Articles by Cheryl Winokur Munk
On Friday, American Express announced that it had completed its acquisition of Kabbage.
“Kabbage, An American Express Company will continue to provide quick and easy cash flow management solutions for small businesses, now backed by the trust, service, and security of a American Express,” American Express wrote on social media. “We’re excited to welcome Kabbage’s talented colleagues to American Express. Together we will combine our over 60 years of experience backing small businesses with Kabbage’s innovative technology to support our customers through this challenging time, and help them get back on their feet and thrive.”
Meanwhile, below is a copy of a Q&A deBanked had with Kabbage co-founder Kathryn Petralia that appeared in our magazine’s July/August issue.
Q: How specifically do you think the pandemic will change the way SMEs bank?
A: The pandemic will first change with whom they bank, and that choice will change the way they bank. For perspective, one hundred percent of Kabbage customers have a bank account, but very few of them can get a loan from their bank. We launched Kabbage Checking earlier this year to serve the smallest of businesses without sacrificing the features they expect and offering other products banks don’t. We’re focused on making cash flow tools accessible to the businesses traditionally underserved and overlooked, and the pandemic has been a catalyst for businesses to find new solutions.
Q: How might the dynamic of banking change after the crisis?
A: It was well-reported that businesses without an existing credit relationship with their bank were turned away from applying for PPP loans. We’ve heard directly from many of our PPP customers that this will compel them to change banks, and the demand for Kabbage Checking has reflected that sentiment since its launch. In the short term, businesses of all sizes and ages will seek out and sign up for new, tech-forward banking partners. In the long term, that shift will change customers’ expectations of what banks should offer. For example, prior to the PPP, Kabbage had issued well over a billion dollars to customers during non-banking hours. On-demand, 24/7 access to funding and cash flow insights, or faster settlements and money transfers will soon become commonplace, and large retail banks will need to adapt if they want to capture or reclaim these customers.
Q: How are these changes likely to impact alternative lenders and funders?
A: For starters, single-product lending companies will realize they must diversify their offerings in order to compete in the new financial-services marketplace. I would expect to see lenders launch new products to more resemble a bank. Conversely, traditional banks will need to begin adopting automated ways to serve customers with a tech-forward experience. Especially in the new normal where customers may be apprehensive about in-person banking meetings, they must adapt online to acquire and serve customers.
Q: What’s still needed to help Main Street recover?
A: The PPP was only the first phase; we’re not out of the woods yet. Businesses now need to restart and eventually grow. The crisis made business owners realize they need tighter controls over their cash flow, as many found themselves on the back foot and ill-equipped to withstand a long-term crisis such as the one through which we are all muddling.
They’ll need cash-flow tools to be more prudent and appropriately plan for similar events. Having said that, it’s not only on the shoulders of small businesses or tech solutions. They need customer demand, and local economies need to begin to reopen safely so consumers feel comfortable returning to normal commerce. That will take the support of cities and states encouraging consumers to shop local so small businesses have greater incentive to recall their employees and get back to work.
Q: How can alternative lenders and funders best play a role in this recovery?
A: Much of what we’re already doing is exactly what our economy needs. For the most part, fintech companies serve the customers banks won’t or can’t. That reality is unfortunately unchanged today. That’s why during the pandemic Kabbage made every effort possible to provide products that helped SMBs through this crisis. With respect to PPP, we helped nearly 300,000 small businesses access over $7 billion, helping preserve an estimated 945,000 jobs. Our payments product saw a near 4X spike in adoption as businesses sought contactless payment options. We built www.helpsmallbsuiness.com in three days to allow any small business to generate needed revenue by selling online gift certificates. We also launched Kabbage Checking, giving small businesses a new banking option, and Kabbage Insights remains available and free to access for any small business.
Q: What changes do you expect to see in the alternative lending and funding industry as a result of the pandemic?
A: Everyone will expand their services. Whether it’s larger companies expanding their solutions through acquisitions, or start-ups investing beyond their primary product, everyone will aim to enhance their offerings to give customers more data-driven products that help them rebuild.
Q: Kabbage just agreed to be purchased by American Express. Should we expect to see more consolidation in the alternative lending/funding space? If so, over what time frame and why do you expect this to happen?
A: I would not be surprised if we saw more deals announced before the end of the year.
Q: Tell us a little about why Kabbage decided to sell and why the timing was right?
A: For us, it has always been about finding the right company with the right mission and intentions. We just happened to be in the middle of a crisis when the conversations started, despite having the financial capacity to support operations for multiple years. American Express shares our vision to be an essential partner to small businesses, and we couldn’t be more excited at the opportunity to continue the important work of providing solutions and innovative capabilities that address a range of small business cash flow needs alongside AmEx.
A number of small businesses—including those in the merchant cash advance industry—faced with little or no way to make money for months—have pivoted to selling personal protective equipment.
It’s no wonder businesses across the U.S. have shifted gears. With the pandemic raging, and consumers and businesses trying to return to some sort of normalcy, there’s high demand for these products, causing even businesses that previously had no connection to them to spring into action.
“It’s not my forte; I had to pivot just to make sure I could stay afloat before things turned around,” says John DiCanio, founding partner of Direct Merchant Funding in Bethpage, N.Y.
This past spring, at a time when everything in the MCA business stopped, he heard from a merchant in the medical supply field that masks were becoming very important. The merchant connected him to a contact in Hong Kong from whom he was able to buy hospital-grade and non-medical grade masks and sell them to local hospitals, local businesses and others.
DiCanio says he did it for a short time only—two months—which was enough to tide him over under his
regular business started coming back. Mask-making is still a big business and a lot of people are still doing it, but he prefers to stick to merchant cash advance, which he’s been doing for around 15 years. He says business has picked up enough that he no longer has the need to do anything on the side—and he hopes it stays that way.
Many funding industry participants are still selling these types of products, but it’s somewhat of a hush-hush business. Not everyone wants to talk about it for any number of reasons, including embarrassment and fear of looking weak to customers and business connections. Even so, small businesses that pivoted say they are doing the best they can to stay afloat—and there’s no shame in that.
Kat Rosati, founder of Apparel Booster in Riverside, Calif., a product development agency for luxury and socially conscious brands, began hand-sewing masks to help support her business that had been hit-hard by the pandemic.
She has manufacturing partners all over the world, and production was at a standstill for her various products. She couldn’t import fabric needed for the company’s various projects and a lot of production partners were forced to close. Luckily, she had a connection to a fabric mill in Pennsylvania that focuses on antimicrobial products that was willing to provide her with material.
She hired temporary workers to help her make masks, which she’s producing at a rate of about 150 a week. She sells them to consumers and small businesses. The revenue has helped defray overhead expenses, among other things. “It hasn’t been super profitable, but it’s definitely helped keep the business alive,” she says.
She had to furlough her four-person team because she can’t afford to pay them without regular client work coming in. Her husband, who works in the restaurant industry, was also furloughed. So whatever money she can bring in, helps. “I’m watching small business owners around me that haven’t made any kind of pivot close left and right,” she says. “The fact that I can keep mine alive makes it worth it for me.”
To be sure, small businesses pivot for all sorts of reasons, and it’s not always because they are struggling. Francis Perdue, a publicist and business consultant in Birmingham, Ala., began selling PPE products including gloves, kn95 masks, surgical masks, customizable cloth masks, child and adult-sized shields, suits, gowns and the Xenon Fever Defense machine which uses AI technology to measure skin temperature and detect potential fever. She says she saw a need for these types of products in local schools as well as in hospitals and clinics in predominantly black neighborhoods. She is still consulting, but doing this as a side gig while the need persists.
Another example is MORGAN Li, a retail and hospitality manufacturer in Chicago Heights, Ill. The company identified the need and opportunity to help businesses remain open or reopen to customers while abiding by new recommendations to support public health. Thus, the company began producing customized social distancing materials including sneeze guards, safety shields, signage and floor graphics for various businesses to remind employees and customers to comply with social distancing requirements, according to a spokeswoman.
More recently, Andy Rosenband, the company’s chief executive, saw another opportunity to help communities prepare for another critical stage—reopening schools. He created a line of personal protective equipment that specifically addresses the challenge of social distancing in schools to keep students, teachers and staff safe.
For some small businesses, the shift is likely to be a permanent one.
JB Herrera, founder of Perceptive Insights a San Diego-based small and medium business consulting and mentoring company, says his firm was growing, but PPE products offer the ability to create a broader impact and are likely to be more profitable than merely a consulting business.
He has clients in China and back in December when things were starting to get bad there, he realized that the problem could spread massively to the U.S., and if it did, 80 percent or more of businesses would be negatively impacted, in his estimation. Using his business expertise regarding supply chains and pre-existing and new contacts, his company shifted gears to introduce in March a line of FDA-registered products designed to create and maintain safe environments. The products include commercial and personal cleaning solutions, masks, light technology disinfectants, air filtration, and personal sanitizing kits.
Even before the pandemic, the PPE market was worth several billion, he says, and that’s likely to grow exponentially over the next five to 10 years. So much so, that he expects the new business line to represent 90 percent of his revenue for the next three years—at least.
“Even after the spike goes away, it’s still going to be a profitable business in its own right,” he says.
With the doors to 2019 firmly closed, alternative financing industry executives are excited about the new decade and the prospects that lie ahead. There are new products to showcase, new competitors to contend with and new customers to pursue as alternative financing continues to gain traction.
Executives reading the tea leaves are overwhelming bullish on the alternative financing industry—and for good reasons. In 2019, merchant cash advances and daily payment small business loan products alone exceeded more than $20 billion a year in originations, deBanked’s reporting shows.
Confidence in the industry is only slightly curtailed by certain regulatory, political competitive and economic unknowns lurking in the background—adding an element of intrigue to what could be an exciting new year.
Here, then, are a few things to look out for in 2020 and beyond.
There are a number of different items that could be on the regulatory agenda this year, both on the state and federal level. Major areas to watch include:
- Broker licensing. There’s a movement afoot to crack down on rogue brokers by instituting licensing requirements. New York, for example, has proposed legislation that would cover small business lenders, merchant cash advance companies, factors, and leasing companies for transactions under $500,000. California has a licensing law in place, but it only pertains to loans, says Steve Denis, executive director of the Small Business Finance Association. Many funders are generally in favor of broader licensing requirements, citing perceived benefits to brokers, funders, customers and the industry overall. The devil, of course, will be in the details.
- Interest rate caps. Congress is weighing legislation that would set a national interest rate cap of 36%, including fees, for most personal loans, in an effort to stamp out predatory lending practices. A fair number of states already have enacted interest rate caps for consumer loans, with California recently joining the pack, but thus far there has been no national standard. While it is too early to tell the bill’s fate, proponents say it will provide needed protections against gouging, while critics, such as Lend Academy’s Peter Renton, contend it will have the “opposite impact on the consumers it seeks to protect.”
- Loan information and rate disclosures. There continues to be ample debate around exactly what firms should be required to disclose to customers and what metrics are most appropriate for consumers and businesses to use when comparing offerings. This year could be the one in which multiple states move ahead with efforts to clamp down on disclosures so borrowers can more easily compare offerings, industry watchers say. Notably, a recent Federal Reserve study on non-bank small business finance providers indicates that the likelihood of approval and speed are more important than cost in motivating borrowers, though this may not defer policymakers from moving ahead with disclosure requirements.
“THIS WILL DRIVE COMMISSION DOWN FOR THE INDUSTRY”
If these types of requirements go forward, Jared Weitz, chief executive of United Capital generally expects to see commissions take a hit. “This will drive commission down for the industry, but some companies may not be as impacted, depending on their product mix, cost per lead and cost per acquisition and overall company structure,” he says.
- Madden aftermath. The FDIC and OCC recently proposed rules to counteract the negative effects of the 2015 Madden v. Midland Funding LLC case, which wreaked havoc in the consumer and business loan markets in New York, Connecticut, and Vermont. “These proposals would clarify that the loan continues to be ‘valid’ even after it is sold to a nonbank, meaning that the nonbank can collect the rates and fees as initially contracted by the bank,” says Catherine Brennan, partner in the Hanover, Maryland office of law firm Hudson Cook. With the comments due at the end of January, “2020 is going to be a very important year for bank and nonbank partnerships,” she says.
- Possible changes to the accredited investor definition. In December 2019, the Securities and Exchange Commission voted to propose amendments to the accredited investor definition. Some industry players see expanding the definition as a positive step, but are hesitant to crack open the champagne just yet since nothing’s been finalized. “I would like to see it broadened even further than they are proposed right now,” says Brett Crosby, co-founder and chief operating officer at PeerStreet, a platform for investing in real estate-backed loans. The proposals “are a step in the right direction, but I’m not sure they go far enough,” he says.
Precisely how various regulatory initiatives will play out in 2020 remains to be seen. Some states, for example, may decide to be more aggressive with respect to policy-making, while others might take more of a wait-and-see approach.
“I think states are still piecing together exactly what they want to accomplish. There are too many missing pieces to the puzzle,” says Chad Otar, founder and chief executive at Lending Valley Inc.
As different initiatives work their way through the legislative process, funders are hoping for consistency rather than a patchwork of metrics applied unevenly by different states. The latter could have significant repercussions for firms that do business in multiple states and could eventually cause some of them to pare back operations, industry watchers say.
“While we commend the state-level activity, we hope that there will be uniformity across the country when it comes to legislation to avoid confusion and create consistency” for borrowers, says Darren Schulman, president of 6th Avenue Capital.
The outcome of this year’s presidential election could have a profound effect on the regulatory climate for alternative lenders. Alternative financing and fintech charters could move higher on the docket if there’s a shift in the top brass (which, of course, could bring a new Treasury Secretary and/or CFPB head) or if the Senate flips to Democratic control.
