One Percent Ventures, a loaded name with implications depending on who reads it, is the latest small business funding company to enter the fray. No, it’s not funding for the one percent, but rather the numerical percentage the company would make off first-time clients with near-perfect performance. They’d make just one percent…
The concept, which caught the attention of deBanked, had to be explained in detail, especially when a merchant paying only $500 on a $50,000 advance was communicated as an example. Say what? The catch is in a rebate and the cost independent of the broker’s commission. Nevertheless, One Percent Ventures CEO Isaac Wagschal seems to be bringing in a new concept, one that was originally supposed to be 0%, he says, but he was already stuck with his company name. deBanked did a Q&A to find out exactly how it all works.
– The Editor
Q (Adam Zaki): Why did you choose the name One Percent Ventures?
A (Isaac Wagschal): The original idea for One Percent Ventures wasn’t to be a funding company that gives one percent deals. Originally, we were going to provide branding and marketing services to small businesses who do not have any marketing, but can benefit from it. Our compensation was to be a one percent partnership in the company. Then a situation came my way where I was able to form a team of people with extensive knowledge and experience in the MCA space. I grabbed the opportunity and switched from marketing to funding small business.
We designed the product with a rebate that refunds basically the entire cost of the first advance. I realized that if we changed the rebate where instead of refunding 100% of the 1st advance factor cost, we keep 1%, I wouldn’t have to change the name and logo of the company. This is the reason our merchants are now paying one percent. If I had not already determined the name, the merchants would have been paying zero instead of one percent.
Q: What was the most difficult part of the shift from marketing to funding?
A: Shifting from marketing to funding was very difficult because of the nature of the market which existed at that time. That difficult transition forced the creation of our unique product, which includes rebates and payment-pauses. I looked into the mainstream MCA product in-depth, and realized that from a marketing point of view the product is flawed, and cannot be marketed properly. The more I scrutinized the MCA industry, I realized that the problems are not just from a marketing perspective. There are existential problems that need to be addressed, or they will eventually cause the demise of the industry altogether. Default rates are so high that mathematically the industry is forced to charge extremely high prices. This makes the product unmarketable to merchants who are not in the absolutely highest risk bracket.
I knew that unless we remade the product to be more attractive and marketable to a larger market share, the funding industry had no tangible room for expansion. Why would we want to get into this market space in the first place? As a team, we agreed that instead of hiring ISO-reps and underwriters, we would first hire accountants, actuaries, and data analysts.
We applied the same psychological principles used in marketing, where you try to predict and manipulate people’s reactions. By doing that, we were able to redesign the old MCA product. We introduced a rebate system that gives the merchant an opportunity to potentially only pay a $500.00 factor cost on a $50k advance. In this way, we expanded the current market share, and turned it into a hot product. I hear from ISOs on a daily basis who recontacted old unsuccessful leads, and turned them into deals after they presented the OPV-rebate and payment-pause-award system. This proved that the OPV product is expanding the market share.
Q: What are your thoughts about the market share in MCA?
A: The current market share consists of the absolute highest risk merchants who are willing to pay such high prices. It is becoming harder and harder to maintain deal flow. This has forced the industry to slowly keep raising the standard with respect to how many positions we are willing to accept. If nothing happens, we will soon find ourselves talking about 10th and 15th positions. This is certainly not sustainable, and puts an amazing amount of stress on the ISOs who are working tirelessly to maintain deal flow. They see it all happening, but feel helpless because at the end of the day, they can only present a product that a funder puts on the table. The tiny market of willing and able merchants is also a source of stress, and a key factor to the mistrust that is largely present between ISOs and funders.
Q: What are your thoughts on a relationship with the ISOs and funders?
A: Let’s face it, the way the current ISO-Funder relationship is set up scientifically creates a conflict of interest. It is simple math – when a funder loses a renewal that carried a potential profit of 50k and thinks that the deal could have happened if not for the 14 points that is reserved for the ISO, there is a natural conflict of interest. You can be honest with your ISOs and even give Rolexes and call them your partners on paper, but the spreadsheet still calculates a conflict of interest at the end. The lavish gifts are nice, but they do not eliminate the scientific conflict of interest.
We have corrected this fundamental problem by designing our business model so that our ISOs are genuine partners. This too is simple math – when a funder’s product is designed to issue an unheard-of large rebate, and 3rd party costs are deducted from the final rebate amount, the merchant will obviously be super happy because of the astronomic refund. More importantly, by using this model, the conflict of interests between ISO and funder is erased because mathematically the merchant paid the commission, not the funder!
Q: How does OPV make money? How do merchants qualify for all of your incentives? What are these incentives?
A: Let me first answer the latter part and explain how our product works and then I’ll come back to answer how we make money.
Our typical product is a ninety-day term at 1.49 sell rate. At mid-term, if the merchant didn’t miss any payments, they are eligible for an add-on, largely known as a renewal. At this phase, we begin to issue an OPV-Pause award after each cycle of four consecutive successfully completed payments. The pause awards can be submitted smoothly on our automated online system either one at a time, or they can be saved and initiate a pause for an entire week. After the final payment, if the merchant didn’t miss more than three payments, excluding the pauses, we refund the entire factor cost of the first advance except for 3rd party fees, processing fees, and 1% of the advance, which gives us only $500 profit on a 50k advance.
Every merchant that qualifies for funding, automatically qualifies for all the incentives. The OPV funding model is actually designed to perform better when more merchants actually receive the rebate. Why? Because that also means there has been a drop in the default rates. If every merchant was to qualify for the rebate, it would mean we had a zero percent default rate, which would allow us to make a healthy return, even if we made profit only on the 2nd advance.
This is precisely the reason we added the OPV-Pause awards. It is in our best interest to keep the merchant motivated to stay current on their payments, in order to qualify for the rebate. We even added a condition that in the event a merchant doesn’t have an unused pause award, they can purchase an OPV-Pause for 20% the daily payment. The goal must be to lower default rates so that we can lower the end cost. In this way we can expand the market share and keep the MCA industry alive. The OPV product is designed to do just that.
Q: What are your immediate goals for OPV? How about long term?
A: Phase I was designing the product and building the platform. Now in phase II, we plan to fund deals for at least a year before making any significant changes. We want to build relationships and earn trust by being transparent and honest, even when it hurts. At phase III we will analyze the data and make tweaks we deem necessary. At phase IV, given that the canary returned from the coal mine, we will share our intelligence, and license the OPV platform to reputable funders throughout the MCA industry.
Q: What is your outlook on the future of the non-bank small business funding/lending sphere?
A: In an effort to truly make a constructive change towards preserving the MCA industry, I will speak openly about the elephant in the room. We are all aware of the unfavorable new laws and regulations that constantly threaten our existence. As long as there are politicians who need to win elections, they will be on the hunt for “do-good projects.” There will always be a lobbyist that is looking for deal-flow, who is willing to provide the perfect “do-good” project. One of those will be – “Let’s save the poor merchant from the greedy funder.” The politician can only succeed because the nature of the MCA industry is such that our funders share only the good news. The bad news is confidential, so there is a stigma of excess profit in the MCA sphere. If we can successfully change that stigma, then we will be a thriving industry for many years to come.
“The Mountains Are Calling” is the motto of Gatlinburg, an East Tennessee town of roughly 4,000 citizens known for its spectacular views of the Smoky Mountains and as a jumping-off spot for hikers, campers and winter skiers. The town also offers attractions such as Ripley’s Aquarium and arts-and-crafts festivals.
To get around, 800,000 tourists and locals alike hop aboard the 20-odd trolley buses operated by Gatlinburg Trolley, the private transit system. Few riders marveling at the picturesque scenery and enjoying the sprightly vehicles, which recall San Francisco’s cable cars, know that they’re riding a custom-made trolley-bus built by Hometown Trolley of Crandon, Wisconsin.
And even fewer would know that the chief executive and president of that company is Kristina Pence-Dunow, making it the only female-owned manufacturer of transit vehicles in the US. Bolstering the manufacturing enterprise—which Pence-Dunow acquired in 1997 from her ex-husband, who wanted to “liquidate” it, she says—have been multiple bank loans backed by the Small Business Administration.
