on funding to grow their business is the ten-year, 3% bank loan that was the standard ten to twenty years ago. The application and approval process was much slower, and if a borrower didn’t fit the mold that mainstream lenders were looking for, approval was difficult. Today, the business loan landscape has changed, and alternative financing methods have captured much of the market. Small business owners who can’t get approved by the banks have access to the funding they need to grow and expand their businesses.
The technology that these alternative lenders use has made small business lending more accessible. Applications are online, underwriting techniques are fine-tuned and often times quicker, and borrowers get personalized offers and service.
More money is going out and more business owners are getting approved.
Changes in loan accessibility
Increased loan accessibility has resulted in more loans, but what does this mean for small business owners? And what are the risks to small business funders?
While alternative lending has opened up more doors for small business owners, as both the industry as a whole and individual lenders move faster, so increases the risk of people taking advantage of the system. Twenty years ago, fewer lenders meant that business owners had fewer options, but on the flip side, it meant that lenders didn’t need to worry as much about dishonest borrowing practices.
Increased competition pushes more lenders to approve more loans faster than ever. After all, if one lender won’t, another may, and the competition is just a Google search away. Unfortunately, this has also resulted in more opportunities for both borrowers and salespeople to take advantage of the system, and one of the largest risks to small business funders and small business owners alike is loan stacking.
What is loan stacking?
Loan stacking is used to refer to borrowers who take out multiple loans from multiple sources within a short window of time without thinking of their business’s long term health, due to the speed and efficiency that the funding occurs in, most business owners do not think twice as it becomes easy to obtain funding. Typically this situation occurs when a borrower can’t get approved for the total amount of money they need, or when a borrower is promised better rates at a future date by accepting the first offer from an overeager salesperson. The biggest red flag for all small business owners is when a promise is made without it being put in writing. If the funder or lender is not willing to put future promises on paper then steer clear of any future funding dealings.
Who is the culprit?
While some small business owners that cannot qualify for the full amount of cash they need may instead obtain multiple smaller loans to satisfy their requirements, others have more malicious intentions. Some borrowers take on funding for their business intending to use those funds for non-business related expenses. Whether it’s to go on vacation, pay down debt, or make a large purchase, this type of loan stacker may not fully understand the consequences of taking on more debt than their business can comfortably handle. During the funding verification calls, prior to funding, any mention of outside use for the funding can have a lasting effect on future funding relations.
An owner whose business is about to go under is another common offender. These borrowers make the decision to accept multiple funded deals, knowing that their business is at the end of its life, take the cash, close their bank accounts, and often declare bankruptcy, leaving the lender with no way to collect.
Finally, a small business owner may choose to lie to the lender about the purpose of the loan, thus convincing the lender to approve them for additional funding. A business loan to help with a larger long term project, like opening a new location that will bring increase revenue. But, when a borrower lies to a lender to get additional funding and thereby stacks loans on top of loans, this can become an issue.
While the borrower is often the offender, this isn’t always the case. Some brokers and salespeople prey on potential borrowers by employing aggressive and unethical sales tactics. “Baiting the borrower with a promise of a better rate down the line, but more importantly offering terms of approval that are unrealistic is a recipe for disaster. It is perfectly fine for any funder or lender to customize approvals to gain long term business relations, but to purposely or viciously offer unrealistic terms in the future, creates a need for a “Small Business Funding Code of Ethics”. Long term funding relationships are created with trust, transparency, and willingness to meet halfway. With the right Code of Ethics in place, the entire Small Business Funding industry can shine above all other financing,” explains Paul Pitcher, managing Partner at First Down Funding and SharpShooter Funding. Often these borrowers have just taken on a loan, probably for less than they had originally wanted, and the prospect of additional funds is quite appealing. The problem is that this often leaves the borrower overstretched, putting all parties at risk.
Understand the risks & signs
Business owners who stack loans are not only affecting the lenders they obtain funding from but are putting both their personal and business finances at risk. “Every business owner must analyze their 30, 60, and 90-day cash flow in order to better serve the purpose and total cost of capital for all rounds of funding” explains Pitcher.