If a White House changing of the guard does occur, the impact could be even more profound depending on which Democratic candidate secures the top spot. It’s all speculation now, but alternative financers will likely be sticking to the election polls like glue in an attempt to gain more clarity.
Election-year uncertainty also needs to be factored into underwriting risk. Some industries and companies may be more susceptible to this risk, and funders have to plan accordingly in their projections. It’s not a reason to make wholesale underwriting changes, but it’s something to be mindful of, says Heather Francis, chief executive of Elevate Funding in Gainesville, Florida.
“Any election year is going to be a little bit volatile in terms of how you operate your business,” she says.
The competitive landscape continues to shift for alternative lenders and funders, with technology giants such as PayPal, Amazon and Square now counted among the largest small business funders in the marketplace. This is a notable shift from several years ago when their footprint had not yet made a dent.
This growth is expected to continue driving competition in 2020. Larger companies with strong technology have a competitive advantage in making loans and cash advances because they already have the customer and information about the customer, says industry attorney Paul Rianda, who heads a law firm in Irvine, Calif.
It’s also harder for merchants to default because these companies are providing them payment processing services and paying them on a daily or monthly basis. This is in contrast to an MCA provider that’s using ACH to take payments out of the merchant’s bank account, which can be blocked by the merchant at any time. “Because of that lower risk factor, they’re able to give a better deal to merchants,” Rianda says.
Increased competition has been driving rates down, especially for merchants with strong credit, which means high-quality merchants are getting especially good deals—at much less expensive rates than a business credit card could offer, says Nathan Abadi, president of Excel Capital Management. “The prime market is expanding tremendously,” he says.
Certain funders are willing to go out two years now on first positions, he says, which was never done before.
Even for non-prime clients, funders are getting more creative in how they structure deals. For instance, funders are offering longer terms—12 to 15 months—on a second position or nine to 12 months on a third position, he says. “People would think you were out of your mind to do that a year ago,” he says.
Because there’s so much money funneling into the industry, competition is more fierce, but firms still have to be smart about how they do business, Abadi says.
Meanwhile, heightened competition means it’s a brokers market, says Weitz of United Capital. A lot of lenders and funders have similar rates and terms, so it comes down to which firms have the best relationship with brokers. “Brokers are going to send the deals to whoever is treating their files the best and giving them the best pricing,” he says.
Profitability, access to capital and business-related shifts
Executives are confident that despite increased competition from deep-pocket players, there’s enough business to go around. But for firms that want to excel in 2020, there’s work to be done.
Funders in 2020 should focus on profitability and access to capital—the most important factors for firms that want to grow, says David Goldin, principal at Lender Capital Partners and president and chief executive of Capify. This year could also be one in which funders more seriously consider consolidation. There hasn’t been a lot in the industry as of yet, but Goldin predicts it’s only a matter of time.
“A lot of MCA providers could benefit from economies of scale. I think the day is coming,” he says.
He also says 2020 should be a year when firms try new things to distinguish themselves. He contends there are too many copycats in the industry. Most firms acquire leads the same way and aren’t doing enough to differentiate. To stand out, funders should start specializing and become known for certain industries, “instead of trying to be all things to all businesses,” he says.
Some alternative financing companies might consider expanding their business models to become more of a one-stop shop—following in the footsteps of Intuit, Square and others that have shown the concept to be sound.
Sam Taussig, global head of policy at Kabbage, predicts that alternative funding platforms will increasingly shift toward providing more unified services so the customer doesn’t have to leave the environment to do banking and other types of financial transactions. It’s a direction Kabbage is going by expanding into payment processing as part of its new suite of cash-flow management solutions for small businesses.
“Customers have seen and experienced how seamless and simple and easy it is to work with some of the nontraditional funders,” he says. “Small businesses want holistic solutions—they prefer to work with one provider as opposed to multiple ones,” he says.
This year could be a “pivotal” year for open banking in the U.S., says Taussig of Kabbage. “This issue will come to the forefront, and I think we will have more clarity about how customers can permission their data, to whom and when,” he says.
Open banking refers to the use of open APIs (application program interfaces) that enable third-party developers to build applications and services around a financial institution. The U.K. was a forerunner in implementing open banking, and the movement has been making inroads in other countries as well, which is helping U.S. regulators warm up to the idea. “Open banking is going to be a lively debate in Washington in 2020. It’ll be about finding the balance between policymakers and customers and banks,” Taussig says.
The funding environment
While there has been some chatter about a looming recession and there are various regulatory and competitive headwinds facing the industry, funding and lending executives are mostly optimistic for the year ahead.
“If December 2019 is an early indicator of 2020, we’re off to a good start. I think it’s going to be a great year for our industry,” says Abadi of Excel Capital.
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.
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 definition of accredited investor, which the SEC is tackling this year, is causing a fair amount of debate.
At issue is the fact that under federal securities laws only persons who are accredited investors may participate in certain types of securities offerings.
As it now stands, to be deemed an accredited investor, a person needs to earn income of more than $200,000 ($300,000 with a spouse) in each of the prior two years and reasonably expect to earn the same for the current year. Alternatively, the person needs to have a net worth of $1 million or more (alone or with a spouse), excluding the value of a primary residence.
The goal of these rules, of course, is investor protection. In theory, the rules are supposed to ensure investors are sophisticated enough to invest in riskier investments and, on top of that, have adequate cushioning against the risk of financial loss.
The trouble, critics say, is that the rules aren’t doing a very good job of achieving these objectives. There’s widespread agreement that the current definition is flawed. Where it gets trickier is in deciding how it should be fixed.
There are some who say the current bar is too high, others who say it’s too low. Some contend that the wealth-based test should be scrapped altogether in favor of a sophistication test. Others promote a sliding scale approach to investing in riskier offerings. This would allow all investors to participate, but in increments that are proportional to their wealth—similar to what happens in the crowdfunding arena today. Some industry players support a combination of measures, a sophistication test in connection with a sliding scale, to maximize investor protection and still open the playing field for others who can’t participate today based on their income or net worth.
The varying opinions are likely to be debated by the SEC as it reviews the accredited investor definition, which it’s required to do every four years by a provision in the Dodd-Frank Act. The SEC is taking the opportunity to do a broad-based review of the regulatory framework for investing in alternative assets; the accredited investor definition is just one of the areas on its docket to examine. The comment period for this review ended on August 30th.
At this point, what the SEC actually decides to do about the accredited investor definition is anybody’s guess. The thrust of these conversations is likely to focus on what constitutes an appropriate degree of protection, which is where many of the disagreements—and alternative suggestions on how to best accomplish this— come into play.
VETTING THE VARIOUS OPINIONS
On one hand, consumer advocates want to maintain the highest degree of investor protection possible. The concern is that consumers generally don’t have enough prowess or information to safely invest in unregistered offerings, which can carry more risk than registered investments.
“We don’t want the definition to be any weaker than it is now because that would do the vast majority of consumers a disservice,” says Brian Young, public policy manager at the National Consumers League. “With these exempt products, there are a lot of unknown variables and there’s a lot more vulnerability,” he says.
One suggestion that’s being proposed is to raise the wealth and income levels to adjust for inflation. It’s a step in the right direction because it would further limit who is eligible to be considered an accredited investor, says Barbara Roper, director of investor protection for the Consumer Federation of America. “The levels haven’t kept pace with inflation since they were set,” she says.
This alone, however, wouldn’t be sufficient to protect investors, consumer advocates say, since there are plenty of wealthy people who have little to no investment prowess.
“Just changing it to correct for inflation doesn’t change it to correct for sophistication and still places investors at risk,” says Ed Mierzwinski, who oversees U.S. PIRG’s federal consumer program, helping to lead national efforts to improve consumer credit reporting laws, identity theft protections, product safety regulations and more.
On this point consumer advocates and industry professionals seem to agree: that limits based on income or net worth aren’t all that useful.
Roper of the Consumer Federation of America gives the example of a 64-year-old who has $200k in income or $1 million of assets in his or her retirement accounts. This doesn’t mean he or she is financially literate, let alone sophisticated enough to take part in certain types of riskier alternative investments, she says. “That would be an inappropriate investment recommendation if it were made by your broker or investment advisor,” she says.
Some industry professionals also find fault with the wealth test, but, unlike consumer advocates, they’d like to see more investors allowed to participate, not fewer. It’s not right, they contend, that a wide range of highly educated people are prevented from investing in certain offerings because of arbitrary limits on net worth and income.
Many promising investment opportunities are not even being offered to a huge majority of American investors, based on the standards that exist today, according to Nat Hoopes, executive director of the Marketplace Lending Association, an industry trade organization.
“By harmonizing and simplifying complex rules and adjusting the current accredited investor standards, my hope is that the SEC will find that they can permit many more Americans to gain access to a wider range of well regulated investment opportunities, without leaving those citizens exposed to fraud or abuse. Done right, changes from the SEC in this area will help to promote more equality of opportunity in our economy, without adding new red tape,” he says.
Brew Johnson, co-founder and chief executive of PeerStreet, an online platform for investing in real estate debt, says it’s “crazy” that people who are highly educated—such as MBAs, accountants, attorneys and other businesspersons can’t invest in certain offerings simply because they don’t have the income or wealth levels. He takes issue with the fact that he didn’t qualify to invest on his own platform when it was first getting off the ground. Some of his employees today also don’t qualify to invest in the platform they are helping to build, which is troubling, he says.
“You don’t want people to make terrible decisions. But the idea that the average person is too dumb to make decisions with their money…is offensive,” Johnson says. Today, there’s much more readily available information and transparency—a significant change from when the rules were first put in place—when only the largest investors had access to the types of information necessary to make critical investment decisions, he says.
Johnson doesn’t take issue with the goal of protecting investors from getting into things they don’t understand. Rather, he says, “I don’t believe wealth is a determiner of sophistication.”
ALTERNATIVE PROPOSALS TO A WEALTH-BASED TEST
That’s where another idea being floated by members of the Marketplace Lending Association and others may come in. The thought is to create a new way to measure an investor’s level of sophistication and ability to withstand loss. An example of this could be some kind of test to identify investors who are deemed to have sufficient investment prowess, despite falling below the SEC’s threshold based on wealth or net worth, to participate in certain types of offerings.
It’s an option that, if adopted, could open up the playing field to additional investors—while still trying to accomplish the SEC’s goal of investor protection, industry participants say.
Ryan Metcalf, head of U.S. Regulatory Affairs at Funding Circle, says the Financial Industry Regulatory Authority Inc. (FINRA) could develop a test to be administered online when an investor who doesn’t meet the wealth or income bar wants to invest. This would allow quick-decisions to be made. People who want to invest a few thousand dollars shouldn’t have to do it in person; this would be too onerous, he says.
There could even be different tests based on what investors are seeking to invest in, says Mark Atalla, owner and managing director at private lending firm Carlyle Capital.
For a private placement in a mortgage fund, there could be questions related to the risks involved there, whereas for a private placement in a start-up technology company, there could be other types of questions pertaining to risk. The goal would be to ensure the investor has a sufficient level of understanding about the particular products they are considering.
Otherwise, Atalla says, there’s too much room for people to lose on a large scale. “These are people’s livelihoods you’re responsible for at the end of the day,” he says. “I think it’s important for investors to understand what they are really doing.”
Some industry professionals say there may be too many practical limitations for this type of an assessment to work. Certainly details would have to be worked out including what the scope of the test or tests should be. Decisions would also have to be made about who would be in charge of creating and administering a test or tests and how and where they would be administrated, among other things.
In theory, if someone can pass a test to show he or she is knowledgeable about investing, the person should be able to invest, says PeerStreet’s Johnson, adding that there’s something to be said about people accepting personal responsibility for their decisions, provided they have been given adequate information from which to make informed, knowledgeable decisions. “The devil is in the details of what [this type of test] would look like,” he says.
Another idea being floated—that could stand on its own or be implemented together with a sophistication test—is to allow all investors to invest on a scale that’s similar to the crowdfunding exemption. Under rules adopted by the SEC in 2015, the general public now has the opportunity to participate in the early capital raising activities of start-up and early-stage companies and businesses by way of crowdfunding. Because of the risks involved with this type of investing, however, investors are limited in how they can invest during any 12-month period in these transactions. The limitation depends on the person’s net worth and annual income.
Some industry watchers say the sliding scale idea is a viable one because it would allow more investors a chance to participate in more risky offerings, while providing a safety net for loss.
This type of model has the potential to offer investors a reasonable amount of protection, says Vincent Petrescu, chief executive of truCrowd, Inc., an equity crowdfunding portal that connects startups and emerging businesses with non-accredited and accredited investors. “If you have less money, you are allowed to invest less, but you still can play your hand,” he says.
Johnson of PeerStreet also supports this approach because it allows investors who otherwise wouldn’t have access a chance to broaden their exposure to areas that could potentially allow them to increase their wealth.
Certainly, questions about this approach persist as well. What should the investment limits be? Would it depend on the type of investment? Would investors need to self-certify as they do in crowdfunding, or would their information need to be verified by a third party? These questions and more are also likely to be probed more deeply during an SEC review.
The Marketplace Lending Association would also like employees of private funds to qualify as accredited investors for investments in their employers funds. The trade group contends that a private fund’s employees likely have sufficient access to the information necessary to make informed decisions about investments in their employer’s funds.
The suggestion would be for the SEC to consider adding a new category of the definition to include “knowledgeable employees” of “covered companies” as those terms are defined in Rule 3c-5 of the Investment Company Act.