The most crucial SBA loan came in 2005, she says, just as she was nearly driven out of business in a price war. “We had to be innovative” to survive the cutthroat competition, Pence-Dunow told deBanked in a telephone interview.
Using a $350,000, five-year SBA credit issued by River Valley Bank (now Incredible Bank of Wausau, Wis.), the transit company developed the prototype for a “lowfloor entry vehicle.” The design feature made her trolleys accessible to riders with walkers and wheelchairs and enabled the company to beat out its competitor for a key contract with Hampton Roads (Va.) Transit. That deal, in turn, generated sales to transit authorities in Miami Beach, Laguna Beach, and the University of Oklahoma.
Subsequent SBA loans, Pence-Dunow says, enabled the company to create its own dealer network and develop battery-powered, clean-energy vehicles. The financings also allowed her to buy out, in 2016, the rival trolley company that had tried to run her buses off the road.
Her grit and determination—for many years Pence-Dunow ran the company as a single mother raising two children—have also paid dividends for her Wisconsin community. With annual sales of $20 million and 65 employees receiving health and life insurance as well as pension benefits, Hometown Trolley has brought good-paying jobs to successive generations of families in the Northwoods.
In 2018, she earned the SBA’s “Small Business Person of the Year” award for the state of Wisconsin.
Hometown Trolley, meanwhile, is just one of 30 million small businesses that make up the backbone of the US economy. Small businesses—a small business is broadly defined as a commercial or professional enterprise with fewer than 500 employees—accounted for the employment of 58.9 million people in 2015, according to the US Census Bureau’s most recent figures. That’s just shy of 50% of the country’s total workforce. And it seems that the smaller the better: In 2018, firms employing fewer than 20 employees added 1.1 million net jobs to the US economy, the largest gains among the small business cohort.
By contrast, large manufacturing companies only employ about 11% of the total workforce, notes Karen G. Mills, former SBA administrator and member of President Barack Obama’s cabinet. The bottom line is that the contribution to the economy made by both small business and the SBA “is under-appreciated,” says Mills, now a senior fellow at Harvard Business School and author of Fintech, Small Business & the American Dream. “It’s a much more powerful job-creator than the manufacturing component of the US economy,” she adds.
During the Great Recession, which coincided with her tenure at the SBA, Mills reports that 60% of the country’s job losses were in the small business sector. As many as 1.8 million jobs disappeared in a single quarter in 2009. Mills credits the SBA’s lending as playing a key role in buffering the US economy against even more severe ravages.
To help reverse the economic free-fall, the SBA eliminated all SBA fees and temporarily upped the 75% government credit guarantee to 90%. The agency also persuaded a thousand commercial banks that had not issued an SBA-backed credit since 2000 to turn on the spigots. “Banks are the primary source of financing for small businesses,” she notes. “They (small businesses) can’t go to the credit markets like big business does.”
S.R. Rosati, Inc., an Italian ice manufacturer based in Clifton Heights, Pa., is one of those small businesses that nearly went belly-up. Headed by Richard Trotter, a West Point graduate, former US Army captain and company president, the Italian ice business is thriving today. It has just under 30 employees and reports annual sales of $10 million. But ten years ago it was in desperate straits. “Even though we’re a 100-year-old company,” Trotter says, “we could have been like a ton of businesses that went out of business every week. The SBA helped us get through tough economic times in 2007-2008 when a lot of businesses took a hit.”
The SBA’s flagship product is the 7(a) loan, which range up to $5 million. Almost 2,000 US banks, as well as a number of nonbanks, participate in the program. The loans are currently backed by a 75% government guarantee and are targeted to those entrepreneurs who, the SBA states, “otherwise would not have access to capital to start, grow, or expand their small businesses.”
An SBA loan, former Administrator Mills explains, “is designed to fill a market gap— to make loans to creditworthy borrowers that the market feels are too risky to make without some support.”
Currently bearing an interest rate of 7.75%-9%, according to financial technology firm Fundera, 7(a) loans are affordable and the terms are fairly generous: typically, the borrower has 10 years to repay the loan. The loans can be used for multiple purposes: as working capital, to purchase equipment and inventory, make a business acquisition, meet payroll, hire new employees, and (in some cases) refinance crushing debt.
If a borrower is eligible and able to secure a 7(a) loan, “it’s the gold standard,” remarks Levi King, chief executive and co-founder of Utah-based Nav, an online, credit-data aggregator and financial matchmaker for small businesses.
William McSweeney, chief operating officer in the business banking section at Citizens Bank in Boston, says that insufficient collateral is most often the reason that a small business fails to qualify for a conventional business loan. With an SBA loan, he says, the government guarantee serves as a bulwark “to cover the weakness of a collateral position.”
He cites the case of a dentist who’s attempting to acquire an existing dental practice for $1 million. Unless the practice owns a building, McSweeney says, there’s probably not enough collateral to support a $1 million borrowing. Yet the deal is attractive: Dentistry is a reliable industry (or “vertical” in lender jargon), the targeted practice has a solid client base, there’s strong cashflow, and the practice boasts a fully equipped armamentarium. “An SBA loan will guarantee the $1 million loan for 75 percent,” McSweeney says. “Now I can ask, ‘Is there $250,000 in collateral.’ That’s the way I look at it.”
Adds Kirk Jacobson, an SBA lender at Northwest Bank branch in Independence, Ohio: “In my experience, the preponderance of SBA loans have a collateral shortfall. Even lending to hotels or something tangible can be risky. The collateral (the hotel) can lose value quickly. The challenge for banks like ours is to use the SBA as the tool where conventional lending doesn’t work.”
By at least one yardstick SBA lending appears to be at a crossroads. The SBA reports that the number of small businesses taking advantage of the 7(a) program fell by 13% in the most recent fiscal year, which ended September 30, 2019. The 52,000 small businesses securing 7(a) credits in 2019 was more than 8,000 fewer than the previous year. The dollar amount of credits acquired also dropped; the $23.7 billion in lending was a 6.5% drop.
This is being taken as a good sign by the agency. “A strong economy is powering America’s 30 million small businesses, and the SBA’s numbers bear that out,” Chris Pilkerton SBA’s acting administrator and general counsel, said in a recent statement. “When the economy is doing well, 7(a) lenders are more willing to provide capital without the need for a federal loan guarantee.”
But even small businesses that are outwardly healthy and experiencing growth often face hardship. Consider the case of Kyle McClelland, owner of Have Lights Will Travel, a Reno-based contractor that handles illumination for office buildings, stores, parking lots, and warehouses across northern Nevada. He got in over his head this year when he subcontracted lighting work for Macy’s and Target parking lots in a string of northern California cities.
There was no money advanced by the main contractor for materials, wages or expenses, he says. As a subcontractor, McClelland doesn’t get paid until the job is done. Yet, almost overnight, he doubled his workforce to 70 employees, footed the bill for a platoon of workers to lighting equipment, all of which exhausted his $100,000 line of credit with a Reno bank. His situation looked dire and it was taking an emotional toll. “The company was on life support.” he says. ”I realized that I needed extra funds to make payroll. I honestly didn’t sleep for months. I was lucky to get three hours of sleep a night.”
McClelland was bailed out in August when he secured a $350,000 line of credit through an SBA Express loan fronted by Five Star Bank, a Sacramento financial institution. SBA Express loans, which are part of the 7(a) program but carry only a 50% government guarantee, can be made in as few as 36 hours. But McClelland says that it took him four weeks to obtain the loan.
Trotter, the owner of the Italian ice company, says that his business too is in an expansion phase and that its financial situation was cramped. He had been saddled with a pricey, short-term note for $1.4 million that was weighing down business. With the intercession of Multifunding, a Philadelphia-area broker, Trotter took out a $2.5 million, 10-year loan with Celtic Bank in Utah at prime plus 2.75%, his third SBA loan in 20 years. The refinancing, which closed in late July, is saving him $30,000 in monthly cashflow, he says, more than $100,000 to date.