Chances are if a lender doesn’t approve a business owner for the full amount they wanted, it’s because their finances can’t handle more and the lender did not want to put the business in a difficult position. After all, it is in the best interest of the lender for the small business to succeed.
In many cases, a business owner could be personally liable for their debt. However, aggressive brokers looking to quickly cash in on loans commissions put lenders at risk as well. Therefore, funders need to be wary of both deceptive business owners and lenders.
Prevention
When it comes to prevention, most lenders benefit from a three-pronged approach; a strong underwriting system, helpful consumer education, and open communication with the competition. “The most important part of funding deals day-to-day is the strength and volume of business and personal references. When the inner circle of the business owner vouches for them positively, 99% of the time, the deal can fund cleanly and perform,” explains Pitcher.
A strong underwriting system and a solid set of procedures can help lenders make sure they don’t unknowingly enter into a cycle of loan stacking. Experience plays an important role, but if you have a strong understanding of what you’re looking for and perform the appropriate amount of due diligence, you should be able to prevent the majority of loan stacking. Nevertheless, most small business funders already have such systems in place and yet loan stacking is continuously growing problem.
An informed applicant becomes a great borrower. Dealing with a frustrated business owner who can’t get approved for the full amount they want, is never fun. But, educating them about why they can only qualify for a certain amount is a key component in preventing loan stacking and ensuring a borrower isn’t taken advantage of. “The first impression a funder gets from an owner, a hand-signed and dated application, and the organizational skills needed to send over prepared financials and bank statements, can say a whole lot about the business owner’s interests, intentions, and overall health. The more rushed we feel, the less likely we will want to work with that said business,” explains Pitcher.
Finally, chatting with your competition might not seem like a great idea, but maintaining open lines of communication with those in your industry can help spot loan stacking schemes before they get out of hand. Trade shows and other industry events are a good place to network and meet other industry stakeholders.
Closing
Running a small business takes time, persistence, passion, and money. This is why small business owners need funders to be on their side of the court.
Educating and providing borrowers with useful information at the right time can help reduce the risk of loan stacking and helps to maintain healthy accounts.
Consultative Selling in Small Business Finance
October 16, 2019
It’s nearly impossible to teach fiscal responsibility to most consumers, according to researchers at universities and nonprofit agencies. But alternative small-business funders and brokers often manage to steer clients toward financial prudence, and imparting pecuniary knowledge can become part of a consultative approach to selling.
Still, nobody says it’s easy to convince the public or merchants to handle cash, credit and debt wisely and responsibly. Consider the consumer research cited by Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and co-director of the Common Cents Lab, which works to improve the financial behavior of low- and moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” Beasley says. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influences lower-income people even less.
The problem stems from trying to teach financial responsibility too late in life, says Noah Grayson, president and founder of Norwalk, Conn.-based South End Capital. He advocates introducing young people to finance at the same time they’re learning history, algebra and other standard subjects in school.
Yet Grayson and others contend that it’s never too late for motivated entrepreneurs to pick up the basics. Even novice small-business owners tend to possess a little more financial acumen than the average person, they say. That makes entrepreneurs easier to teach than the general public but still in need of coaching in the basics of handling money.
Take the example of a shopkeeper who grabs an offer of $50,000 with no idea how he’ll use the funds to grow the business or how he’ll pay the money back, suggests Cheryl Tibbs, general manager of One Stop Commercial Capital, Douglasville, Ga. “The easy access to credit blinds a lot of merchants,” she notes.
Entrepreneurs often make bad decisions simply because they don’t have a background in business, according to Jared Weitz, CEO of New York based United Capital Source. “Many of the people who come to us are trying their hardest,” he observes.
Weitz offers the example of his own close relative who’s a veterinarian. That profession attracts some of the brainiest high-school valedictorians but doesn’t mean they know business. “He’s the best doctor ever and he’s not a great businessman because he doesn’t think about those things first. What he thinks about is helping people. That’s why he got into his profession.”