Industry watchers are hopeful to have some clarity on these issues within the coming months, so stay tuned.
“The SEC’s mandate is to protect investors, which sometimes is needed,” says Petrescu of truCrowd, the equity crowdfunding portal. “There needs to be checks and balances,” he says.
The Australian alternative lending market continues to gain momentum, bolstered in part by increased awareness, heightened competition and growing dissatisfaction with the status quo.
Indeed, there’s been significant growth in the few years since deBanked first wrote about the nascent alternative lending business down under. Notably, Australia’s alternative funding volume surpassed $1.14 billion in 2017, up 88 percent from $609.59 million in 2016, according to the latest data available from KPMG research. It’s the largest country in terms of total alternative finance market volume in the Asia Pacific region, excluding China, according to KPMG.
To be sure, the Australian market is still relatively small—at least compared with the U.S. Digging deeper, the largest share of market volume in 2017—the latest data available—came from balance sheet business lending, accounting for more than $574 million, according to KPMG. P2P marketplace consumer lending had the second largest market volume at $256 million. Invoice trading was the next largest segment of the Australian alternative finance market, accounting for $142.65 million, according to the KPMG report.
Its small size notwithstanding, what makes the Australian market particularly interesting is the potential promise it holds for the companies already established there and the opportunities it may offer to new entrants that find ways to successfully compete in the market.
Certainly alternative lending opportunities in Australia are growing, as awareness increases and the desire by consumers and businesses for favorable rates and faster service intensifies. The Australian alternative lending market is similar to Canada in that a small number of large banks dominate the market both in terms of consumer lending and small business lending. But, like in Canada, alternative lenders are gaining ground amid a changing customer mindset that values speed, favorable rates and a digital experience.
Equifax estimates that alternative finance volume in Australia is now growing at about 10 percent to 15 percent per year; that compares to a decline of approximately 20 percent for some major traditional lenders in terms of credit growth, says Moses Samaha, executive general manager for Equifax in Sydney. This presents an opportunity for alternative lenders to serve parts of the market the banks don’t want and those that are more attuned to a digital experience.
Even so, challenges persist. For instance, digital disruptors are still working on gaining brand awareness, and the market is only so big to be able to accommodate a certain number of alternative players. Time will time whether there will be consolidation among alternative lenders and more bank partnerships, which haven’t been so successful to date. “It doesn’t feel like they are as active as they were announced to be,” Samaha says.
At present, the Australian market consists of a few dozen alternative lenders pitted against four major banks. RateSetter, SocietyOne and Wisr are among the largest alternative players in the consumer lending space. On the small business side, Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap are some of the leading companies. PayPal Working Capital also has a growing presence in the Australian small business lending market.
New lenders continue to eye the Australian market for entry, but it’s not an easy market to crack, according to industry participants. The market consists of mostly home-grown players and that’s not expected to change drastically. (Capify, OnDeck and Berlin-based Spotcap are notable exceptions. Another U.S. major player, Kabbage, previously provided its technology to Australia’s Kikka Capital, but that agreement is no longer in force.)
There can be a steep learning curve when it comes to outsiders doing business in Australia. What’s more, there’s no longer the first-to-market advantage that existed a decade or so ago. It’s also a relatively limited market in terms of size, which can be off-putting. Australia has a population of around 25 million, making it less populated than the state of California, with an estimated 39.9 million residents.
Still, for alternative players that are able to successfully navigate the challenges the Australian market presents, there’s ample opportunity to grab market share away from traditional players—similar to the pattern that’s emerged elsewhere around the globe.
Take consumer lending, for example. The unsecured consumer lending market in Australia sits at about $70 billion, with the large banks occupying maybe a 90 percent share of that, says Mathew Lu, chief operating officer of Wisr (previously known as DirectMoney Limited). Compared with other markets such as U.K. and the U.S., who went through a similar journey around a decade ago, “Australia is probably three or four years into that same journey of growth. It’s shifting and changing,” he says.
Alternative lenders have made strides in undercutting the large banks by offering generally lower rates and typically faster loan times. Unfavorable press related to bank lending practices has also benefited alternative lenders. Lu refers to these conditions as “a perfect storm” for growth.
Wisr, for instance, saw loan origination volume spike 409 percent in fiscal year 2018. The company secured $75 million in loan funding agreements last year and boasts more than 80,000 customers, according to a company presentation.
Marketplace lender, SocietyOne, which in March reached $600 million in loan originations, is another example of an alternative lender that has benefited from the momentum. The company— celebrating its 7th anniversary this summer—is hoping to reach $1 billion in loans by 2020, according to its website.
RateSetter—another major player in this space—has also experienced significant growth since launching in Australia in 2014, and is now funding over $20 million in loans each month, according to its website. In April, the company soared past $500 million in loans funded and in May it saw a record number of new investors register. The company has more than 15,000 registered investors by its own account.
One question for the future is whether the consumer alternative lending space in Australia will ultimately be too crowded amid a spate of new entrants. Wisr’s Lu says “there’s a big question mark” regarding how many alternative lenders the market can sustain. “Will there be a level of consolidation or amalgamation? These are questions ahead of us,” he says.
For its part, alternative lending to small businesses is also a growing force within Australia. As a testament to the development of this market, in June 2018, a group of Australia’s leading online small business lenders released a Code of Lending Practice, a voluntary code designed to promote fair terms and customer protections. Currently, the Code only covers unsecured loans to small businesses. Signatories include Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap.
Capify—an early entrant to Australia—has been pursuing businesses there since 2008. The company, which integrated its U.S. business in 2017 to Strategic Funding Source (now called Kapitus) is now operating only in Australia and the U.K. In Australia, it has executed more than 7,500 business financing transactions for Australian businesses and has more than 50 staff members in its Australian offices.
The company recently closed a deal with Goldman Sachs for a $95 million line of credit for growth in Australia and the U.K., which includes building out its broker program to increase distribution and technology investment.
David Goldin, the company’s chief executive, says Capify is hoping to grow its Australian business between 25 percent and 30 percent in 2019. The company is looking at M&A activity as well as organic growth.
Since Capify has been in the market, he has seen a number of new entrants—some more successful than others. One concern Goldin has is the lack of experience by some of these competitors. Many aren’t pricing the risk properly and not underwriting prudently to be able to weather a downturn, he says. They are so new, he questions whether they have the expertise to be able to survive a downturn given what he characterizes as pricing and underwriting missteps.
“You can’t go out 24 months on a 1.25 factor rate – that’s crazy,” he says, referring to some contracts he’s seen. “I’ve seen this movie in the U.S. before and it doesn’t end well.”
Meanwhile, competition has driven down prices and made moving quickly on potential leads more of a necessity. When leads come in today, if you’re not on the phone in 30 minutes, you could lose it to a competitor, he says.
While the small business market is an enticing one for alternative lenders, raising awareness of their offerings continues to be a challenge.
“The small business market is fragmented and raising awareness is expensive,” says Beau Bertoli, co-founder and co-chief executive of Prospa, another prominent small business lender in Australia. “There hasn’t been much innovation in small business banking, but many Australians still don’t think of switching from banks and traditional lenders,” he says.
That said, more small businesses are turning to alternative lenders and these companies say they expect growth to increase over time. Recent research commissioned by OnDeck found that 22 percent of small and medium-sized businesses would consider an online lender, up from 11 percent in the past. This could be buoyed further by the introduction of Open Banking in Australia, which was set to be introduced in Australia in 2019, but this was pushed back to early 2020.
“We look forward to the introduction of Open Banking in Australia as it should allow lenders to use incremental data points to improve risk modeling, and increase competition in the SME lending space, ultimately providing SMEs with improved access to cashflow solutions to grow and run their businesses,” says Cameron Poolman, chief executive of OnDeck in Australia.
Bertoli of Prospa, which recently listed on the Australian Stock Exchange, says the Australian alternative lending market will also benefit from strong support from industry and government to increase competition and improve consumer and small business outcomes. The government recently established a $2 billion Australian Business Securitisation Fund, which is a huge win for small business, he says, that will ultimately make the finance available to small business owners more affordable by lowering the wholesale cost of funds for alternative lenders. “We expect this will boost credibility and consideration of alternative lenders among small business owners,” he says.
Declining property values is another factor helping alternative lending. “In November 2018 we saw the largest annual fall in property prices in Australia since the global financial crisis in 2009,” says Simon Keast, managing director of Spotcap Australia and New Zealand.
“As property prices decline, business owners find it more difficult to use their home as loan security and as such, turn to alternative lenders such as Spotcap that can provide them with unsecured loans for their business,” he says. What’s more, the SME Growth Index in March showed for the first time that business owners are almost as likely to turn to an alternative lender as they are to their main bank to fund growth, says.
Overall, the market opportunity for alternative lending to small businesses is compelling, says Bertoli of Prospa. “We estimate the potential market for small business lending in Australia is more than $20 billion per annum and we’ve penetrated only about 2 percent of the market so far. There are 2.3 million small businesses in Australia, and they’re crying out for capital,” he says.
Keast of Spotcap says he expects to see more banks and non-financial enterprises looking to leverage the technology fintech lenders have built to provide swift and digital lending products to small businesses. He offers the example of a partnership Spotcap, a German-based company, has with an Austrian Bank to provide same-day finance to SMEs in Austria as an example of the types of partnerships the company could also seek in Australia. “We have already partnered with an Austrian Bank that is leveraging our lending platform to provide same-day finance to SMEs in Austria, and there is plenty of interest for similar partnerships on the ground here,” he says.
OnDeck, meanwhile, expects to see a shake-out within the alternative finance sector, which will result in a smaller number of bigger players, with the ability to scale and serve multiple customers with a variety of products, according to Poolman, the company’s chief executive.
For his part, Goldin of Capify is bullish on the Australian small business market, but he cautions others that it’s not a gold rush type of place where everyone who comes in can make money.
“The state of California has more opportunity than the entire continent of Australia,” he says.
Canadians have been slow out of the gate when it comes to mass adoption of alternative financing, but times are changing, presenting opportunities and challenges for those who focus on this growing market.
Historically, the Canadian credit market has traditionally been dominated by a few main banks; consumers or businesses that weren’t approved for funding through them didn’t have a multitude of options. The door, however, is starting to unlock, as awareness increases about financing alternatives and speed and convenience become more important, especially to younger Canadians.
Indeed, the Canada alternative finance market experienced considerable growth in 2017—the latest period for which data is available. Market volume reached $867.6 million, up 159 percent from $334.5 million in 2016, according to a report by the Cambridge Centre for Alternative Finance and the Ivey Business School at Western University. Balance sheet business lending makes up the largest proportion of Canadian alternative finance, accounting for 57 percent of the market; overall, this model grew 378 percent to $494 million in 2017, according to the report.
Industry participants say the growth trajectory in Canada is continuing. It’s being driven by a number of factors, including tightening credit standards by banks, growing market demand for quick and easy funding and broader awareness of alternative financing products.
To meet this growing demand, new alternative financing companies are coming to the market all the time, says Vlad Sherbatov, president and co-founder of Smarter Loans, which works with about three dozen of Canada’s top financing companies. He predicts that over time more players will enter the market—from within Canada and also from the U.S.—and that product types will continue to grow as demand and understanding of the benefits of alternative finance become more well-known. Notably, 42 percent of firms that reported volumes in Canada were primarily headquartered in the U.S., according to the Cambridge report.
To be sure, the Canadian market is much smaller than the U.S. and alternative finance isn’t ever expected to overtake it in size or scope. That’s because while the country is huge from a geographic standpoint, it’s not as densely populated as the U.S., and businesses are clustered primarily in a few key regions.
To put things in perspective, Canada has an estimated population of around 37 million compared with the U.S.’s roughly 327 million. On the business front, Canada is similar to California in terms of the size and scope of its small business market, estimates Paul Pitcher, managing partner at SharpShooter, a Toronto-based funder, who also operates First Down Funding in Annapolis, Md.
Nonetheless, alternative lenders and funders in Canada are becoming more of a force to be reckoned with by a number of measures. Indeed, a majority of Canadians now look to online lenders as a viable alternative to traditional financial institutions, according to the 2018 State of Alternative Lending in Canada, a study conducted by online comparison service Smarter Loans.
Of the 1,160 Canadians surveyed about the loan products they have recently received, only 29 percent sought funding from a traditional financial institution, such as a bank, the study found. At the same time, interest in alternative loans has been on an upward trajectory since 2013. Twenty-four percent of respondents indicated they sought their first loan with an alternative lender in 2018. Overall, nearly 54 percent of respondents submitted their first application with a non-traditional lender within the past three years, according to the report.
Like in the U.S., there’s a mix of alternative financing companies in Canada. A number of companies offer factoring and invoicing and payday loans. But there’s a growing number focused on consumer and business lending as well as merchant cash advance.
Some major players in the Canadian alternative lending or funding landscape include Fairstone Financial (formerly CitiFinancial Canada), an established non-bank lender that recently began offering online personal loans in select provinces; Lendified, an online small business lender; Thinking Capital, an online small business lender and funder; easyfinancial, the business arm of alternative financial company goeasy Ltd. that focuses on lending to non-prime consumers; OnDeck, which offers small business financing loans and lines of credit; and Progressa, which provides consolidation loans to consumers.
By comparison, the merchant cash advance space has fewer players; it is primarily dominated by Thinking Capital and less than a dozen smaller companies, although momentum in the space is increasing, industry participants say.
“The U.S. got there 10 years ago, we’re still catching up,” says Avi Bernstein, chief executive and co-founder of 2M7 Financial Solutions, a Toronto-based merchant cash advance company.