“Now we can play a little bit of offense,” he says. “We have the up-front money to go into convenience stores and supermarkets with our product.”
One common experience of the business-people who spoke to deBanked is that assembling the required documents and applying for SBA loans can be a daunting and often discouraging task. “The whole thing with these loans is making sure the I’s are dotted and the T’s are crossed,” says Domenic Rinaldi, managing partner at Sun Acquisitions, a Chicago-based firm specializing in lower middle-market, merger-and-acquisition deals using SBA loans. “The government is demanding,” he adds, “and if everything is not in order, you won’t get your money.”
To cut through the inordinate amount of red tape, many businesses turn to brokers like Multifunding and other financial midwives, who receive a commission from the bank. “The fastest I’ve done an SBA loan is two weeks and the longest is 18 months,” says Ami Kassar, founder and chief executive of Multifunding. He says that the firm’s SBA credit business constitutes 70% of his work and that he relies on a network of 10 banks. “The average time it takes for an SBA loan is probably 90 days,” he adds.
“Grueling” is how Daniel Shemtob of Los Angeles describes his experience obtaining an SBA loan. “I had gone to 30 banks,” he says, “and I did qualify for a loan but I didn’t like the deal.”
Shemtob is the chief executive and—thanks to securing an SBA backed financing for an acquisition—the sole owner of The Lime Truck, which has bragging rights to winning the Food Network’s “Great Truck Race.”
In addition to the truck, his Southern California business also includes a couple of brick-and-mortar restaurants and a catering company. The operation, which will do $5.5 million in sales this year, employs 40 full-time workers plus part-time catering help.
Shemtob finally scored an SBA loan with assistance from Kassar’s Multifunding, which he found through Entrepreneurs’ Organization, where he’s a board member of the L.A. chapter. He was able to take out a pair of 10-year loans totaling $1.8 million with IncredibleBank at prime plus 2.75%. Even with a broker, he says, it took him three months to get the loan, which closed earlier this year. “The ten-year loans give you stability and an affordable payment,” he says. “If I hit my sales targets,” he adds, “the loans will allow me to grow the business.”
But what if he hadn’t obtained SBA-backed financing? “I don’t know if the company would be around today,” Shemtob says.
SBA loans used for acquisitions play a major role in extending the life of enterprises that likely would have disappeared upon the retirement or death of an entrepreneur, the unwillingness of succeeding generations to take control of a family business, or the break-up of a partnership, notes Rinaldi, the Chicago M&A specialist.
To arrange SBA acquisition loans for purchasers of small businesses, Rinaldi deals mainly with 18 banks, including Busey Bank (Champaign, Ill.), U.S. Bancorp (Minneapolis), Byline Bank (Chicago) and Canadian Imperial Bank of Commerce (Toronto). “Banks may say, ‘Bring us all your manufacturing deals’ and two years later there’s a management change and they’ll only make loans to distribution and service companies,” Rinaldi says. “Part of my job is understanding which sectors are handled by which banks.”
Meanwhile, an emerging debate is brewing within banking circles about the best use of SBA 7(a) loans, which were capped at $28 billion in the last fiscal year. While the overall U.S. economy has continued to prosper since the Great Recession, and the official unemployment rate has dipped below 4%, the lowest in 50 years, the bounty is being shared unevenly. While most large US cities and suburbs are generally adding jobs and experiencing good times, many rural areas and Rust Belt communities are dealing with stagnant wages, job losses and population outflows.
The question is: Should more banking resources be directed to distressed communities through SBA loans? Or should the banking industry lend as it sees fit, largely focused on profitability and shareholder value, albeit within the SBA’s guidelines, perhaps with a nod to businesses owned by women, minorities and veterans? Many banks incorporate both philosophies. But this dichotomy in operational goals can sometimes be seen in sharp relief.
The stark difference in SBA lending practices between Live Oak Bank of Wilmington, N.C. and Northwest Bank of Warren, Pa. is a case in point.
With $4.6 billion in assets, Live Oak Banking Company, which was founded in 2007, is just a dozen years old but it’s already become the No. 1 SBA lender in the US. In the most recent fiscal year, from just one branch on North Carolina’s seacoast, it made 913 SBA loans totaling $1.347 billion, an average of nearly $1.5 million per loan. To comprehend the magnitude of that accomplishment: Live Oak nearly lapped Wells Fargo Bank, the No. 2 lender with $786.4 million in loan totals, despite the latter’s making triple the number of SBA loans. It also out-lent such worthies as J.P. Morgan Chase and Bank of America, both of which lagged well behind Live Oak in the SBA lending tables.
With its adroit use of technology and its meteoric rise to become an SBA powerhouse, Live Oak has emerged as a Wall Street darling. Thomas Brown, a founder and chief executive at Second Curve Capital, a hedge fund that invests exclusively in financial services companies and manages $150 million in assets, calls Live Oak “a freak of nature.”
“For their veterinarian-lending practice,” Brown observes, “they hire a vet as their lending officer. They do this with all their verticals, whether it’s chicken farming or funeral homes. And when they’re dealing with a client, they have all this incredible expertise.”
Steve Smits, chief credit officer at Live Oak, told deBanked that the bank now lends to 29 verticals across all 50 states. Its most recent additions were early childhood education centers and franchisees for aftermarket companies like Jiffy Lube and Meineke. Not only does Live Oak have experienced loan officers with deep knowledge of their sectors making the loans, but the bank is conscientious about keeping up with its clients. So much so that it maintains a stable of consultants, accountants and other professionals who are on call to add value.
For example, says Smits, a former associate administrator of the SBA’s office of capital access, one of Live Oak’s board members is Jerald Pullins, a former president of Service Corporation International, the Houston-based owner and operator of nearly 1,500 funeral homes and 481 cemeteries in the US and Canada.
For critics who say that an SBA lender should be modeled on George Bailey, the small-town banker immortalized in “It’s a Wonderful Life,” Smits says: “On a moral plane, we visit 100 percent of our small business owners face-to-face at a minimum of a two-year rotation. With 10-year loans, it would be easy to take a hands-off approach, but we’re very vigilant.”
Smits adds: “We’ve had our customers say to us, ‘You know what. You’ve traveled across the country to see me. And I’ve been banking with the branch down the street and they’ve never been in my office.’”
Founded in 1896 and headquartered in Warren, Pa., Northwest Bank’s service area looks like a jagged triangle traversing three states, running from Lancaster, Pa. to greater Cleveland to Buffalo, N.Y. and back. Inside the tri-state perimeter are a plethora of gritty old factory towns and Rust Belt communities.
“Our banks are located in all kinds of small cities,” Jacobson, the bank’s chief SBA lender, says. “I’m biased,” he adds, “but I believe in reinvesting in our communities. Our business model is to lend in our footprint. It’s where our branches are and where our clients are. Our strategy is not to lend around the US.”
One example of Northwest’s targeted SBA lending, Jacobson says, can be seen in Lorain, Ohio, a city of 64,000 on Lake Erie that is working to reinvent itself. Lorain was once the proud home of iconic heavy industries like the American Ship Building Company, a Ford Motor assembly plant, and U.S. Steel’s sprawling mill on the city’s south side. The economy was so dynamic that it “outshined Cleveland” says Kevin Nelson, the Lorain-based president of Northwest Bank’s Ohio region.
But in the 1980s deindustrialization began to take its toll and the city experienced high unemployment, rising poverty, and urban decay. Now, however, Lorain is hoping to rise like the mythical Phoenix from its ashes. And Northwest Bank is doing its part by marshaling resources in concert with the city’s government, the Black River Port Authority, the Chamber of Commerce, the Lorain Historical Society and other citizens groups to transform the waterfront and downtown into an entertainment center and destination for weddings, rock concerts, and other events.
Nelson is bullish on the just-completed Broadway Streetscape, in the heart of downtown, which has given Lorain a physical makeover. There are, Nelson says, “new sidewalks, lighting, archways, and parking areas.” Condominiums are being built and the marina is under new management, which could make the city a boating center. Black River Landing has become a magnet for celebrants with more than 200,000 people attending the “Rockin’ on the River” concerts over the summer. And the city is witnessing “new restaurants, coffee shops, bars, and other gathering places for people,” the banker says. “We’re seeing outside investment and we’re just beginning to see Lorain becoming a destination for millennials.”