Entrepreneurs often devote themselves to a vision that isn’t businesses-oriented. “They start a business because they have a great idea or a great product, and that’s what excites them,” Grayson says. “They jump in with both feet and don’t think much about the business side.” The business side isn’t as much fun.
Merchants also attend to so many aspects of an enterprise—everything from sales, production and distribution to hiring, payroll and training—that they can’t afford to devote too much time to any single facet, notes Joe Fiorella, principal at Kansas City, Mo.-based Central Funding. Business owners respond to what’s most urgent, not necessarily what’s most important.
For whatever reason, some business owners spiral downward into financial ruin, bouncing checks, stacking merchant cash advances and continually seeking yet another merchant cash advance to bail them out of a precarious situation, says Jeremy Brown, chairman of Bethesda, Md.-based Rapid Advance.
Weitz advises sitting down with those clients and coming to an understanding of the situation. In some cases, enough cash might be coming in but the incoming autopayments aren’t timed to cover the outgoing autopayments, he says by way of example.
Informing clients of such problems makes a demonstrable difference. “We can see that it works because we have clients renewing with us,” says Weitz. “We’re able to swim them upstream to different products” as their finances gradually improve, he says.
The products in that stream begin with relatively higher-cost vehicles like merchant cash advances and proceed to other less-expensive instruments with better terms, says Brown. Those include term loans, Small Business Administration loans, equipment leasing, receivables factoring and, ultimately the goal for any well-capitalized small business—a relationship with the local bank.
Failing to consider those options and instead simply abetting stackers to make a quick buck can give the industry a “black eye,” and it benefits none of the parties involved, Tibbs observes. But merchants deserve as much blame as funders and brokers, she maintains.
Prospective clients who stack MCAs, don’t care about their credit rating and simply want to staunch their financial bleeding probably account for 35 percent to 40 percent of the applicants Tibbs encounters, she says.
Just the same, alt-funders continue to urge clients to hire accountants, consult attorneys, employ helpful software, shore up credit ratings, keep tabs on cash flow, calculate margins, improve distribution chains and outline plans for growth. It’s what helps the industry rise above the “get-money quick” image that it’s outgrowing, Weitz, says. Many funders and brokers consider providing financial advice an essential aspect of consultative selling. It’s an approach that begins with making sure applicants understand the debt they’re taking on, the terms of the payback and how their businesses will benefit from the influx of capital. It continues with a commitment to helping clients not just with funding but also with other types of business consultation.
“It’s not so much selling as building a rapport with clients—serving as a strategic advisor or financial resource for them, identifying their needs and directing them to the right loan product to meet those needs,” says Grayson. “They should feel they can call you about anything specific to their business, not just their loan requests.” He also cautions against providing information the client will not absorb or will find offensive.
Justin Bakes, CEO of Boston-based Forward Financing also advocates consultative selling. “It’s all about questions and getting information on what’s driving the business owner,” he says. “It’s a process.”
Consultative sales hinges on knowing the customer, agrees Jason Solomon, Forward Financing vice president of sales. “Businesses are never similar in the mind of the business owner,” he notes. “To effectively structure a program best-suited to the merchant’s long-time business needs and set a proper path forward to better and better financial products, you need to know who the business owner is and what his long term goals are.”
“It’s taking an approach of actually being a consultant as opposed to a $7 an hour order taker,” Tibbs says of consultative selling. “I like to teach new reps to think of it as if you were a doctor. Doctors ask questions to arrive at a final diagnosis. So if you’re asking your prospective customer questions about their business, about their cash flow, about their intentions of how they’re planning to get back on track.”
Learning about the clients’ business helps brokers recommend the least-expensive funding instrument, Tibbs says. “I really hate to see someone with a 700 credit score come in to get a merchant cash advance,” she maintains. The consultative approach requires knowing the funding products, knowing how to listen to the customer and combining those two elements to make an informed decision on which product to recommend, she notes.