In terms of opportunities, Canada has a population that is very used to dealing with major banks and who are actively looking for alternative solutions that are faster and more convenient, says Sherbatov of Smarter Loans. This is especially true for the younger population, which is more tech-savvy and prefers to deal with finances on the go, he says.
Because the alternative financing landscape is not as developed in Canada, new and innovative products can really make a significant impact and capture market share. “We think this is one of the key reasons why there’s been such an influx of international companies, from the U.S. and U.K. for example, that are looking to enter the Canadian market,” he says.
Just recently, for example, Funding Circle announced it would establish operations in Canada during the second half of 2019. “Canada’s stable, growing economy coupled with good access to credit data and progressive regulatory environment made it the obvious choice,” said Tom Eilon, managing director of Funding Circle Canada, in a March press release announcing the expansion. “The most important factor [in coming to Canada] though was the clear need for additional funding options among Canadian SMEs,” he said.
OnDeck, meanwhile, recently solidified its existing business in Canada through the purchase of Evolocity Financial Group, a Montreal-based small business funder. The combined firm represents a significantly expanded Canadian footprint for both companies. OnDeck began doing business in Canada in 2014 and has originated more than CAD$200 million in online small business loans there since entering the market. For its part, Evolocity has provided over CAD$240 million of financing to Canadian small businesses since 2010.
“There is an enormous need among underserved Canadian small businesses to access capital quickly and easily online, supported by trusted and knowledgeable customer service experts,” Noah Breslow, OnDeck’s chairman and chief executive, said in a December 2018 press release announcing the firms’ nuptials.
There are also a number of home grown Canadian companies that are benefiting from the growth in the alternative financing market.
2M7 Financial Solutions, which focuses on merchant cash advances, is one of these companies. It was founded in 2008 to meet the growing credit needs within the small and medium-sized business market at a time when businesses were having trouble in this regard.
But only in the past few years has MCA in Canada really started picking up to the point where Bernstein, the chief executive, says the company now receives applications from about 200 to 300 companies a month, which represents more than 50 percent growth from last year.
“We’re seeing more quality businesses, more quality merchants applying and the average funding size has gone up as well,” he says.
NAVIGATING THROUGH CHALLENGES
Despite heightened growth possibilities, there are also significant headwinds facing companies that are seeking to crack the Canadian alternative financing market. For various reasons, some companies have even chosen to pull back or out of Canada and focus their efforts elsewhere. Avant, for example, which offers personal loans in the U.S., is no longer accepting new loan applications in Canada at this time, according to its website. Capify also recently exited the Canadian business it entered in 2007, even as it continues to bulk up in the U.K. and Australia.
One of the challenges alternative lenders face in Canada is distrust of change. Since Canadians are so used to dealing with only a few major financial institutions to handle all their finances, they are skeptical to change this behavior, especially when the customer experience shifts from physical branches to online apps and mobile devices, says Sherbatov of Smarter Loans. He notes that adoption of fintech products in Canada has lagged in recent years, partially because there has been a lack of awareness and trust in new financial products available.
One way Smarter Loans has been working to strengthen this trust is by launching a “Smarter Loans Quality Badge,” which acts as a certification for alternative financing companies on its platform. It is issued to select companies that meet specified quality standards, including transparency in fees, responsible lending practices, customer support and more, he says.
The Canadian Lenders Association, whose members include lenders and merchant cash advance companies, has also been working to promote the growing industry and foster safe and ethical lending practices. For example, it recently began rolling out the SMART Box pricing disclosure model and comparison tool that was introduced to small businesses in the U.S. in 2016.
Another challenge that impacts alternative lenders in the consumer space is having restricted access to alternative data sources. Because of especially strict consumer privacy laws, access is “substantially more limited” than it is in any other geography,” says Jason Mullins, president and chief executive of goeasy, a lending company based in Mississauga, Ontario, that provides consumer leasing, unsecured and secured personal loans and merchant point-of-sale financing.
From a lending perspective, goeasy focuses on the non-prime consumer—generally those with credit scores of under 700. Mullins says the market consists of roughly 7 million Canadians, about a quarter of the population of Canadians with credit scores. The non-prime consumer market is huge and has tremendous potential, he says, but it’s not for the faint of heart.
Another issue facing alternative lenders is the relative difficulty of raising loan capital from institutional lenders, says Ali Pourdad, co-founder and chief executive of Progressa, which recently reached the $100 million milestone in funded loans for underserved Canadian consumers. “The onus is on the alternative lenders to ensure they have good lending practices and are underwriting responsibly,” he says.
What’s more, household debt to income ratios in Canada are getting progressively worse, with Canadians taking on too much debt relative to what they can afford, Pourdad says. As the situation has been deteriorating over time, there is inherently more risk to originators as well as the capital that backs them. “Originators, now more than ever, have to be cautious about their lending practices and ensure their underwriting is sound and that they are being responsible,” he says.
On the small business side of alternative lending, getting the message out to would-be customers can be a challenge in Canada. In U.S. there are thousands of ISOs reaching out to businesses, whereas in Canada, most funders have a direct sales force, with a much smaller portion of their revenue coming from referral partners, says Adam Benaroch, president of CanaCap, a small business funder based in Montreal.
He predicts this will change over time as the business matures and more funders enter the space, giving ISOs the ability to offer a broader array of financing products at competitive rates. “I think we’re going to see pricing go down and more opportunities develop, and as this happens, the business is going to grow, which is exactly what has happened in the U.S,” he says.
Generally speaking, Canadian businesses are still somewhat skeptical of merchant cash advance and require considerable hand-holding to become comfortable with the idea.
“You can’t wait for them to come to you, you have to go to them and explain what the products are,” says Pitcher of SharpShooter, the MCA funding company.
While Pitcher predicts more companies will continue to enter the Canadian alternative financing market, he doesn’t think it will be completely overrun by new entrants—the market simply isn’t big enough, he says. “It’s not for everyone,” he says.
The merchant cash advance business has come under repeated fire of late from regulators, legislators and customers. “Every aspect of the industry is under scrutiny right now. Syndication agreements, underwriting, and collections are the subject of bills in Congress and across multiple states,” says Steven Zakharyayev, managing attorney for Empire Recovery Services in Manhattan, which offers debt recovery services to financial companies. So how should funders respond amid these obstacles? Here are a few pointers to help funders succeed despite ongoing challenges from a legal, regulatory, business and public relations perspective:
DIFFERENTIATE BETWEEN CASH ADVANCES AND LOANS AND MODEL BUSINESS DEALINGS ACCORDINGLY
In the eyes of the law, merchant cash advances and loans are very different. With a cash advance, a funder advances the merchant cash in exchange for a percentage of future sales, plus a fee. A loan, on the other hand, is a lump sum of cash in exchange for monthly payments over a set time period at an interest rate that can be fixed or variable. While the two types of funding options have certain similarities, funders have to be extremely careful to make appropriate distinctions in their business practices; otherwise legal trouble can easily ensue, experts say.
Most funders know that they are supposed to draw a bright line between merchant cash advance and lending, but it’s critical they put this knowledge into practice. Funders have to ensure the distinction is evident in their business lexicon, says Gregory J. Nowak, a partner in the Philadelphia office of law firm Pepper Hamilton LLP who focuses on securities law.
For example, it’s extraordinarily important that funders don’t refer to merchant cash advances as loans in their business dealings. Business records, emails and other documents can be requested in litigation for discovery purposes. If the funder’s internal documentation refers to cash advances as loans, it’s going to be hard for the company to argue that they aren’t, in reality, loans.
“Most judges want to see consistency of treatment and that includes your vocabulary,” Nowak says. “The word ‘loan’ should be banned from their email and Word files.”
There’s a fair amount of litigation surrounding what is and what isn’t a cash advance. This can be helpful guidance for funders in setting out the criteria they need to follow to be able to defend their activities as cash advances. Even so, the line is somewhat of a moving target and funders need to be stalwart in these efforts given heightened regulatory scrutiny, experts say.
“If it looks like a loan, the law will treat it as a loan—and all the consequences that follow such a determination,” says Christopher K. Odinet, an associate professor of law at the University of Oklahoma College of Law.
BE CAREFUL ABOUT YOUR COLLECTION POLICIES
Obviously companies want to collect their payments. But some funders are too quick to file lawsuits, which could lead to unwanted trouble, says Paul A. Rianda, who heads a law firm in Irvine, Calif.
“The business model of sue first, ask questions later can be a problem,” says Rianda, whose clients include merchant cash advance companies.
The concern is that when funders sue, merchants start talking to attorneys and that could open the MCA firm to other types of lawsuits. The more a funder sues, the more it increases media attention and invites examination by state regulators and others. “You invite class action lawsuits and regulatory scrutiny that you really don’t want. It’s a boomerang thing,” he says.
The issue is especially pertinent now as legislators grapple with how to handle the thorny issue of confessions of judgement, more popularly known as COJs. For instance, since the start of the year, New York courts and county clerks have become much more rigid in processing confessions of judgments.
Certainly, not all funders use COJs. Just recently, for instance, Greenbox Capital suspended the use of COJs indefinitely, in response to the heightened industrywide debate over their use. While there’s no all-encompassing directive to stop using COJs, experts say it is incumbent upon funders to ensure they are used in a responsible and proper manner, especially amid political and regulatory uncertainty.
For instance, it would be irresponsible and potentially actionable to execute on a COJ simply because the merchant doesn’t remit receivables the merchant cash advance company purchased because he didn’t generate receivables, says Catherine M. Brennan, a partner at the law firm Hudson Cook LLP in Hanover, Maryland.
To be lawful, the COJ has to be based on a breach of performance under the agreement. Fraud, for instance, is actionable. But simple failure to remit receivables because the business has failed is not, she says.
“Conflating those two things—breaches of repayment versus performance—leads to a world of hurt,” she says. “MCA transactions do not have repayment as a concept.”
In places like New York, where COJs are more controversial, funders have to be especially careful about using them properly, experts say. Even though COJs are still enforceable under New York law for the time being, funders should understand every county processes them a bit differently, says Zakharyayev of Empire Recovery Services. “If they have a preferred county for filing, they should ensure their COJs are not only compliant with state law, but also complies with local rules,” he says.
What’s more, funders should ensure their COJs are properly notarized under New York law, ensure party names and the amount confessed is accurate, and avoid blanket statements such as naming each and every county in New York as a possible venue for filing, he says.
While some funders have suggested changing their venue provisions to a COJ-friendly state if New York outlaws COJs, Zakharyayev says he recommend New York funders keep their venue in New York regardless since it would still be one of the most efficient states to enforce a judgment. “I’ve filed COJs outside of New York and, even without a COJ, New York is much more efficient in judgment enforcement as New York courts are less restrictive in allowing the judgment creditor to pursue the debtor’s assets,” he says.
BE CAREFUL WHEN RAISING THIRD-PARTY MONEY
Aside from their dealings with merchants, funders also have to be cautious when it comes to interactions with potential investors.
Some companies have ample balance sheets and don’t need money from third parties to fund their operations. But funders that decide for business purposes to solicit money from investors, have to be careful not to run afoul of SEC rules, says Nowak, the attorney with Pepper Hamilton.
He recommends funders treat these fundraising efforts as if they are issuing securities and follow the rules accordingly. Otherwise they risk being the subject of an enforcement action where the SEC alleges they are raising money using unregulated securities. “You need to be very careful here because these rules are unforgiving. You can’t ignore them,” Nowak says.
TACKLE ACCOUNTING CHALLENGES
Accounting is another business challenge many funders face. Some have fancy customer relationship management systems, but the systems aren’t always set up to provide the detailed information the accounting department’s needs to effectively reconcile the firm’s books, says Yoel Wagschal, a certified public accountant in Monroe, New York, who represents a number of funders and serves as chief financial officer at Last Chance Funding, a merchant cash advance provider.
Ideally, a funder’s CRM and accounting systems should be integrated so both sales and accounting receive the relevant data without the need for either department to input duplicate data. The two systems need a way to get information from each other, without someone manually entering the data in both systems, which is inefficient and prone to error, Wagschal says.
DON’T SKIMP ON LEGAL SERVICES
There’s no set standard for funders to follow when it comes to legal advice. Some funders have in-house counsel, some contract with external law firms and some don’t have attorneys at all, which, of course, can be a risky proposition.
Some funders use contracts they’ve poached from a reputable funder online or from a friend in the industry, says Kimberly M. Raphaeli, vice president of legal operations at Accord Business Funding in Houston, Texas. The trouble is what flies in one state may not be legal in another, she says.
Many contracts include things such as jury waivers and class-action waivers or COJs and depending on the state, the rules surrounding the enforcement of these types of clauses may be different. So it’s really important to know the nuances of the state you’re doing business in and even potentially the states where your merchants are located, she says.
Having dedicated legal staff is arguably better. But at the very least, funders should have an attorney on speed dial who can provide advice on contracts, compliance and other areas of their business. Even when a funder has in-house attorneys, Raphaeli says it’s a good idea to tap external counsel to review documents in situations where potential liability exists. Not only does this offer a second set of eyes, it can provide added peace of mind. “A funder should never shy away from paying a little bit of money for long-term business security,” Raphaeli says.
FOLLOW BEST PRACTICES
The Small Business Finance Association, an advocacy group for the non-bank alternative financing industry, has developed a list of best practices for industry participants to follow. These encompass principles of transparency, responsibility, fairness and security.
“It’s a very competitive market and companies are trying to differentiate themselves. I think it’s important to make sure you’re following industry standards,” says Steve Denis, executive director of the association whose members include funders and lenders.