Many of the trendy new establishments are being financed with SBA loans. “SBA lending has helped us support some of these new ventures coming in,” Nelson says. “They don’t make up for bad credit, lack of a business plan or cashflow,” he adds. “It has to be the right type of business. But SBA loans are a component.”
Who knows? Maybe Lorain will be home to the next Ben & Jerry’s or Calloway Golf, both of which commenced life as small business start-ups. A city can hope, can’t it?
When Ty Austin, who owns a florist shop in West Palm Beach, secured a $5,000 loan from National Funding last year, he was happy to have working capital and could build inventory for mini-gardens and landscaping,
The experience, moreover, was surprisingly pleasant. “The guy I worked with was really cool,” Austin says, referring to the sales representative at the San Diego-based financial technology firm. “It turned out that he was getting married and I ended up giving him and his fiancé advice on floral arrangements.”
The borrowing worked out so well that the Floridian, who is 46 and the sole proprietor of Austintatious Designs, re-upped for a second loan of $12,000 to help purchase a commercial van. The van will be used to transport flowers, plants and tools while doubling as a billboard-on-wheels. “It gives me more ‘street cred,’” he jokes.
To register his approval with National Funding, Austin went online to TrustPilot and posted a rave review of the sales rep: “James Johnson Rocks!”
Pam, a Texas wellness coach who provides clients with an array of holistic health therapies, needed extra money to buy an infrared sauna to add to her portfolio of services. But her credit rating was “poor,” she told deBanked in an e-mail interview, “from when I changed careers and lost my health and struggled to make my credit card and student loan payments on time.”
Like Austin, Pam — who asks to be identified by her first name —found National Funding through an online search. And she too secured $5,000, although her transaction was structured as a merchant cash advance, rather than a loan. The terms of the MCA require a daily debit from her bank account. She reckons that the total cost of the MCA to be roughly $1,500.
Pam pronounces herself satisfied with the deal and mightily impressed with the way National Funding treated her. The process took about three days — and would have gone even quicker if she’d located her professional licenses sooner. Best of all, she says, the agent at the company tailored the financing to suit her circumstances. “They were great as far as getting my questions answered, even listening to my past situation, which others may not have cared about,” she says.
“They really wanted to get me an option that they knew I’d be able to repay,” Pam adds. “They said they were in the business of helping small businesses grow rather than putting them in a hard financial situation.”
The positive experiences that Austin and Pam had with National Funding are not isolated instances. Rather, they are representative of clients’ dealings with the company. Witness its online reviews from business borrowers at TrustPilot which go back three years, run for 36 pages, and merit National Funding a 9.4 rating on a scale of 10. That’s a straight-A grade on any report card. Although there’s the occasional naysayer — four percent assert that their experience was “poor” or “bad” (and some negative comments can be blistering) — the weight of the reviews is almost embarrassingly positive.
Typical postings find that National Funding and its agents win kudos for, among other things, being “prompt and professional,” providing service that is “hassle free and about as friendly as you can be,” and even being “accommodating and gracious.” A man named Al McCullough spoke for many when he declared: “My experience was great. Professional and on time. Couldn’t ask for more.”
All of which helps account for why National Funding — its 230 employees working out of a sleek suburban office building guarded by a tall stand of palm trees in San Diego — is a rising star in the world of alternative business lending and financial technology. In 2017, the company raked in $94.5 million in revenues, a 24.8 percent bounce over the $75.7 million recorded a year earlier and nearly fourfold the $26.7 million posted in 2013.
In recognition of the company’s three-year growth rate of 142%, Inc. magazine included National Funding in its current list of the country’s 5,000 fastest-growing companies, the lender’s sixth straight appearance on the coveted roster. Since its inception in 1999, National Funding reports that it has originated more than $2 billion in loans to some 35,000 borrowers.
The company’s impressive performance has similarly merited accolades for David Gilbert, the 43-year-old chief executive who started the company on little more than a shoestring and whom employees regularly describe as “visionary.” Among Gilbert’s trophies: Accounting firm Ernst & Young recently presented him with its “Entrepreneur of the Year 2017 Award” for San Diego finance.
At first glance, the San Diego financier doesn’t look too much different from its cohorts. The company proffers unsecured loans of $5,000 to $500,000 to a mélange of small businesses in all 50 states and across multiple industries, including retail stores, auto repair shops, truckers, construction companies, heating-and plumbing contractors, spas and beauty salons, cafes and restaurants, waste management, medical and dental clinics, and insurance agencies.
To qualify for financing, a prospective borrower should have been in business for a year, have at least $100,000 in revenues, and boast a personal credit score of at least 500. While there’s no collateral required for loans, National Funding insists on a personal guarantee. The website reviewer NerdWallet cautions borrowers that this “puts your personal assets and credit at risk if you fail to repay the loan.”
Along with unsecured loans, National Funding offers equipment leasing – usually for heavy trucks and construction equipment – as well as merchant cash advances. The equipment lease is secured by the machinery. As in the case of Pam, the wellness coach cited above, MCAs are debited daily, the money automatically withdrawn from bank accounts.
There are a number of businesses that National Funding disdains, no matter how stellar their credit. “We won’t finance casinos, strip bars, tobacco, or firearms,” Gilbert says. “We’re not going to support industries like that.”
For CEO Gilbert, doing business ethically is a signature feature of the company. Among other things, National Funding presses its salespeople to steer clear of putting people into dodgy loans that are likely to default. “We’re lending capital,” Gilbert says, “and one of our core values is the way we support our customers. Are we placing people with the right product to meet their needs or are we being selfish? The best way to be customer oriented is to get a better understanding of what capital will do for them.”
That corporate ethos, coupled with the company’s remarkable performance, has raised its profile while earning it a measure of esteem among industry peers. “What I do know about National Funding,” says Douglas Rovello, senior managing partner at Fund Simple, a lender and broker in the Tampa area, “is that they have five or six different programs and set their rates high but competitively. They’re known for fitting their products to a client’s needs,” he adds. “And in a business that has its share of bad actors, they have a reputation as a company with a conscience.”
A company with a conscience. Customers come first. And yet National Funding turns heads with its sales production of roughly 1,000 financings a month and triple-digit growth rate. So how do they it? A good place to start is with Gilbert, whose leadership skills, business acumen, and second-to-none work ethic “set the tone,” says Kevin Bryla, the company’s 52-year-old chief marketing officer.
For his part, Gilbert credits his family background and an upbringing in which education and academic achievement were strongly encouraged. The fifth of six children, he’s the only one who opted for a business career. “There are three doctors, two lawyers – and me,” Gilbert says.
The son of a prominent physician, his mother a homemaker and volunteer docent at the nearby Nixon Library for the past 25 years, Gilbert grew up in Yorba Linda. He attributes his keen interest in business to observing how his father, a pathologist, operated his own laboratory, which employed 60 people. “It was the business side of medicine that fascinated me,” he asserts.
Even so, his two closest friends at the University of Southern California — fraternity brothers Marc Newburger and Sean Swerdlow– tell a somewhat different story. They remember Gilbert as someone who found his true calling, his métier, during his college years. Enrolled initially in pre-med courses, he was a diligent student but, his friends assert, manifestly unsuited for a career in medicine.
“Formative,” says Swerdlow, the older of the two fraternity brothers and now a management consultant based in Southern California, “would be a very good word” to characterize that period during which Gilbert abandoned medicine in favor of the world of commerce. In 1997, he earned a bachelor’s degree in business administration “with an emphasis in entrepreneurship.”
But it was fraternity life just as much as the classroom, his friends agree, that shaped him and foreshadowed his future. “It wasn’t ‘Animal House,’” Swerdlow says of Alpha Epsilon Pi. “We boasted the highest GPA (grade point average) on fraternity row.”