Consultative sales can greatly benefit clients, Weitz maintains. If a pizzeria proprietor asks for an expensive $50,000 cash advance to buy a new oven, a responsible broker may find the applicant qualifies for an equipment loan with single-digit interest and monthly payments over a five-year period that puts less pressure on daily cash flow.
It’s also about pointing out errors. Brokers and funders see common mistakes when they look at tax returns and financial records, says Brown. “The biggest issue is that small-business owners—because they work so hard— make a profit of X amount of money and then take that out of the business,” he notes. Instead, he advises reinvesting a portion of those funds so that they can build equity in the business and avoid the need to seek outside capital at high rates.
Another common error occurs when entrepreneurs take a short-term approach to their businesses instead of making longer-term plans, Brown says. That longer-term vision includes learning what it takes to improve their businesses enough to qualify for lower-cost financing.
Sometimes, small merchants also make the mistake of blending their personal finances and their business dealings. Some do it out of necessity because they’re launching an enterprise on their personal credit cards, and others act of ignorance. “They don’t necessarily know they’re doing something wrong,” Grayson observes. “There are tax ramifications.”
Some just don’t look at their businesses objectively. Take the example of a company that approached Central Funding for capital to buy inventory in Asia. Fiorella studied the numbers and then informed the merchant that it wasn’t a money problem—it was a margins problem. “You could sell three times what you’re wanting to buy, and you still won’t get to where you want to be,” he reports telling the potential customer.
Consultative selling also means establishing a long-term relationship. Forward Financing uses technology to keep in contact with clients regularly, not just when clients need capital, Bakes notes. That cultivates long-lasting relationships and shows the company cares. As the relationship matures it becomes easier to maintain because the customers want to talk to the company. “They’re running to pick up the phone.”
The conversations that don’t hinge on funding usually center on Forward Financing learning more about the customer’s business, says Solomon. That include the client’s needs and how they’ve used the capital they’ve received.
“We have our own internal cadence and guidelines for when we reach out and how often and what happens,” says Solomon. Customer relationship management technology provides triggers when it’s time for the sales team or the account-servicing team to contact clients by phone or email.
Do small-business owners take advice on their finances? Some need a steady infusion of capital at increasingly higher cost and simply won’t heed the best tips, says Solomon. “It’s certainly a mix,” he says. “Not everybody is going to listen.”
Paradoxically, the business owners most open to advice already have the best-run companies, says Fiorella. Those who are closed to counseling often need it the most, he declares.
Moreover, not everybody is taking the consultative approach. “New brokers are so excited to get a commission check they throw the consultative approach out the window,” Tibbs says.
Yet many alt-funders bring consultative experience from other professions into their work with providing funds to small business. Tibbs, for example, previously helped home buyers find the best mortgage.
Consultative selling came naturally to Central Funding because the company started as a business and analytics consultancy called Blue Sea Services and then transformed itself into an alternative funding firm, says Fiorella. Central Funding reviews clients’ financial statements and operations between rounds of funding, he notes.
Consultations with borrowers reach an especially deep level at PledgeCap, a Long Island-based asset-based lender, because clients who default have to forfeit the valuables they put up as collateral—anything from a yacht to a bulldozer—says Gene Ayzenberg, PledgeCap’s chief operating officer. Conversations cover the value of the assets and the risk of losing them as well as the reasons for seeking capital, he notes.
No matter how salespeople arrive at their belief in the consultative approach, they last much longer in the business than their competitors who are merely seeking a quick payoff, Tibbs says. Others contend that it’s clearly the best way to operate these days.
“The consultative approach is the only one that works,” says Weitz. “Today, everything is about the customer experience. People are making more-educated, better informed decisions.” What’s more, with the consultative approach clients just keep getting smarter, he adds.