Funders also need to be mindful that best practices can change based on business and competitive realities, so it’s important for funders to review procedures periodically, says Raphaeli, of Accord Business Funding. Because the industry is fast-moving, a good rule of thumb might be for a funder to review the entire set of policies and procedures every 18 months. But more frequent review could be necessary if outside factors such as new case law or regulation demand it, she says.
“Periodically taking a look at your collections techniques, your default procedures, even your funding process down to your funding call – these are all critical components of having a successful MCA funder,” she says.
TAKE PAINS TO AVOID INDUCTION INTO THE PUBLIC HALL OF SHAME
While there is no shortage of unseemly news stories involving MCA, funders need to do their best to avoid negative press. This means being extra careful about the way they present themselves to businesses, at public speaking engagements, at conferences, industry trade shows, brokers and others, says Denis of the Small Business Finance Association.
Denis, a long-time Washington, D.C., resident, recommends funders invoke what he calls the “The Washington Post test,” though it applies broadly to any news outlet. Before sending an email, leaving a voicemail or saying anything publicly, funding company employees need to ask themselves: Am I comfortable with that information being on the front page of the paper? “I think our industry has a big problem with public relations right now,” he says. “The stigma is only as true as our industry allows it to be.”
Conference season will soon kick off, but many attendees are at a loss at how to score big at these events. Without a doubt, trade shows and conferences offer participants a prime opportunity to boost brand exposure, make professional connections and increase sales.
But there’s also a lot of behind-the-scenes work required to turn these events into successful business endeavors. While the playbook won’t be the same for every company, here are some tried-and-true tips to help attendees get the most out of conferences.
Start by determining which conferences to attend. With dozens to choose from, it’s not realistic from a budget, time or value perspective to hit every conference, says Jim Larkin, who manages events for OnDeck. Companies should select conferences based on which ones make the most sense for their goals and objectives. Not all conferences will offer the same benefits to every company or industry professional, frequent conference attendees say.
Ideally, management teams should meet early in the year to weigh the pros and cons of each conference, against the backdrop of the company’s budget. Some factors to consider include where and when the conference is being held, which of your competitors, prospects and customers are likely to attend and how many employees it makes sense to send, if any. “Budgets drive everything and you want to be smart with spending money,” says Janene Machado, Director of Events for deBanked, whose flagship conference, Broker Fair, is scheduled for May 6 in New York. “You need to be strategic about why you are attending a particular conference,” she says.
It’s essential to plan ahead for each conference to make the most out of the event. This includes carefully combing through the agenda, scheduling meetings ahead of time and getting acquainted with the physical layout of the event space. If more than one company representative is attending, it’s also important to coordinate their activities in advance to avoid duplicating efforts and to maximize productivity.
“You have to make your own luck at these conferences,” Larkin says.
Most events have an online or mobile agenda and networking portal that are open to participants at least a few weeks beforehand. Bookmark the sessions you would like to attend, build your wish-list of people you would like to meet and start requesting meetings as soon as possible, says Peter Renton, co- founder and co-chairman of LendIt Fintech, which has an upcoming conference scheduled for April 8 and 9 in San Francisco. “Last year we helped to enable nearly 2,100 meetings at our USA event, and most of those meetings were organized through our networking portal,” Renton says.
Don’t delay when it comes to setting up advance appointments because schedules can fill up quickly, says Monique Ruff-Bell, event director for Money20/20 USA, which will take place in Las Vegas from Oct. 27 through Oct. 30. “Identifying the right contacts beforehand, reaching out and establishing what you’d like to achieve in a short meeting will make your time much more productive,” she says.
It’s fine for attendees to leave some time in their schedule for impromptu meetings as well; just be sure to fill those slots, says Ken Peng, head of business development and marketing at Elevate Funding. “No one should ever be asking, ‘what are we doing next?’ You should know,” he says.
It’s also a good idea to plan ahead for a dedicated meeting space so you’ll have a convenient, comfortable and quiet space to conduct meetings, seasoned conference attendees say. This can be especially important at big conferences where thousands congregate. For those who don’t want, or can’t afford, to pay for a meeting room, it’s a good idea to find a quiet restaurant or coffee shop outside the busy convention center area where you can have quiet, uninterrupted, productive conversations in a relaxed environment, says Larkin of OnDeck. Don’t choose the heavily frequented coffee shop next to the hotel where meetings are sure to be disrupted by heavy foot traffic, he says. “Get away from the noise, the hustle, the chaos. Quiet is king.”
Conferences can be expensive, so it’s important to make the right decisions with the available budget. For instance, companies don’t have to miss out on promotional opportunities just because the highest level of sponsorship is out of reach for their budget. Instead, look for creative ways to make an impact without breaking the bank, says Stephanie Schlesinger, director of marketing for LEND360.
Schlesinger suggests that would-be sponsors have an open conversation with conference organizers about what they can afford to spend and what they hope to reap in return for their marketing dollars. She offers the examples of companies that have sponsored popcorn breaks, pens and pads of paper, badges, lanyards and other marketing materials. “There could be opportunities to do something very unique. By brainstorming together we can think of outside-the-box opportunities to really make an impact for your brand,” she says.
Another cost consideration is where to stay. Though it can be tempting to save a few bucks by bunking off-site, that’s not always the most prudent decision, frequent conference attendees say.
“Time is really valuable at these shows and events. If you’re staying off-site you have to battle everybody for the cab line, and the increased expense of commuting can offset any cost savings,” says Sheri Chin, chief marketing officer at BFS Capital. Also, staying on-site “gives you more flexibility when unscheduled things come up,” she says.
If staying on premises isn’t an option, conference attendees should make extra efforts to spend considerable time in the bar or lobby of the conference site, says Jeffrey Bumbales, marketing director at Credibly. People will come in and go and it’s an easy way to start conversations, he says.
Conferences typically consume a lot of energy, so Eden Amirav, chief executive and co-founder of Lending Express, recommends participants try to catch people well before they are running on empty. As the conference goes on, it becomes harder to engage people because they also get drained, he says. Typically conference doors open a few hours before the first sessions begin, and this can be an especially effective time to network, Amirav says.
Arriving early also allows participants to find their way around. Ruff-Bell of Money20/20 USA recommends participants walk through the entire event space upon arrival to get their bearings. “Many of these large conferences can be overwhelming, and knowing where to go will help with your time management,” she says.
Bumbales of Credibly also recommends conference attendees pack their schedule tightly—even though it might mean activities extend late into the evening. Instead of calling it quits at 6 p.m. he recommends conference attendees plow through and host evening meetings over dinner or drinks. Even though a participant may be tired, it’s best not to miss these important networking opportunities, he says.
The proper conference mindset includes knowing there’s a good chance sleep won’t be plentiful. To accommodate, Bumbales tries to ensure he’s well-rested before a conference. He also makes sure to pack protein bars and non-perishable snacks for replacement meals as needed throughout the conference in case he needs to eat on the go. The goal is to hit the ground running and be able to focus entirely on conference-related business, he says.
Although numerous social opportunities abound at conferences, not everyone takes advantage. Certainly not everyone is as comfortable approaching strangers. But it’s important for conference- goers to try to break out of their shell whenever possible, industry professionals say. When he first started going to conferences, Gary Lockwood, vice president of business development at 6th Avenue Capital, says he found it difficult to strike up conversations with strangers because it took him out of his “comfort zone.” But he forced himself to make the extra effort, and it has served him well. He says that some of the best connections he’s made have come from these chance meetings at breakfast, lunch or during random breaks.
Although attendees don’t always stay on-site for meals, Peng of Elevate Funding recommends people stick around during these times, if possible. He finds these meals a good opportunity to chat with others in a comfortable setting as opposed to the more strained conversations that can happen when someone approaches him at an exhibitor booth. These informal conversations offer a better chance to build a rapport with someone and learn—in a non- pressured environment—about what the other person does, he says.
Bumbales of Credibly says elevator time offers another opportunity for chance meetings that can turn into business opportunities. Most times, he prefers to take the stairs, but not at conferences. Elevators can be great for short, yet productive conversations. He likes to position himself next to the elevator buttons, which gives him an opening to break the ice. He says he’s had a few business opportunities arise as a result of elevator conversations.
It’s also important not to monopolize anyone’s time says Machado of deBanked. Everyone is there to meet as many people as possible, so she recommends keeping conversations quick, meaningful and relevant.
When he’s talking to someone for the first time, Lockwood of 6th Avenue Capital tries to listen more than he speaks. “I want to listen a little more than I talk in the beginning so I can tailor the conversation to what they need.”
While not every exchange will be fruitful, it’s important to recognize that any conversation could lead to future business; even a commercial real estate broker who has no present connection to merchant cash advance can be a potential partner or resource at some point, Lockwood says.
It’s also a good idea to keep your business cards handy at all times. Bumbales says he’s been in several situations when people don’t have them available, which makes exchanging information more awkward. “It’s a lot less awkward to exchange business cards then it is to ask for someone’s cell phone number,” Bumbales says.
Because each day is so jammed- packed with information, it’s a good idea to take notes so you don’t lose track of important details, says Ruff-Bell of Money20/20 USA. Each person will have his own system, but effective note-taking becomes important for recapping the event back in the office and for sending post-event follow-ups to new contacts. “At the end of each day, go through your notes and clean them up, ensuring you’ll understand the key points and important details weeks later,” she says.
Some conference participants fall short when it comes to following up with new connections they’ve made, but this can be a grave mistake. Follow-up emails are most effective when they are personal, says Peng of Elevate Funding. He recommends attendees jot down a few notes on the business card of each person they meet to jog their memory later on about their conversation. Then, weave details of the conversation into the follow-up email, so the correspondence won’t seem cold, generic or canned, he says.
Remember, conference-goers will be meeting hundreds of other people at the conference, Ruff- Bell says. “Ensure your follow-up is prompt, effective, and most importantly, memorable,” she says
Even though the setting is social, conference attendees need to be mindful about maintaining proper decorum at all times. This is a seemingly obvious rule of thumb that people sometimes forget, conference participants say.
“You’re there for work first, play second,” Peng says.
Professionalism also dictates that attendees and exhibitors should be where they are supposed to be at appropriate times. Peng recalls a conference he attended last year where one of the exhibitors left its booth unmanned for most of the conference. There’s no way to know where an interaction at these booths can lead in terms of new business or face-time with existing clients.
“It’s not doing the company any favors” by passing up the opportunity, he says.
Some alternative funders are anxious for “open banking” to become the gold standard in the U.S., but achieving widespread implementation is a weighty proposition.
Open banking refers to the use of open APIs (application program interfaces) that enable third-party developers to build applications and services around a financial institution. It’s a movement that’s been gaining ground globally in recent years. Regulations in the U.K., a forerunner in open banking, went into effect in January, while several other countries including Australia and Canada are at varying stages of implementation or exploration.
For the U.S., however, the time frame for comprehensive adoption of open banking is murkier. Industry participants say the prospects are good, but the sheer number of banks and the fragmented regulatory regime makes wholesale implementation immensely more complicated. Nonetheless, industry watchers see promise in the budding grass-roots initiative among banks and technology companies to develop data-sharing solutions. Regulators, too, have started to weigh in on the topic, showing a willingness to further explore how open banking could be applied in U.S. markets.
Open banking “is a global phenomenon that has great traction,” says Richard Prior, who leads open banking policy at Kabbage, an alternative lender that has been active in encouraging the industry to develop open banking standards in the U.S. “It’s incumbent upon the U.S. to be a driver of this trend,” he says.
The stakes are particularly high for alternative lenders since they rely so heavily on data to make informed underwriting decisions. Open banking has the potential to open up scores of customer data and significantly improve the underwriting process, according to industry participants.
“Open banking massively enables alternative lending,” says Mark Atherton, group vice president for Oracle’s financial services global business unit. What’s missing at the moment is the regulatory stick to ensure uniformity. Certainly, data sharing is gradually becoming more commonplace in the U.S. as banks and fintech companies increasingly explore ways to collaborate. But even so, banks in the U.S. are currently all over the map when it comes to their approach to open banking, posing a challenge for many alternative lenders. Many alternative lenders would like to see regulators step in with prescriptive requirements so that open banking becomes an obligation for all banks, as opposed to these decisions being made on a bank-by-bank basis. Especially since many consumers want to be able to more readily share their financial information, they say.
“It will create huge value to everyone if that data is more accessible,” says Eden Amirav, co-founder and chief executive of Lending Express, an AI-powered marketplace for business loans.
Some global-minded banks like Citibank have been on the forefront of open banking initiatives. Spanish banking giant BBVA is also taking a proactive approach. In October, the bank went live in the U.S. with its Banking-as-a-Service platform, after a multi-month beta period. Also in October, JPMorgan Chase announced a data sharing agreement with financial technology company Plaid that will allow customers to more easily push banking data to outside financial apps like Robinhood, Venmo and Acorns.
There are several other examples of open banking in action. Kabbage customers, for instance, authorize read-only access to their banking information to expedite the lending process through the company’s aggregator partners, says Sam Taussig, head of global policy at Kabbage.
Also, companies such as Xero and Mint routinely interface with banks to put customers in control of their financial planning. And companies like Plaid and Yodlee connect lenders and banks to help with processes such as asset and income verification.
Some banks, however, are more reticent than others when it comes to data sharing. And with no regulatory requirements in place, it’s up to individual banks how to proceed. This can be nettlesome for alternative lenders trying to get access to data, since there’s no guarantee they will be able to access the breadth of customer data that’s available. “As an underwriter, you want the whole financial picture, and if data points are missing, it’s hard to make appropriate lending decisions,” Taussig says.