Nonetheless, Gilbert took to the social life and camaraderie that the fraternity offered with gusto, and his friendship with the colorful Newburger was especially fateful. A freewheeling entrepreneur today, Newburger takes a measure of credit — Gilbert’s disapproving parents might have preferred the word “blame” — for contributing to his fraternity brother’s metamorphosis. “Dave hated all of his pre-med classes,” Newburger insists. “He had zero stomach for it. He was so much like I was: a natural people person and a born entrepreneur.”
Newburger is the quintessential soldier of fortune. After college, he tried his hand as an actor, supporting himself by playing poker and getting paid to be a contestant on TV game shows including “The Dating Game,” “Card Sharks,” and “3’s A Crowd.” He’s now the co-president and co-inventor of Drop Stop, a patented device that “minds the gap” between a car’s front seat and the console and prevents coins, keys, glasses, and mobile phones from disappearing down that rabbit hole. (Drop Stop really took off after Newburger and his business partner appeared on the television show “Shark Tank” and scored a $300,000 capital injection from celebrity-investor Lori Greiner who took a 30% stake in the company and slapped her name on the brand.)
Back at the frat house, Newburger and Gilbert collaborated on business ventures. The pair once sold T-shirts sporting an off-color message about USC’s archrival, the University of California at Los Angeles. “The (anti-UCLA) message was pure hatred,” Newburger recalls. “But it was just for the day of the football game and it was all in fun.”
At first, sales at the stadium were lackluster. USC students kept trying to bid down the price or importune them to throw in an extra tee. As for the game itself, USC’s chances for victory looked equally unpromising. As time ran out, however, the Trojan quarterback completed a Hail Mary pass and USC won. The two fraternity brothers grabbed the bundle of shirts and sprang into action. “We got to the exit just in time and sold out in a matter of seconds,” Newburger recalls.
Newburger takes credit too for introducing his friend to Las Vegas’ gaming tables. Gilbert, his friend says, immediately demonstrated a knack for counting cards, handling money, and taking risks. “It was typically blackjack,” recalls Swerdlow, who sometimes accompanied them. “We didn’t have much money then. But there were moments when Dave would bet a big pile of chips. He’s willing to make a bet and live with the consequences.”
Sports are another of Gilbert’s enthusiasms. His friends say that, whether he’s returning serve at ping pong or standing over a putt — he plays to an 11 handicap at golf – he wants to win. Remarks Newburger: “He’s competitive to the point that — when he beats you — he wants the Goodyear blimp flying overhead to announce his victory.”
Gilbert, who is married with two children, is legendarily loyal to friends and family. While most members of a college fraternity might keep up with old companions after graduation by exchanging greeting cards and attending college reunions, Gilbert goes the extra mile.
He once footed the bill for Swerdlow to travel with the USC football team to an away game, arranging it so that his fraternity brother could view the action from field-level. After Newburger had a recent health scare (no worries, he’s O.K.), Gilbert rounded up a couple of dozen fraternity brothers and their wives (or companions), and put together a four-day bash in his buddy’s honor. The event was held at Cabo, the Mexican beach resort in Baja California, and Gilbert underwrote a fair amount of the cost. “He shares his success with his friends,” Newburger says, adding: “I don’t know anybody who works harder on friendships.”
Many of the personality traits described by friends and colleagues — tenacity and competitiveness, self confidence and leadership — played a key role in the development and success of National Funding, which Gilbert founded just two years out of college with $10,000 borrowed from his uncle, Howard Kaiman, of Omaha.
He’d worked a couple of quick jobs right after college, including a stint at small-business lender Balboa Capital, but he was always destined to be his own boss. Gilbert’s start-up was called Five Point Capital and, at first, it was located in the affluent Chatsworth section of Los Angeles and concentrated on equipment leasing.
“The first two years we were a cold-calling company and then we got into direct mail and saw some success and then we moved to San Diego and started to scale up the company,” Gilbert says. The decampment, he explains, was “for the quality of life, but we also felt we could hire from a better talent pool than L.A. We wanted to set ourselves apart.”
By 2007, Five Point was cranking up operations, revenues shot to $28 million and its headcount totaled 210 employees. “Then the Great Recession hit” in 2008-2009, Gilbert says. The company was forced to furlough 140 employees, two-thirds of its workforce. Yet even as it retrenched, the company managed to branch out. It began making merchant cash advances, Gilbert says, and, also in 2007, it linked up with CAN Capital to do broker financings. “We were pretty well known and they were looking for partners for factoring and leasing,” Gilbert explains.
It took time to recover after the financial crisis. But by 2013 – the year that Gilbert re-branded his company “National Funding” – the company was able to hire back as many as 15% of its laid-off employees (most had found other jobs, in many cases relocating to Silicon Valley, Gilbert reports). By then, the company had secured a $25 million credit facility from Wells Fargo Bank, which allowed it to move up the food chain to “become a balance-sheet lender,” Gilbert says, and offer a wider selection of financing options.
Key to driving the company’s phenomenal growth has been its flood-the-zone marketing and sales strategies. The company spends $16 million annually on marketing using a full panoply of channels and media, both online and offline. These include direct mail and targeted marketing, paid advertising, search-engine optimization or SEO, and sports sponsorships. “We try to build a whole range of marketing mechanisms,” explains marketing chief Bryla, “and when you get the mix right, they all help each other.”
Gilbert is a big believer in the benefits of sports marketing, the company’s website featuring the logos of the San Diego Padres (baseball), and Anaheim Ducks and Los Angeles Kings (hockey). Ever the faithful alumnus, Gilbert and his company back USC football as well. During the 2015 2016 college football season, the company paid for naming rights for what became, for one night, the “National Funding Holiday Bowl” at Qualcomm Stadium.
Janet Fink, department chair at the McCormack School of Sports Management located at the University of Massachusetts-Amherst, told deBanked that sponsorship programs can easily cost a million dollars or more. “It’s not cheap,” she says. “When a company sponsors a team, they get a number of benefits. One is that they get to put the team’s logo on their website. The idea is that fans are passionate or have an affinity for the team and that it will rub off on a sponsor.
“Sports enthusiasts,” Fink adds, “often make good customers. When you have enough disposable income to go to these sporting events, you’re probably a good prospect for a loan.”
The sponsorships — which include civic involvement such as offering Holiday Bowl tickets to members of San Diego’s large military contingent as well as to company employees — also build good will in the community and team spirit among the workforce. (National Funding also makes an effort to hire veterans, says Bryla.)
Gilbert believes in the old adage that you have to spend money to make money. The company spends $14 million rewarding its network of outside brokers. Inside the company, high-performing salespeople are compensated with commissions, bonuses and an assortment of rewards, including resort trips.
But sales representatives’ must conform to company guidelines. Justin Thompson, National Funding’s sales chief, explains that the “customer comes first” philosophy is not just a slogan but a core value. “We’re not a factory spitting out widgets,” Thompson says. “We’re here to build relationships and sell a repeatable product. We want that customer to come back to us. Every loan is customized. Six of ten customers who pay off their loans come back for a second financing. Whether your business is dog grooming or you’re an asphalt company,” he adds, “people will do business with people they like and trust.”
Using the software program “customer relationship management” (CRM), National Funding expends a lot of effort gathering data on its business customers and extrapolating the information for use in credit evaluations. But the use of technology only goes so far.
Gilbert reckons that the art of the deal involves about “70 percent algorithm and 30 percent people.” He adds, “You still need the people component to look at credit profiles. The algorithm spits out a recommendation but we still need the human element.”
If there’s a fly in the National Funding ointment, it’s that the company’s fees can be more expensive than a bank loan.
But borrowers who have been denied loans at a bank or other lender are likely to overlook those costs. Austin, the florist in West Palm Beach, for example, came to National Funding when his bank, North Carolina-based BB&T Bank, gave him the cold shoulder despite the $15,000 in deposits that he averages each month. “I’ve been with them for six years,” he fretted, “and they treated me shabbily.”
Even more grateful was Jimmy Frisco, of Annapolis, who is co-owner with his wife of Lisa’s Luncheonette, a business that includes a food trailer and several cafeterias located in the city’s office buildings. They employ about a dozen people.