The days of the hard sell have ended, Grayson agrees. Customers have access to information on the internet, and brokers and funders can prosper by helping customers, he says. “Our compensation doesn’t vary much depending upon which product we put a client in so we can dig deeper into what will fit the client without thinking about what the economic benefit will be to us.”
Even though the public has become familiar with alternative financing in general, most haven’t learned the nuances. That’s where consultative selling can help by outlining the differing products now available for businesses with nearly any type of credit-worthiness. “It’s for everybody,” Weitz says of today’s alternative small business funding, “not just a bank turn-down.”
What Happened to Borro?
October 6, 2019Borro has since relaunched. Story is HERE
In 2013, Borro, an innovative online lending company that was poised to disrupt pawn shop lending forever, invited me to their stylish offices at 767 Third Avenue in Manhattan. It wasn’t for a story per se, but rather to learn more about each other’s place in the world of online lending. AltFinanceDaily was still called Merchant Processing Resource and Borro, well they were beginning to take a shine to the idea that business owners could be a good source of potential customers. Framed as a “luxury asset-backed lender,” AltFinanceDaily would eventually cover the concept two years later as Borro and other lenders like them took off.
A then-executive of Borro explained the model as follows, “People don’t want to put their house at risk when they need capital. They’d rather lose the Maserati or a lovely piece of art than the house.” Ferraris, fine wine, rolexes, whatever, they would take it and make loans as low as $20,000 to as high as $10 million. Borro made $50 million worth of such loans in 2013 and doubled that number in 2014. Founded in the UK, the company’s expansion into the US was indicative of untapped demand and sky high potential. Big name investors got behind it including Victory Park Capital, Canaan Partners, Eden Ventures, and Augmentum Capital, eventually tallying up to more than $200 million raised.
But less than two years after AltFinanceDaily ran its story, Borro went into administration, the UK’s version of bankruptcy.
What happened?
Zelf Hussain, Partner at PwC, had to answer that question in his position as joint administrator of BGH Realisations (2017) Limited, a Borro holding company. Hussain retells the tale in a 2018 Companies House report. It is as follows:
In February 2014, Victory Park Management LLC (VPM) entered into a £67 million credit facility with a number of Borro companies which was guaranteed, inter alia, by the Company. The VPM loan was intended to allow Borro to expand its portfolio and make larger value loans to clients.
Following the VPM loan, Borro’s loan book increased in size and it moved into property lending. This was not a successful move and several loans went into default. In addition, Borro was unsuccessful in selling the underlying properties of defaulted loans in a timely manner. These issues exacerbated its cash flow issues due to carrying costs and the cost of interest due to VPM.
Following a review of the Borro business, it was decided that the property lending side of the business would be closed down. In addition, VPM became aware of other customer loans that were in arrears and these lead to further cash flow issues and a depletion of Borro’s working capital.
In an effort to raise additional capital, Borro instructed investment advisors to run a sales proces. No bids were received which would serve to fully repay VPM or provide any equity value beyond the debt obligations to VPM.
In light of the failed sales process, PwC was engaged by the Company to assess its options. Following discussions, VPM offered to purchase the business and assets of the Company, including its share in Borro Limited (BL) and therefore indirectly the shares in other Borro group companies.
On 15 November 2017 the Company directors resolved that placing the Company into administration to facilitate the transfer of ownership of BL to VPM was in the best interests of all stakeholders and, in particular, the Company’s creditors. VPM would be a well-capitalised and supportive owner, with a long term plan for the business.
We were appointed as administrators on 15 November 2017, and effected the sale of the business and assets to VPM in a pre-packaged transaction on the same day.
Since then, Borro trudged along, but earlier this year the company stopped making new loans.
The news was cheered by one of the same pawn shop lenders that Borro was supposed to disrupt. Jordan Tabach-Bank, a board member of the National Pawnbrokers Association and CEO of a family owned pawn shop business, used the company’s downfall to promote the benefits of doing business offline. “Our clients like the personal touch of a face-to-face loan, particularly when entrusting us to safeguard their most precious and expensive personal possessions,” he wrote in a release.