The problem can be particularly acute among smaller banks, industry participants say. While the quality of data you can get from one of the money-center banks is quite good, “as you go down the line, it becomes a little less consistent,” says James Mendelsohn, chief operating officer of Breakout Capital Finance. For these smaller banks, the issue is sometimes one of control. There’s a feeling among some community banks, that “if I make it easier for my small business customers to get loans elsewhere, I’m done,” says Atherton of Oracle.
Absent regulatory requirements, alternative lenders are hoping that this initial hesitation among some banks changes over time as they continue to gain a better understanding of the market opportunity and as more of their counterparts become open to data sharing through APIs.
Open banking could be a boon for banks in that it would enable them to service customers they probably couldn’t before, says Jeffrey Bumbales, marketing director at Credibly, which helps small and mid-size businesses obtain financing. Open banking makes for a “better customer experience,” he says.
One challenge for the U.S. market is the hodgepodge of federal and state regulators that makes reaching a consensus a more arduous task. It’s not as simple here as it may be in other markets that are less fragmented, observers say.
Major rule-making would be involved, and there are many issues that would need attention. One pressing area of regulatory uncertainty today is who bears the liability in the event of a breach—the bank or the fintech, says Steve Boms, executive director of the Northern American chapter of the Financial Data and Technology Association. Existing regulations simply don’t speak to data connectivity issues, he says.
To be sure, policymakers have started to give these matters more serious attention, with various regulators weighing in, though no regulator has issued definitive requirements. Still, some industry participants are encouraged to see regulators and policymakers taking more of an interest in open banking.
A recent Treasury Report, for example, notes that as open banking matures in the United Kingdom, “U.S. financial regulators should observe developments and learn from the British experience.” And, The Senate Banking Committee recently touched on the issue at a Sept. 18 hearing. Industry watchers say these developments are a step in the right direction, though there’s significant work needed, they say, in order to make open banking a pervasive reality.
“We’re seeing the pace and interest around these things picking up pretty significantly,” Boms says. Even so, it can take several years to implement a formal process. “The hope is obviously as soon as possible, but the financial services sector is a very fragmented market in terms of regulation. There’s going to have to be a lot of coordination,” Boms says.
Another challenge to overcome is customers’ willingness to use open banking. Many small business owners are more comfortable sending a PDF bank statement versus granting complete access to their online banking credentials, says Mendelsohn of Breakout Capital Finance. “There’s a lot more comfort on the consumer side than there is on the small business side. Some of that is just time,” he adds.
Certainly sharing financial data is a concern—even in the U.K. where open banking efforts are well underway. More than three quarters of U.K. respondents expressed concern about sharing financial data with organizations other than their bank, according to a recent poll by market research body, YouGov. This suggests that more needs to be done to ease consumers into an open banking ecosystem.
The topic of data security came up repeatedly at this year’s Money20/20 USA conference in Las Vegas. How to make people feel comfortable that their data is safe is a pressing concern, says Tim Donovan, a spokesman for Fundbox, which provides revolving lines of credit for small businesses. Clearly, it’s something the industry will have to address before open banking can really become a reality in the U.S., he says.
Despite these challenges, many market watchers feel open banking in the U.S. is inevitable, given the momentum that’s driving adoption worldwide. Several countries have taken on open banking initiatives and are at varying states of implementation—some driven by industry, others by regulation. Here is a sampling of what’s happening in other regions of the world:
In the U.K., for example, the implementation process is ongoing and is expected to continually enhance and add functionality through September 2019, according to The Open Banking Implementation Entity, the designated entity for creating standards and overseeing the U.K’s open banking initiative.
At the moment, only the U.K.’s nine largest banks and building societies must make customer data available through open banking though other institutions have and continue to opt in to take part in open banking. As of September, there were 77 regulated providers, consisting of third parties and account providers and six of those providers were live with customers, according to the U.K. open banking entity.
In Europe, the second Payment Services Directive (PSD2) requires banks to open up their data to third parties. But implementation is taking longer than expected—given the large number of banks involved. By some opinions, open banking won’t really be in force in Europe until September 2019, when the Regulatory Technical Standards for open and secure electronic payments under the PSD2 are supposed to be in place.
In Australia, meanwhile, the country has adopted a phase-in process to take place over a period of several years through 2021. Starting in July 2019, all major banks will be required to make available data on credit and debit card, deposit and transaction accounts. Data requirements for mortgage accounts at major banks will follow by February 1, 2020. Then, by July 1 of 2020, all major banks will need to make available data on all applicable products; the remaining banks will have another 12 months to make all the applicable data available.
For its part, Hong Kong is also pushing ahead with plans for open banking. In July, the Hong Kong Monetary Authority published its open API framework for the local banking sector. There’s a multi-prong implementation strategy with the final phase expected to be complete by mid-2019.
Singapore, by contrast, is taking a different approach than some other countries by not enforcing rules for banks to open access to data. The Monetary Authority of Singapore has endorsed guidelines for Open Banking, but has expressed its preference to pursue an industry-driven approach as opposed to regulatory mandates.
Other countries, meanwhile, are more in the exploratory phases. In Canada, the government announced in September a new advisory committee for Open Banking, a first step in a review of its potential merits. And in Mexico, the county’s new Fintech Law requires providers to provide fair access to data, and regulators there are reportedly gung-ho to get appropriate regulations into place. Still other countries are also exploring how to bring open banking to their markets.
The U.S. meanwhile, is on a slower course—at least for now. More banks are using APIs internally and have been exploring how they can work with third-party technology companies. Meanwhile, companies like IBM have been coming to market with solutions to help banks open up their legacy systems and tap into APIs. Other industry players are also actively pursuing ways to bring open banking to the market.
As for when and if open banking will become pervasive in the U.S., it’s anyone’s guess, but industry participants have high hopes that it’s an achievable target in the not-too-distant future.
Thus far, there has been little pressure for banks to adopt open banking policies, says Taussig of Kabbage. But this is changing, and things will continue to evolve as other countries adopt open banking and as pressure builds from small businesses and consumers in an effort to ensure the U.S. market stays competitive, he says. Open banking “is going to happen in the near future,” Taussig predicts.
Artificial intelligence such as machine learning has the potential to dramatically shift the alternative lending and funding landscape. But humans still have a lot to learn about this budding field.
Across the industry, firms are at different points in terms of machine learning adoption. Some firms have begun to implement machine learning within underwriting in an attempt to curb fraud, get more complex insights into risk, make sounder funding decisions and achieve lower loss rates. Others are still in the R&D and planning stage, quietly laying the groundwork for future implementation across multiple areas of their business, including fraud prevention, underwriting, lead generation and collections.
“It’s entirely critical to the success of our business,” says Paul Gu, co-founder and head of product at Upstart, a consumer lending platform that uses machine learning extensively in its operations. “Done right, it completely changes the possibilities in terms of how accurate underwriting and verification are,” he says.
While there’s no absolute right way to implement machine learning within a lender’s or funder’s business, there are many data-related, regulatory and business-specific factors to consider. Because things can go very wrong from a business or regulatory perspective—or both—if machine learning is not implemented properly, firms need to be especially careful. Here are a few pointers that can help lead to a successful machine learning implementation:
Using machine learning, funders can predict better the likelihood of default versus a rule-based model that looks at factors such as the size of the business, the size of the loan and how old the business is, for example, says Eden Amirav, co-founder and chief executive of Lending Express, a firm that relies heavily on AI to match borrowers and funders.
Machine learning takes hundreds and hundreds of parameters into account which you would never look at with a rule-based model and searches for connections. “You can find much more complex insights using these multiple data points. It’s not something a person can do,” Amirav says.
He contends that machine learning will optimize the number of small businesses that will have access to funding because it allows funders to be more precise in their risk analyses. This will open doors for some merchants who were previously turned down based on less precise models, he predicts. To help in this effort, Lending Express recently launched a new dashboard that uses AI-driven technology to help convert business loan candidates that have been previously turned down into viable applicants. The new LendingScore™ algorithm gives businesses detailed information about how they can improve different funding factors to help them unlock new funding opportunities, Amirav says.
Lenders and funders always have to be thinking about what’s next when it comes to artificial intelligence, even if they aren’t quite ready to implement it. While using machine learning for underwriting is currently the primary focus for many firms, there are many other possible use cases for the alternative lenders and funders, according to industry participants.
Lead generation and renewals are two areas that are ripe for machine learning technology, according to Paul Sitruk, chief risk officer and chief technology officer at 6th Avenue Capital, a small business funder. He predicts that it is only a matter of time before firms are using machine learning in these areas and others. “It can be applied to several areas within our existing processes,” he says.
Collection is another area where machine learning could make the process more efficient for firms. Machines can work out, based on real-life patterns, which types of customers might benefit from call reminders and which will be a waste of time for lenders, says Sandeep Bhandari, chief strategy and chief risk officer at Affirm, which uses advanced analytics to make credit decisions.
“There are different business problems that can be solved through machine learning. Lenders sometimes get too fixated on just the approve/decline problem,” he says.
“Most underwriters don’t have enough data to effectively incorporate AI, deep learning, or machine learning tools,” says Taariq Lewis, chief executive of Aquila, a small business funder. He notes that effective research comes from the use of very large datasets that won’t fit in an excel spreadsheet for testing various hypotheses.
Problems, however, can occur when there’s too much complexity in the models and the results become too hard to understand in actionable business terms. For example, firms may use models that analyze seasonal lender performance without understanding the input assumptions, like weather impact, on certain geographies. This may lead to final results that do not make sense or are unexpected, he says.
“There’s a lot of noise in the data. There are spurious correlations. They make meaningful conclusions hard to get and hard to use,” he says.
The more precise firms can be with the data, the more predictive a machine learning model can be, says Bhandari of Affirm. So, for example, instead of looking at credit utilization ratios generally, the model might be more predictive if it includes the utilization rate over recent months in conjunction with debt balance. It’s critical to include as targeted and complete data as possible. “That’s where some of our competitive advantages come in,” Bhandari says.
Underwriters also have to pay particularly close attention that overfitting doesn’t occur. This happens when machines can perfectly predict data in your data set, but they don’t necessarily reflect real world patterns, says Gu of Upstart.
Keeping close tabs on the computer-driven models over time is also important. The model isn’t going to perform the same all along because the competitive environment changes, as do consumer preferences and behaviors. “You have to monitor what’s going well and what’s not going well all the time,” Bhandari says.
Certainly, as AI is integrated into financial services, state and federal regulators that oversee financial services are taking more of an interest. As such, firms dabbling with new technology have to be very careful that any models they are using don’t run afoul of federal Fair Lending Laws or state regulations.
“If you don’t address it early and you have a model that’s treating customers unfairly or differently, it could result in serious consequences,” says Tim Wieher, chief compliance officer and general counsel of CAN Capital, which is in the early stages of determining how to use AI within its business.
“AI will be transformative for the financial services industry,” he predicts, but says that doing it right takes significant advance planning. For instance, Wieher says it’s very important for firms to involve legal and compliance teams early in the process to review potential models, understand how the technology will impact the lending or funding process and identify the challenges and mitigate the risk.
To be sure, regulation around AI is still a very gray area since the technology is so new and it’s constantly evolving. Banking regulators in particular have been looking closely at the issues pertaining to AI such as its possible applications, short-comings, challenges and supervision. Because the waters are so untested, there can be validity in asking for regulatory and compliance advice before moving ahead full steam, some industry watchers say.
Upstart, for example, which uses AI extensively to price credit and automate the borrowing process, wanted buy-in from the Consumer Financial Protection Bureau to help ease the concern of its backers as well as to satisfy its own concerns about the legality of its efforts. So the firm submitted a no-action request to CFPB. The CFPB responded by issuing a no-action letter to Upstart in September 2017, allowing the company to use its model. In return, Upstart shares certain information with the CFPB regarding the loan applications it receives, how it decides which loans to approve, and how it will mitigate risk to consumers, as well as information on how its model expands access to credit for traditionally underserved populations.
The No-Action Letter is in force for three years and Upstart can seek to renew it if it chooses.
Theoretically firms could have a computer underwriting model constantly updating itself without having a human oversee what the model is doing—but it’s a bad idea, industry participants say. “I believe there are companies doing that, and it’s a risky thing to do,” says Scott M. Pearson, a partner with the law firm Ballard Spahr LLP in Los Angeles.
During review of the models—and before implementing them—people should carefully review the models and the output to make sure there’s nothing that causes intrinsic bias, says Kathryn Petralia, co-founder and president of Kabbage, which is one of the front-runners in using machine learning models to understand and predict business performance.
“If you’re not watching the machine, you don’t know how the machine is complying with regulatory requirements,” she says.
Kabbage has teams of data scientists regularly developing models that the company then reviews internally before deploying. The company is also in frequent contact with regulators about its processes. Petralia says it’s very important that firms be able to explain to regulators how their models work. “Machines aren’t very good at explaining things,” she quips.
As a best practice, Pearson of Ballard Spahr says lenders and funders shouldn’t use any machine learning model until it’s been signed off on by compliance. “That strikes a pretty good balance between getting the benefits of AI and making sure it doesn’t create a compliance problem for you,” he says.
While AI has many benefits, industry participants say alternative lenders and funders need to be mindful of how it can be applied practically and effectively within their particular business model.
Craig Focardi, senior analyst with consulting firm Celent in San Francisco, contends that the classic FICO score continues to be the gold standard for credit decisions in the U.S. He warns firms not to get overly distracted trying to find the next best thing.
“Many fintech lenders have immature risk management and operations functions. They’re better off improving those than dabbling in alternative scoring,” he says, noting that data modeling is an entirely separate core competency.