Frisco had taken a nasty spill and was laid up for seven months. Health insurance covered the $18,000 in medical costs but he and Lisa fell behind in their bills and needed working capital to pay for food purchases and other business expenses. By the time a flyer from National Funding popped up in his mailbox, he and his wife “had been turned down by several other lenders, including banks,” he says, adding: “Things happen in life and we don’t have the best of credit.”
Getting that loan for $25,000 from National Funding took just three days. Frisco’s health is much improved and business is back to normal. He won’t discuss the terms of the financing, other than to say “it was reasonable.”
He adds: “There were no problems with National Funding, no hassle with the paperwork. They’re great people to work with.”
SAN FRANCISCO, CA – December 5, 2016 – SmartBiz Loans, the first SBA marketplace and bank-enabling technology platform, has ranked as the number one provider of non-Express, SBA 7(a) loans under $350,000 for the 2016 government fiscal year. SmartBiz also ranked number five among providers of under $350,000 traditional SBA 7(a) and Express 7(a) loans combined.
“SmartBiz’s success in this year’s SBA 7(a) ranking demonstrates how technology can support banks in meeting the needs of small businesses,” said Evan Singer, CEO of SmartBiz Loans. “SmartBiz is committed to creating the leading marketplace for both banks and small business owners, by matching small business owners with the bank best suited to their needs and enabling a higher percentage of SBA loans to be approved.”
SmartBiz generated $200 million in funded SBA 7(a) loans through its bank lending partners, which helped them earn the top spot. The data used is based on SBA lending data released in November, reflecting its 2016 fiscal year which ended on Sept. 30. Wells Fargo Bank, which was ranked just below SmartBiz, generated $155 million in funded non-Express SBA 7(a) loans under $350,000. This is the first time a technology platform and marketplace has achieved the number one position in SBA’s ranking of 7(a) loans.
“Small businesses are the driving force of the economy,” said Ann Marie Mehlum, retired Associate Administrator, Office of Capital Access, U.S. Small Business Administration. “By supporting them, the SBA and lending partners like SmartBiz are investing in the economy as a whole.”
SmartBiz is revolutionizing SBA lending. Its marketplace helps increase approval rates by automatically directing businesses to the right lender, while its advanced software streamlines the SBA loan application, underwriting and origination process. In this way, SmartBiz fills a critical gap in the small business loan market and enables small businesses nationwide to grow without settling for the sky-high rates of alternative online lenders or undergoing the typically slow and tedious traditional bank process.
About SmartBiz Loans
SmartBiz Loans is a unique combination of an online SBA loan marketplace and a bank enabling technology platform. The company’s online software provides SBA preferred lenders customized and automated origination, underwriting and documentation, making approval and funding fast and easy. Sophisticated algorithmic sorting in the SmartBiz marketplace also enables higher approval rates for small businesses because the right applications are automatically directed to the right bank. SmartBiz is based in San Francisco and was founded in 2009 by a team of experienced financial services entrepreneurs with backing from leading venture capital firms including Investor Growth Capital, Venrock, First Round Capital, Baseline Ventures, and SoftTech VC. Learn more at www.smartbizloans.com.
Though neither company has made an announcement, deBanked has learned that FinSight Ventures, a venture capital firm that was a late stage investor in Lending Club, has acquired a stake in NY-based Fundry. As reported last week, Fundry is the newly formed parent company of Yellowstone Capital and Green Capital. Combined, they have originated more than $1 billion in small business funding since inception.
It was a small piece of equity, a single digit percentage share of ownership, said a source with knowledge of the transaction. In return, Fundry reportedly got a big boost in their valuation, though we were unable to ascertain a figure.
FinSight participated in Lending Club’s $125 million equity round back in May of 2013 that gave the company a $1.55 billion valuation and put them on track for an IPO. They were part of another equity round with Lending Club in April, 2014.
The transaction with Fundry is a nod to the industry that merchant cash advances have a lot more room to grow and perhaps a signal that Fundry is also on some kind of track.
After five years in finance, Peter Ribeiro decided to strike out on his own and start US Business Funding in 2008, providing equipment leasing and financing for businesses. But when the housing market collapsed four months later, Ribeiro saw a second major business opportunity emerge. Earlier that year, he had purchased a $250,000 home in southern California that appraised for $355,000 at the time he bought it. Within seven months, the home’s value plummeted to $95,000. “I told myself I knew the area really well, so I might as well start buying some properties.”
At that point, Ribeiro’s fledgling company still wasn’t generating much revenue. “I thought, ‘Man, I just can’t get a lot of loans done right now. I only have three or four employees.’ That’s how I got into the real estate industry.” Twelve years later and at the height of a global pandemic, Ribeiro is simultaneously running two thriving ventures —US Business Funding, and a portfolio of hundreds of rental properties he now owns.
At a time when fintech startups and other industry innovators are looking for investors, alternative lending execs like Ribeiro are instead choosing to put their money in real estate to beef up their investment portfolios. Although some execs shy away from talking publicly about their real estate dealings, citing the fact that they don’t want too much exposure, the consensus is that there’s a lot of money to be made in buying, selling and renting property – if you know what you’re doing.
“I think real estate is lucrative because when you look at the history of investments, there are two or three ways to really make money: You can put your money in the stock market, or you can put it in bonds. And the other one guaranteed to go up in value is real estate,” Ribeiro says.
To Ribeiro, real estate offers a few major advantages: It’s a tangible asset. You can leverage it as it appreciates in value. Deductions make it so you pay very little in taxes. And it offers significant cash flow. “It’s the best investment you can make,” he says.
What makes real estate an especially good fit for alternative lending and fintech execs is that they possess the skills, resources and financial literacy to succeed at it.
“Real estate is a long-term gain,” Ribeiro says. “The industry we’re in is a cash-flow cow. People who are doing well are printing money. But what can you do with that money? You can put it in the stock market, but you won’t control much. Then you pay capital gains on it.”
Attorney Paul Rianda, who represents both cash advance clients and real estate investors, says it makes sense that real estate investing appeals to alternative lenders – especially amidst the uncertainty of COVID-19.
“If you’re a cash advance guy and COVID happened, then you’re not doing very well,” he says. “If you diversified your assets by doing real estate and cash advance, you’re able to weather these downturns a lot more easily than you would otherwise.”
Rianda has not yet counseled any of his own cash advance clients on real estate matters. But based on his insights from working with both areas, he says real estate would be a logical move for MCA executives, and he’s seen some of his clients in the bankcard industry buy up properties.
“One of my clients had a portfolio of merchants and sold it for a few million, then flipped over to real estate. So it’s a means (to an end),” Rianda says.
Ribeiro has relied on a simple strategy to steadily build his portfolio of residential properties: Buy. Fix. Leverage. Repeat.
“I feel like the portfolio is doubling every couple of years. It’s just a snowball effect,” he says.
After Ribeiro buys a home, he waits about six months before he has it appraised and fixes it up in the meantime.
“If you go to the bank within the first six months of purchasing it, they’re going to give you the actual market value of whatever you purchased the house for,” he says. “If you wait six months, they’ll reappraise the home and give its true market value, which could be another 40, 50 or 60 percent. And so now you’re going to have a lot more equity in the house, and you’re going to get a lot more money when you leverage that home to go buy the next one.”
Ribeiro says he sees lots of people making the mistake of buying a home, and then going to the bank a week or two later for a loan.
Constantly maintaining a positive cash flow is Ribeiro’s number one rule of real estate investing. “Your best friend is depreciation,” he says.
Depreciation refers to one of the key tax benefits of real estate. Since owning a rental property is technically a type of business because it generates income, the property is considered a business asset. The IRS allows you to deduct the cost of acquiring that asset – the property – over the span of its useful life. For residential properties, the IRS sets a standard depreciation period of 27.5 years.
So if you buy a $100,000 property with a $20,000 land value, $80,000 of the asset is considered depreciable. Over the course of 27.5 years, you can take an annual deduction of just over $2,900 a year.
The trick, Ribeiro says, is to stick to lower-priced properties with an 80/20 home-to-land value. Most of his properties are single- and multifamily homes between southern California and Las Vegas.
