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Merchant Cash Advance: A New Breed of Lender

Date: Mar 30, 2015 @ 07:00 AM
Filed Under: Industry Trends

Just like the gunslingers of the Old West, the merchant cash advance companies (MCAs) have entered the small business lending territory ... and they are making up new rules as they go along. With no regard for established practices, or even laws for that matter, the MCAs are booking clients by the scores in the traditional niches that heretofore were the exclusive domain of the small business lending community. And these new funding sources are willing to take risks far beyond the norm. They will provide financing without a first position on the A/R, nor a lien on property, plant and equipment. If lenders think “this too shall pass,” then they must also believe in fool’s gold, because MCAs have the numbers (they have been multiplying like rabbits for over a decade) and they have the financial backing (several MCAs are funded by some of the largest hedge funds in the U.S.).  They are truly a force to be reckoned with. It is far better to understand the enemy than it is to underestimate them.

Where Did They Come From?

The company that started it all back in the late 1990s was founded by a man who was in charge of an institutional investment in one of my start-up factoring companies. He used to complain to me that given the size of the small business market, my one year old factoring firm should be easily purchasing $100 million per month in volume and in just a couple more years should approach the $1 billion per month mark. I quickly pointed out that he clearly didn’t understand that the majority of small businesses sold to consumers, and that factors only funded B2B or B2G transactions. He replied that we should start funding the consumer transactions. I then had to educate him on the fact that there was already a very efficient funding mechanism in place that handled these transactions and it was called the credit card. He countered that we should fund the credit card paper. He was a persistent sort, wasn’t he? I shot back that while it was certainly possible to do so, and I actually funded credit card receipts once in my past, there was not going to be a big demand to accelerate the payment of paper that turned anywhere from one day (for large retailers) to one week (for smaller merchants). Also, the fees wouldn’t be that great either.

Undeterred, he went off and started a company that factored “future” credit card receipts based on estimated credit sales to occur over the next 90 to 120 days. The estimate was based on past, documented history from the client’s merchant credit card processor. And he did this at APRs over 100% per annum. I guess I wasn’t nearly as smart as I thought I was. Today, the average term of an MCA funding transaction has increased out to nearly 9 months, with most clients “re-upping” prior to paying off the original advance in full. Their yields have come down, but still average well over 50% a year.

The skyrocketing growth of the MCAs can be attributed to their distribution channel. All those credit card swipe machines that you see when you pay at retail outlets are sold through Independent Sales Organizations or ISOs for short. These people work a local market to sell, repair and upgrade these important tools of commerce. Since they are in the face of local merchants on a consistent basis already, why not ask if they need some extra financing for equipment or working capital.

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