Indeed, Lewis of Aquila cautions underwriters not to view AI as a silver bullet. “AI is just one tool out of many in the lenders’ toolbox, and our industry should use it and respect its limitations,” he says.
For brokers, funding partnerships are critical to success. But making the most of these connections can be elusive.
“Transparency, efficiency and a thorough scrubbing on the front end can help the whole process,” says William Gallagher, president of CFG Merchant Solutions, an alternative funder with offices in Rutherford, N.J. and Manhattan.
Gallagher recently moderated an “Underwriting 101” panel at Broker Fair 2018, which deBanked hosted in May. The panel featured a handful of representatives from different funding companies discussing various hot-button items including striking the proper balance between technology and human underwriting, trade secrets of the submission process and stacking. Here are some major takeaways from that discussion and from follow-up conversations deBanked had with panel participants.
Each funder has slightly different processes and requirements. Brokers need to understand the different nuances of each firm so they know how to properly prepare merchants and send relevant information, funders say.
Many brokers sign up with funders without delving deeper into what the different funders are really looking for, says Jordan Fein, chief executive of Greenbox Capital in Miami Gardens, Fla., that provides funding to small businesses.
For example, there are a growing number of companies that rely more heavily on advanced technology for their underwriting, while others have more human intervention. Brokers need to know from the start what the funder’s underwriting process is like—the nitty gritty of what each funder is looking for—so they can more effectively send files to the appropriate funder.
“They will look poor in front of the merchant if they don’t really know the process,” Fein says.
Certainly, it’s a different ballgame for brokers when dealing with funders that are more human based versus more automated, says Taariq Lewis, chief executive and co-founder of Aquila Services Inc., a San Francisco-based company that offers merchants bank account cash flow analysis as well as funding that ranges from 70 days to 100 business days.
At Aquila, the process is meant to be totally automated so that brokers spend more time winning deals faster, with better data to do so. This means, however, that some of the underwriting requirements differ from some other industry players. Aquila’s most important requirement is that a merchant’s business is generally healthy and shows a positive history of sales deposits. Other funders require documents and background explanations, whereas Aquila strives to be completely data-driven, Lewis says. These types of distinctions can be important when submitting deals, funders say.
Stacking is another example of a key difference among funders that brokers need to understand. It’s a controversial practice; some funders are open to stacking, while others will only take up to a second or third position; a number of funders shy away from the practice completely. Brokers shouldn’t waste their time sending deals if there’s no chance a funder will take it; they have to do their research upfront, funders say.
Most times, brokers “don’t invest enough time to understand the process,” Fein says.
Some brokers may feel competitive pressure to sign up with as many funders as possible, but it can easily become unwieldy if the list is too long, funders say. Better, they say, to deal with only a handful of funders and truly understand what each of them is looking for.
“There are brokers that deal with 20 [funders], but I don’t think it’s a good, efficient practice,” says Rory Marks, co-founder and managing partner of Central Diligence Group, a New York funder that provides working capital for small businesses.
He suggests brokers select funders that are easy to work with and responsive to their phone calls and emails. Not all funders will pick up the phone to speak with brokers who have questions, but he believes his type of service is paramount, he says. “It’s something we do all the time,” he says.
He also recommends brokers consider a funder’s speed and efficiency of funding as well as document requirements and their individual specialties. There are plenty of funders to choose from, so brokers shouldn’t feel they have to work with those that are more difficult, he says.
To prevent a broker’s list from becoming too unwieldy, Gallagher of CFG Merchant Solutions suggests brokers have two to three go-to funders in each category of paper from the highest quality down to the lowest. Having a few options in each bucket allows greater flexibility in case one funder changes its parameters for deals, he says.
Brokers “sometimes just shotgun things and throw things against the wall and hope they stick,” Gallagher says. Instead, he and other funders advocate a more precise approach –proactively deciding where to send files based on what they know about the merchant and research they’ve done on prospective funders.
It used to be that when sending files to funders, brokers would provide some background on the company in the body of the email. This was helpful because even a few sentences can help funders gain some perspective about the company and better understand their funding needs, says Fein of Greenbox Capital.
These days, however, Fein says he’s getting more emails from brokers that simply request the maximum funding offer, without providing important details about the business. The financials on ABC importing company aren’t necessarily going to tell the whole story because funders won’t know what products they import and why the business is so successful and needs money to grow. Providing these types of details could help sway the underwriting process in a merchant’s favor. Brokers don’t have to say a lot, but funders appreciate having some meaty details. “A few sentences go a long way,” Fein says.
Many brokers make the mistake of overpromising what they can get for merchants and how long the process could take, funders say. Both can cause significant angst between merchants and brokers and between brokers and funders.
If a company is doing $15k in sales volume and asking for $50k in funding, the broker should know off the bat, the merchant is not going to get what he wants, says Marks of Central Diligence Group. By managing merchant’s expectations, brokers are doing their clients—and themselves—a favor. Why waste time on deals that won’t fund because they are fighting an uphill battle? Brokers shouldn’t knowingly put themselves in the position of having to backtrack later, Marks says.
Instead, explain to the merchant ahead of time he’s likely to receive a smaller amount than he’d hoped for. To show him why, walk the merchant through a general cash flow analysis using data from the past three to four months, says Gallagher of CFG Merchant Solutions. This will help merchants understand the process better, and it can help raise a broker’s conversion rate, he says.
“It’s about setting realistic expectations,” Marks says.
Sometimes brokers take only a cursory look at a merchant’s financials, and because of this, they overlook important details that can delay, significantly alter, or sink the underwriting process, funders say.
Heather Francis, founder and chief executive of Elevate Funding in Gainesville, Fla., offers the hypothetical example of a merchant who has total deposits of $80k in his bank account. On its face, it may look like a solid deal and the broker may make certain assurances to the merchant. But if it comes out during underwriting that most of the deposits are transfers from a personal savings account as opposed to sales, there can be trouble. Based on the situation, the merchant may only be eligible for $30k, but yet the owner is expecting to receive $80k based on his discussions with the broker. Now you have an unhappy merchant, a frustrated broker and a funder who may be blamed by the merchant, even though it’s really the broker who should have dug deeper in the first place and then managed the merchant’s expectations accordingly. “We see that a lot,” says Francis.
To get the most favorable deals for merchants, some brokers only present the rosiest of information in the hopes that the funder won’t discover anything’s amiss. Several panelists expressed frustration with brokers who purposely withhold information, saying it puts deals at risk and makes the process much less efficient for everyone.
Marks of Central Diligence Group offers the hypothetical example of a merchant whose sales volume dipped in two of the past six months. To push the deal through, a broker might submit only four months of data, hoping the funder doesn’t ask about the other two months. Some funders might accept only four statements, but other shops will want to see six. If a funder then asks for six, the broker’s omission creates unnecessary friction, he says.
Funders say it’s better to be upfront and disclose relevant information such as sales dips or some other type of temporary setback that weighs a merchant’s financials. Kept hidden, even small details could easily become game-changers—or deal-breakers—a losing proposition for merchants, brokers and funders alike.
“If we have the full story upfront and we’re going in eyes wide open, we can look at the file in a little bit of a different way,” says Gallagher of CFG Merchant Solutions.
Last year, alternative funding in Puerto Rico ground to a halt after the island was ravaged by two devastating hurricanes in close proximity. Now, however, the alternative funding business in Puerto Rico is getting its second wind, after a several-month hiatus.
Puerto Rico got lashed by high winds and rain from Hurricane Irma in early September 2017, causing large-scale power outages and damage. Then, about two weeks later, Hurricane Maria hit the island square on, causing even more catastrophic destruction. Millions were without power for months (thousands still are), homes were destroyed, multiple lives were lost, businesses were decimated and the island’s already shaky economy teetered on the brink of disaster.
More than half a year later, residents are still trying to pick up the pieces of the epic humanitarian crisis. Hurricane Maria caused an estimated $90 billion in damage, according to the National Hurricane Center, making it the costliest hurricane on record to strike Puerto Rico and the U.S. Virgin Islands. The hurricane knocked out 80 percent of Puerto Rico’s power lines and destroyed its generators. Even months later, the lives of many residents are still in disarray as they wait desperately for insurance payments to materialize and get back to a semblance of their former lives. The island faces additional challenge—and uncertainty— with another hurricane season just around the corner.
In the midst of this turmoil, however, there’s a glimmer of hope for the budding alternative funding sector. Some businesses are once again seeking funds to rebuild or expand, and alternative funders are once again dipping their toes into the Puerto Rican market—albeit somewhat slowly. While some funders have exited the Puerto Rican alternative lending market, other new entrants are starting to stake a claim, citing an expected uptick in economic development that tends to follow natural disasters. Some funders also see Puerto Rico as a sweet spot because the market isn’t as mature as the U.S. and competition from other alternative funders is scant. Banks on the island aren’t always willing to provide businesses there with much- needed funds, so opportunities for non-bank funders are considered plentiful.
Businesses struggling to rebuild from the storms need more help than ever before, says Sonia Alvelo, president of Latin Financial LLC, an ISO that has been arranging funding for business owners in Puerto Rico for three years. “There is no doubt that Puerto Rico has a long, hard road ahead,” she says. But “I can assure you the entrepreneurial spirit is alive and well,” she says.
Latin Financial and other ISOs and funders are back to business—courting merchants and trying to help them get back on their feet. In December, Latin Financial processed its first renewal since Maria; in January it funded its first new client since September. Latin Financial continues to arrange funding of between $500k and $1 million per month on average in Puerto Rico, after some hurricane-related downtime.
“The storm destroyed a lot, but it didn’t set the small business drive back. They’re still pushing hard and really trying to maintain and grow business,” says Brendan P. Lynch, business partner and fiancé to Latin Financial’s Alvelo.
Greenbox Capital in Miami Gardens, Fla., an early entrant to the Puerto Rican alternative funding market, has also returned to funding small businesses on the island after a few-month hiatus. The company put off new deals right before Maria hit, and as a goodwill measure suspended the payments of existing customers for 90 days. Given the extension, almost all customers were able to stay on track and the firm suffered very few losses, says Jordan Fein, the company’s chief executive. Greenbox began funding again in January, he says.
To be sure, it’s not exactly business as usual, since many businesses in Puerto Rico are still struggling, Fein says. While the situation should continue to improve, it will take time for the economy and businesses to fully recover, he says.
“They’ve come a long way since September, but they still aren’t fully back. We’re not seeing the same type of submissions that we saw before,” Fein says. Nonetheless, Fein remains positive about the market’s long-term prospects. “I think they are going to come back stronger, I really do,” he says.
To be sure, not all funders are interested the Puerto Rican market. Ripe with political uncertainty and economic instability, Puerto Rico already posed challenges that made many funders hesitant to do business there. The devastation wrought by Irma and Maria complicated matters further, and some funders pulled out of the market completely.
For others, however, the market’s still an opportune one, albeit not as stable as the U.S. market. Certainly, there are reasons for alternative funders to be optimistic. Despite its recent troubles, Puerto Rico is still considered a growth market. What’s more, with new businesses popping up in the wake of the storms, new infrastructure being instituted and businesses anxious to bounce back even bigger and better than before, some funders are striking while the iron is hot.
“This is the right time, as the island is growing,” says Paul Boxer, chief marketing officer and vice president of business development at Quicksilver Capital, a New York-based small business funder. Quicksilver funded its first deal in Puerto Rico in late April.
The company had been mulling over the possibility of doing business in Puerto Rico when an actual funding prospect arose. The company decided to give it a shot, sensing a potentially viable business opportunity. Existing businesses are rebuilding after the hurricane, there’s plenty of new business development and there’s a pressing need for new infrastructure as Puerto Rico continues to recover from the devastation, Boxer says.
Accordingly, Boxer says his company is in the process of vetting additional funding opportunities in Puerto Rico and hopes to continue growing this business in what he says is a largely untapped market. “I see it as a positive addition to what we offer, and I see a lot more opportunity in the future,” Boxer predicts.
In marketing, there’s a basic tenet that it takes seven “touches” within 18 months to prod someone into action.
Nowadays, with customers exposed to thousands of ads a day and across so many channels, it takes several times that in interactions to generate viable sales leads, according to Samantha Berg, a marketing and strategic partnerships executive with 6th Avenue Capital in New York.
That’s why it’s so important for funders, ISOs, brokers and other alternative funding professionals to have a solid marketing and lead-generation strategy that incorporates multiple channels such as search engine optimization, digital ads, direct mail, email and social media. The challenge, of course, is to find the right balance between being invasive and being top of mind, industry professionals say. Here are a few ways tried and true ways to generate warm leads and potential new business:
DON’T DIS DIRECT MAIL
Many marketers have a negative view about the importance of direct mail to consumers. But consumers may be more interested in this medium than you think. Consider a survey of more than a thousand consumers by Yes Lifecycle Marketing, a provider of email and digital marketing services. According to this study, 56 percent of all consumers say they find direct mail influential when researching a purchase. By contrast, a separate survey by Yes Lifecycle Marketing paints a very different picture of how marketers view direct mail; 78 percent of those polled say they believe direct mail is not influential for any age group.
One good thing about direct mail is that it can be opened at the merchant’s convenience, unlike a phone call which some merchants find annoying, especially since they often get multiple calls a day from numerous funders. With direct mail, even if a business does not need funding immediately, there’s a decent chance the merchant will keep your information on file for future reference, says Glen Faulhaber, vice president of sales at G-Plex Direct Mail Services in Holtsville, N.Y. Sending a follow-up mailing within a week of the first helps you gain additional brand recognition, he says.