Like Ribeiro, Rianda’s investor clients concentrate on one geographic area to find the best properties. “They look at the area for a long time, understand the area,” he says. “In my neighborhood, three blocks can make a 50 percent difference in the price of a house. You need to focus on a particular geographic area and do a lot of transactions in it.”
Small portfolio, big impact
“For me, it’s just a really good second income stream and a way to have a secure return of 4.5% to 6.5% a year,” he says.
Growing up, Weitz got a feel for real estate by watching his uncles invest in multifamily properties. At one point, Weitz’s uncle owned 15 different multifamily homes, and Weitz would help do the maintenance on them.
Eight years ago, Weitz invested in his first two-family home and has fixed and flipped eight properties since then. He currently owns two two-family homes and invests primarily in multifamily homes in Long Island, Brooklyn and Queens. Over the next five years, he plans to pick up at least two more four- or eight-family properties. Working with a small portfolio of residences in his home state has allowed Weitz to have full control over managing his properties and to turn a good profit.
“I think for me, it just offers more liquidity,” he says. “It’s an asset I can sell and liquidate at any time. That’s really important for me.”
Ideally, Weitz would like for his investment to build generational wealth that he can pass down to his son. With many people in the U.S. unable to qualify for mortgages, Weitz sees real estate investing as an opportunity to help the economy by giving renters a place to live and put down roots. “Depending on the neighborhood, you can put yourself in a situation where you have good renters for 20 to 30 years. They want to raise their families and have their kids grow up there,” he says.
Litigation among the pitfalls
Even though Ribeiro has had success with his business model, he cautions that there’s considerable risk involved with real estate.
“I love the industry. It’s a passion. It’s beyond my wildest dreams of the size of the portfolio and how well it performs,” he says. “But don’t think it’s all cupcakes and unicorns. There’s a lot to the madness. That’s why not everyone can replicate the model.”
“Professional litigators” and multiple lawsuits from renters are a major downfall that Ribeiro points to. He sees at least one substantial suit each year and tries to settle outside of court whenever possible.
As an attorney, Rianda says his real estate clients call on him not just for the purchase of the property, but for various issues that occur during the ownership period.
Here’s one scenario: A property owner has a tenant who isn’t paying rent, so the property owner sues the tenant. But while the lawsuit proceedings are under way, the tenant declares bankruptcy, which puts a stall on further litigation.
“There are people who understand the system and can make it difficult for you to get them out (of the property),” Rianda says, adding that it’s important to have legal counsel readily available. “You need someone who has really done this a lot and knows how the system works to get that person out of the rental property as quickly as possible.”
To minimize liability, Ribeiro has divided his properties into about 10 different business entities – each with a separate umbrella insurance policy.
Rianda sees his own real estate investor clients follow this strategy by grouping multiple homes under the name of an LLC. “If you personally own all these various assets, there’s the potential that if something catastrophic happened at one, it could bleed into all your other properties and potentially put them at risk,” he says.
Ribeiro’s real estate investments and finance company both serve as full-time occupations for him. Some years, he’ll focus more on one area than on the other, depending on market conditions. He spent more time on real estate between 2008 and 2013; then his business needs flip-flopped when real estate prices started going back up. This past year, he’s directed more attention to the finance company because of COVID, which necessitated some operational changes and a need to help clients who had been trying to get PPP loans. But he’s also started investing in commercial real estate, which has taken a hit because of companies forgoing office space to save overhead costs while employees work remotely.
Ribeiro expects to start seeing more mortgage defaults on lower-level homes in 2021 and 2022, after forbearance periods are over. And he’s been leveraging his assets to start buying more properties around the second quarter of the new year. “I think it will be a good time to start buying heavy again,” he says.
An attractive investment vehicle
With the pandemic weakening business portfolios, secondary investment options might sound like just what the doctor ordered.
When COVID first hit, some of Rianda’s clients started pursuing other investments like personal protective equipment (PPE). Most of his cash advance clients closed up shop for a few months.
“As time goes on, I’m starting to see my clients go back into their lending,” Rianda says.
Even as clients start to recoup their business, Rianda sees the wisdom in other investments and says cash advance executives are well suited for real estate. “It’s just a way that people who have been successful and spin off a lot of cash for their businesses see as a safe way to diversify their income,” Rianda says. “It’s something I find that people who are doing well in their business do, regardless of what business they’re in. So cash advance guys are just following the things people have done for years.”
Ribeiro cautions that people who get into real estate should look at it as a 10-year investment minimum, and not just a two- or three-month stint.
“It’s not a lottery ticket, and it’s not an overnight race,” Ribeiro says. “This is a long-term gain. But it’s a very lucrative gain from a cash-flow perspective and a tax perspective. I don’t think there’s a more attractive vehicle than real estate.”
For alternative lenders and funders, 2021 is starting out with a question mark and will lead (hopefully) to a resounding exclamation point of recovery.
Many industry participants waved goodbye to 2020 with relief, and are welcoming a bounce-back in 2021, despite some trepidation about potential bumps along the way and how long a full recovery will take. While things started to improve somewhat toward the latter half of 2020 after grinding to a halt earlier in the year, the pandemic is still raging, with economic growth highly dependent on the immunization trajectory. Then there’s the incoming Democratic administration and the possibility of new rule- making, along with January’s runoff elections in Georgia that could change the balance of power in the Senate, and thus impact the new president’s law- making abilities.
Beyond these macro-issues, the funding industry is also dealing with its own uncertainties. Small business lenders and funders have been hit particularly hard, with underwriting decidedly more difficult in this environment. Some industry players have been forced to find alternative revenue streams in order to ride things out. Not only that, but there are scores of small businesses still reeling from pandemic-induced shutdowns and lighter foot traffic, with some gloomy estimates about their ability to bounce back. Many alternative players are weighing diminished returns against a widely-held bullish outlook for the industry long-term. Many are simply hoping they can hunker down and stick it out long enough and to avoid additional carnage and consolidation that’s widely expected over the short-term.
Ultimately things will get better, but it’s unclear precisely when, says Scott Stewart, chief executive of the Innovative Lending Platform Association. “It’s going to be a bumpy ride for the next year to figure out who is going to be able to survive,” he says.
Here’s a deeper dive into how industry participants see 2021 shaping up in terms of the challenges, competition, M&A, regulation, changing business model, expansion opportunities and more.
SPECIFIC CHALLENGES FOR SMALL BUSINESS FINANCERS
Companies that focus on consumer financing haven’t struggled quite as much amid the pandemic as their small business brethren, and they could continue to see demand grow in 2021. Even amid high unemployment rates, many consumers still need loans for home repairs or as a stop-gap to pay necessary expenses, helping to mitigate the impact on firms that focus on personal loans.
Small business financers, however, got pummeled in 2020 and the situation remains precarious, especially given the prognosis for small companies broadly. Consider that 163,735 Yelp-listed businesses closed from the beginning of the pandemic through Aug. 31—at least 97,966 of them permanently. Further underscoring how dire the situation is for small businesses, 48 percent of owners feared not earning enough revenue in December to keep their businesses afloat, according to a recent poll by Alignable, an online referral network for small businesses. What’s more, 50 percent of retail establishments and 47 percent of B2B firms could close permanently, according to the poll of 9,204 small business owners.
A SHRINKING COMPETITIVE LANDSCAPE
For many lenders and funders, the latter part of 2020 proved more successful for originations, though business is still a far cry from before the pandemic. A number of players who suspended or reduced business operations for a period of time during the first wave of the pandemic have dipped their toes back in and are in the process of trying to adapt to the new normal. For some, though, the challenges may prove too great, industry observers say. Given that many brokers and funders that were on the fringe have been hurt by the pandemic, more shake- out can be expected, says Lou Pizzileo, a certified public accountant who advises and audits alternative finance companies for Grassi in Jericho. N.Y.
And, with fewer competitors, there will be more of a need for those who are left to pick up the slack, says Peter Renton, founder of Lend Academy. Beyond being a lifeline for many alternative financers, PPP loans helped open the eyes of many small businesses who hadn’t previously considered working with anyone but a bank. In the beginning, when it was so difficult for small businesses to get these funds, they looked beyond banks for options and some found their way to online providers. This could be a boon for the industry going forward since alternative providers are now on the radar screen of more small businesses, says Moshe Kazimirsky, vice president of strategic partnerships and business development at Become.
He predicts that larger, stronger players will gradually ease some of their lending and funding criteria early on in 2021, but no one is expecting a quick revival, with some predicting it could be well into 2022 before the industry is on truly stable footing. “I think it’s going to be a very slow recovery,” Kazimirsky says.
In 2020, the industry saw bellwethers like Kabbage and OnDeck get swallowed up, and with so many businesses pinched, there are likely to be more bargains ahead from M&A standpoint, Pizzileo says. “The damage from Covid is palpable; we just haven’t seen the real impact of it yet,” he says.
No matter what product you are providing, if you’re a smaller player who can’t find your way, you’re going to have a hard time staying in business,” says Stewart of the Innovative Lending Platform Association. “There will be some collateral damage going into next year,” he predicts.
In terms of likely buyers, Renton says he expects other fintechs to step in, and possibly even mid-size community banks snap up some alternative providers. If you can buy something for “a song” it’s compelling, he says. “I expect to see a few more offers that are too good to refuse,” he says.
CHANGING BUSINESS MODELS
Pizzileo, the CPA, predicts there will be ongoing opportunities in the year ahead for well-positioned, strong businesses with available capital. In some cases, however, this may require tinkering with their existing ways of doing business.
Before the crisis, some lenders applied the same or very similar lending model across industries. “That is going the way of the dinosaur. That’s not going to be a successful model going forward,” Renton says. Lenders will focus more on having a differentiated model for the businesses they serve. “I think the crisis created this necessity to treat each industry on its own merits and create a model that has some level of independence, he says.
The year ahead is also likely to be one in which e-commerce lending continues to thrive. According to the third quarter 2020 report from the U.S. Census Bureau, U.S. retail e-commerce stood at $209.5 billion, up 36.7% year over-year. E-commerce accounted for 14.3% of total retail sales in Q3. Because it’s such a high-growth area, and many businesses that didn’t have this vertical before are moving in this direction and more lenders are focusing on it and growing that part of their business, says Kazimirsky of Become.
It will also be interesting to watch how lenders and funders continue to reshape themselves. Sofi, for instance, is continuing to pursue its goal of receiving a national bank charter. Other lenders and funders may also seek to reinvent themselves as they attempt to stay afloat and compete more effectively.
“Monoline lenders that rely on a single product will have more difficulty supporting customers in the wake of Covid,” says Gina Taylor Cotter, senior vice president and general manager of global business financing at American Express, which purchased Kabbage in 2020. “Small businesses need multi-product solutions to not only access working capital, but also real-time insights to help them be more prudent with their cash flow and accept contactless payments safely to encourage more business,” she says.
CHANGES IN RISK MODELING
Another pandemic-driven change is that lenders have had to tweak their risk modeling. Everyone understands the economy is not in the greatest spot, but their challenge in 2021 will be developing a way to assess future losses in the absence of a baseline, says Rutger van Faassen, head of product and market strategy for the benchmarking and omnichannel research group at Informa Financial Intelligence.
Consumer behaviors have changed, for instance. So even though the pandemic will end, it’s too soon to say what the structural impacts on an industry will be and how that affects the desirability of lending to especially hard-hit businesses, such as restaurants, cruise lines and fitness centers. “Clearly the behavior that everyone is showing right now is because of the pandemic. The question is: how will people behave once the pandemic ends,” he says.
“In the meantime, a lot of lenders will have to do more in-the-moment decision-making, until we get to a point when we’re truly in a new normal, when they can start recalibrating models for the longer-term,” he says.
OPPORTUNITIES TO HELP SMALL BUSINESSES
One certainty in the year ahead is the need to help existing small businesses with their recovery, says Cotter of American Express. “Small businesses represent 99 percent of all jobs, two-thirds of new jobs and half of the non-farm GDP in America. Our country’s success depends on small businesses, and financial institutions have a great opportunity to meet their needs to recover and return to positions of growth in 2021,” she says.
How to make this happen is something many alternative financers will grapple with in 2021. Another opportunity may exist in providing funding solutions to new businesses or those that have pivoted as a result of the pandemic. Cotter points to the inaugural American Express Entrepreneurial Spirit Trendex, which found 76% of businesses have already pivoted their business this year and 73% expect to do it again next year. “New-business applications have reached record heights as entrepreneurs pivot and adapt, indicating a surge of new ventures that will require financial solutions to build their business,” Cotter says.
Several regulatory issues hang in the balance in 2021, including state-based disclosure laws, expected rules on third-party data aggregation and demographic data collection, and the status of a special purpose charter for fintechs, says Ryan Metcalf, head of U.S. public policy, regulatory affairs and social impact at Funding Circle. With a new administration coming in, the regulatory environment could become more favorable for measures that stalled during Trump’s tenure.
Armen Meyer, vice president of LendingClub and an active member of the Marketplace Lending Association, says he’s hoping to see a bill pass in 2021 that requires more transparency for small business lending. He would also like to see more states follow the lead of California and Virginia and make the 36% interest rate standard of Congress’s Military Lending Act, which covers active- duty service members (including those on active Guard or active Reserve duty) and covered dependents, the law of the land. “We’re calling for this to be expanded to everybody,” he says.
Meanwhile, our neighbors to the North have their own challenges and opportunities for the year ahead. The alternative financing industry in Canada originated out of the 2008 recession when banks restricted their credit box and wouldn’t lend to certain groups. While conditions are very different now, “this period of economic uncertainty is going to be an incredible fertile period of time for fintechs to come up with new and interesting and creative credit products just like they did entering the last financial crisis,” says Tal Schwartz, head of policy at the Canadian Lenders Association.
Open banking continues to be on the Canadian docket for 2021 and how the framework shapes up is of utmost interest to fintech lenders in Canada. Schwartz says he’s also hopeful that alternative players in Canada will have a role to play in subsequent government- initiated lending programs. He’s also expecting to see more growth in the e-commerce area, particularly when it comes to extending credit to e-commerce companies and in financing solutions at checkout for online shopping.
Last month, a group of fintech companies christened the Fintech Equality Coalition. Dedicated to ensuring racial equality is a right extended to everyone, the group pledges to focus on enhancing access to financial services for the underrepresented- particularly within the black community.
The coalition comes at a pivotal time for fintech, currently facing the challenges created by the 2020 pandemic.
In August, the Federal Reserve Bank of New York released a study into the distribution of PPP and how the funds affected black communities. The institution found that the number of small business owners fell by 22% from February to April- the largest drop on record. But the closure of businesses was not felt equally.
“Black businesses experienced the most acute decline, with a 41 percent drop,” The study said. “Latinx business owners fell by 32 percent, and Asian business owners dropped by 26 percent. In contrast, the number of white business owners fell by 17 percent.”
The study also showed that forty percent of Black-owned businesses are concentrated in 30 counties across the country. 19 out of 30 of these counties were the hardest hit by COVID 19 in the nation.
Unfortunately, other studies have shown that the PPP did not accurately get funds to areas hit by the virus. The National Bureau of Economic Research (NBER) published in July, found that companies more negatively affected by COVID were less likely to be approved.
This may explain why the Small Business Majority study into PPP found that while 63% of Black and Latino small business owners applied, less than two-thirds received funding.
The Fintech Equality Coaltion’s pledge is overall a promise to do more for minority communities, stating:
- Because the Black community is underserved by financial services
- Because there are Black voices and issues in our industry that should be but are not currently amplified
- Because Black employees and Black-owned businesses are underrepresented in the tech community, including at many of our companies
- Because the Black community is underrepresented in leadership roles, including at many of our companies
- Because these promises are meaningless without accountability
The coalition is a pledge to host and sponsor events like forums that feature black speakers. The pledge is also a recognition that the black community has been underserved by financial services in the past, and the signers aim to incorporate more black-owned businesses than before.