Of course, for direct mail to be successful, certain parameters should be followed. For starters, mailings have to be based off good data; meaning the people or businesses you are sending to have a high likelihood of needing funds. Without worthwhile data, you’re basically throwing money out the window, Faulhaber says.
Timing is also important, he says. With direct mail, Faulhaber says you have about five seconds to get someone’s attention, so your message has to be catchy.
MAKE YOUR WEBSITE SHINE
Trey Markel, a software specialist at CentrexSoftware, a customer relationship management software company in Costa Mesa, Calif., says it’s shocking how many funders don’t use their websites to generate leads. Markel, who consults with B2B lenders and MCA providers on marketing strategies using enterprise software, recommends funders spend time working on their website so that it appeals to all types of visitors: those who want to read relevant articles, those who want to watch webcasts and those who want to listen to podcasts.
The idea is for funders to use their website to provide helpful information to merchants that will, in turn, encourage them to seek funding from you. For instance, you might consider hosting monthly webinars on topics such as how businesses can use loaned money to increase their marketing budget. Another topic merchants may find appealing is how to use credit cards to increase customers. “You give them a solution to a problem, and then you give them the money to go afford that solution,” Markel says.
Many funders know how to close a deal, but they fail to understand that the consultative approach over time will gain them even more business, Markel says. “Becoming a trusted information source in the industry is so much more valuable to customers than just being a funder,” he says. The industry needs “professionals who are going to tell you how to solve a problem.”
Jennie Villano, vice president of business development at Kalamata Advisors LLC, says ISOs looking to build their business should attend networking events where small businesses are present. Sounds simple, but many ISOs don’t take advantage of this, meaning a missed opportunity to connect with “people from every facet” including accountants and other business professionals who can be a good source of referrals.
She also recommends ISOs hire at least one professional who is warm, trusting and engaging to visit merchants at their place of business. She recommends they pick places such as local strip malls which have a sizeable number of merchants. If you saw 20 merchants a day and only two funded with you that amounts to 40 extra deals a month, she points out. “Many ISOs would benefit from an extra 40 deals a month,” she says. On top of that, you have additional touchpoints because each of the merchants you visit may tell other businesses about your services, she says.
USE SOCIAL MEDIA
ISOs should also use social media more often than they do now—and not just to find sales help, Villano recommends. She uses it to target ISOs, but in the course of that, she gets inquiries from small businesses. ISOs should be using social media to find small businesses in need of funds. “I just don’t know why they aren’t using it more. It has tremendous reach,” she says.
To be sure, you don’t have to bombard your connections with posts. Once every other week is a good target. Make sure to include your business name and phone number, but posts shouldn’t be a hard sell. “There are ways to stand out and get your message across without appearing pushy or too sales oriented. The two-minute video ‘Cooking with Kalamata Capital’ that went viral in the industry is an example,” she says.
Also remember there are many social media venues. Sometimes funders focus their efforts on LinkedIn, Facebook and, to a lesser extent, Twitter. But Instagram and Pinterest can also be used to target potential customers. Posting aspirational videos or photos in these venues can help encourage businesses to think about ways to fund the things they might need, says Berg of 6th Avenue Capital.
USE EMAIL MARKETING TO YOUR ADVANTAGE
Some funding professionals say text messaging works well for them, though others prefer email for a host of reasons.
For one thing, it’s a “little less intrusive” than a telephone call or a text, Berg says. Also, with email, there’s ample ability to personalize, and you can run analytics to determine helpful metrics such as open rates and click-through rates, for example. You can compare how these metrics change when you tinker slightly with email subject lines or messages.
“We see email as a very viable channel,” she says.
Another advantage of email is that it helps funders and brokers get around the restrictions imposed by the Telephone Consumer Protection Act (TCPA) that has hampered lead generators’ ability to solicit business owners, says Michael O’Hare, president of Blindbid, a B2B lead generation site.
With email, you can direct the prospect to click on a link, which then triggers a phone call from a sales rep. In an environment when cold-calling can result in a lawsuit, email is a viable alternative, says O’Hare, an outspoken opponent of TCPA restrictions for business-related matters.
A growing number of funders are also using or exploring the use of artificial intelligence to help with lead generation, says Matthew Martin, managing director of Silver Bullet Marketing, a provider of trigger lead data.
One company that’s working in this area is AI Assist. Using Conversica, an AI-powered virtual sales assistant, funders can send automated emails to prospects. The automated sales assistant determines whether the prospect is interested, and if so, it alerts a human sales representative. The automated sales assistant can also gather additional information from a lead, such as the best phone number and best time to call. The entire “dialogue” is available for the human sales rep to review.
“AI is not going to make the sale for you, but it’s going to give you enough information to move forward,” Martin says.
REFINE YOUR LEADS
To generate leads, funders, ISOs and brokers tend to buy banner ads on Google or send an email blast with a link for interested businesses to click on. The link usually directs businesses to an online form that typically asks for their name, telephone number, email and how much money is being requested.
But it doesn’t generate meaningful information about the business or what type of funding product the business is looking for, says O’Hare of Blindbid. These forms don’t typically include critical information such as whether the person has been in business for less than a year, whether he or she has mounds of debt or what kind of funding the business is seeking.
One way to get better, more tailored leads is with “lead quizzes” similar to those used by the online insurance industry, he says. Instead of a basic form, potential leads would be directed to fill out a form that has much more pointed questions about the person, the business and the type of funding sought, he explains. Some questions might be, for instance: Is your credit score over 500? Have you been in business for more than a year? And, what type of funding are you seeking? Based on the merchant’s responses, he or she could be directed to a certain funding product or a specific funder, if you’re an ISO working with multiple providers. The funder could also decide to pass on an opportunity based on a merchant’s answers to the lead quiz.
O’Hare says he doesn’t know of MCA providers currently using this type of form, but it’s one of the things he’s working on as a way to generate better leads for his clients. With the basic forms many funders use today, you get a “lot of garbage,” O’Hare says.
Certainly, there are many ways to market and get leads, but industry professionals say one thing is clear: you can’t rely on one avenue alone. According to Markel of CentrexSoftware, too many in the industry put too much faith in raw data that gets plugged into a phone system dialer. The quality of this data isn’t always the best, which means funding professionals are wasting a lot of time, he says. “There are only so many small businesses in the country and an even smaller amount that are fundable,” he says.
deBanked Magazine recently caught up with Peter Renton, founder of Lend Academy, a leading educational resource for the marketplace industry. Through his writing, podcasts and video courses, he’s been helping multitudes of people better understand the industry since 2010. Renton is also the co-founder of LendIt, one of the world’s largest fintech conventions, which recently branched out beyond its marketplace lending focus to include other types of fintech. The flagship U.S. conference will take place April 9 through April 11 in San Francisco. The following is an edited transcript of our discussions.
deBanked: Why did you decide to rebrand LendIt as LendItFintech?
Renton: The main reason is that we have moved beyond the online lending space. While it’s still the core of what we do, it’s not all of what we do anymore. Many of the large online lenders have also moved beyond online lending. Lending is part of financial services, but our attendees want to know what else is important. Our attendees also want to look at other opportunities for expansion. They want to know how other areas of fintech are going to affect their business—topics such as blockchain and digital banking. LendItFintech tells people that lending is what we focus on, but it also makes clear that we’re about more than lending.
deBanked: In addition to your marketplace lending investments, you entered into the cryptocurrency space back in early 2015. Tell us what you’re doing now with respect to cryptocurrency?
Renton: This was not something that I spent much time thinking about back then. At the time, I expected bitcoin to never amount to anything. But I’m interested in financial innovation and I decided to give it a go. I never thought in my wildest dreams that it would get to $10,000. (Editor’s note: In 2017, bitcoin climbed to nearly $20,000; in early February it fell below $8,000 for the first time since Nov. 2017)
I opened up a Coinbase account with $2,000, which got me 10 bitcoins. I have since sold a portion of it gradually as the price of bitcoin went up, and I diversified into a handful of other coins as well. I have recently moved a significant portion of my investment into a privately managed cryptocurrency fund, and I still maintain my Coinbase account too.
deBanked: How are things different now than when you first entered the digital currency market?
Renton: In January 2015, I created my bitcoin account and I don’t think I ever logged in over the next 18 months, or if I did, it was maybe just once or twice. No one was talking about bitcoin back then. It was still on the fringe of fintech. Sure, there were some people focused on it, but it wasn’t part of mainstream media coverage. Then, all of a sudden, it became hot because people love get-rich-quick schemes and hearing about people who hit the big time from nothing. These stories really fuel people’s imagination. Then suddenly bitcoin became one of the biggest phenomena of 2017; no one would have predicted a few years ago that would happen.
deBanked: What are the biggest risks you see with cryptocurrency today and how can investors best overcome these challenges?
Renton: Many people are buying purely on speculation with no thought that bitcoin could go down in price. You hear of people buying bitcoin on their credit card and paying 20 percent interest on that purchase. It’s insane. I feel that cryptocurrencies are here to stay, but I don’t like that they have these massive 20 percent to 30 percent swings in a day. The speculators have helped drive the price up, but they’ve also driven the volatility up and that’s been a bad thing.
deBanked: Do you think cryptocurrency will ever dethrone cash? If so, what will it take to get to that point?
Renton: I feel that some kind of digital currency is inevitable—but whether it’s a Federal Reserve-backed currency or something else remains to be seen. I have an 11-year-old and a 9-year-old and I am confident that at some point in their lifetime there will be no such thing as cash. In China, for example, there are some places where you can’t even use cash. You can go to a street vendor and buy a piece of fruit with your phone. Certainly in the U.S. we’re not there yet, but I think China shows where we are going to be.
Cryptocurrency is only one type of digital cash, and it’s hard to say how it will ultimately fit into the larger picture. To dethrone cash as we know it today, cryptocurrency needs to be a quick and efficient way of transacting, and right now it’s not quick and it’s not cheap.
That said, I believe there will be some kind of digital currency in the future. It will take a long time for the Federal Reserve to say cash is no longer legal tender, but I expect we’ll see some kind of digital currency in the next 10 years for sure.
deBanked: How do you think regulation will change the cryptocurrency landscape? Is it inevitable and, more importantly, do you think regulation of cryptocurrency is necessary to take it beyond the level it is today?
Renton: Right now bitcoin is not systemically important. At a market cap of around $156 billion in early February, if something happens and it completely crashes, it won’t make a dent on the U.S. or world economy. But if bitcoin continues to rise and reaches a market cap of say $16 trillion, and then it falls to zero, that would reverberate around the world. The largest economies that have the most bitcoin would be the most impacted.
At some point governments will step in with regulation. It’s already happening in places like China and South Korea and there are rumors of other governments taking action. I don’t think the largest governments will allow their economy to be at the whim of speculators.
deBanked:deBanked: How do you feel about the SEC stepping into regulate ICOs? Is this necessary to protect investors?
Renton: There are certainly some ICOs that are complete scams while others are obviously violating securities laws. But many ICOs have strong legal teams supporting them and are doing it right now. The SEC should absolutely clamp down on those doing the wrong thing, but my hope is that they don’t overreact and throw the baby out with the bathwater.
deBanked: What about online lending? The industry has gone through a lot of changes in its relatively short history. How do you expect to see the competitive landscape change in the next year or so? What about farther out?
Renton: The online lending space has gone through a lot of changes in its short history. I feel like the biggest trend we’re seeing right now is banks launching their own platforms. Take Goldman Sachs with the Marcus online lending platform, for example. More than anything else that has happened in the history of online lending that is among the most telling for the future, I think. Goldman has gone all in with this effort, and that move woke up all the large banks. Top banks like PNC and Barclays are also launching their own initiatives instead of partnering with others, which was surprising to me. I would have thought there would be more partnerships. There are still some, but several banks have decided to do it themselves rather than partnering. Smaller banks, however, that want to get into the space, will likely partner because they can’t afford to do it themselves. While we have seen a few partnerships develop, I expect we will see many more over the next couple of years.
deBanked: What do you see as the biggest risks for online lenders today? How can they best overcome these challenges?
Renton: As an industry, we have to focus on profitability. Profitability comes down primarily to two things. First, you have to get your cost of acquisition down. Some of the companies that failed recently were never able to get their costs of acquisition down to a manageable level. Underwriting is the second piece. Particularly if you’re a balance sheet lender and you’re not underwriting well, you can’t make money. The pullback in the industry in 2016 occurred because many of the major platforms got a little too aggressive in their underwriting. Investors are still paying for some of those mistakes.
Successful companies are ones that have figured out how to profitably acquire customers and how to underwrite effectively. Most of them have learned their lesson, but in business companies sometimes have short memories. We need to keep a close eye on it.
deBanked: What advice do you have for alternative lenders and funders?
Renton: In addition to paying careful attention to profitability and underwriting, another important piece is having diversified funding sources. You want to make sure that you don’t have one big bank or some other source providing 90 percent of your funding. You should really have different kinds of lending sources. Some loans you can fund through a marketplace, some loans you can fund through your balance sheet. It’s good when you’re not reliant on one particular way of funding your loans.
deBanked: How is regulation likely to impact the online lending industry?
Renton: Having support in Congress for the online lending space is important. Congress hasn’t devoted a lot of attention to it in the past few years, but it’s starting to. The Madden decision—which has the potential to lead to significant nationwide changes in consumer and commercial lending by non-bank entities—has created uncertainty in the industry. In states affected by the decision (Connecticut, New York and Vermont) already there has been less access to credit. I’m hopeful that Congress moves ahead with legislation to override the Madden decision that’s having such an impact in the Second Circuit states. People are worried that it could expand nationwide and Congress needs to act so there’s clarification. There’s too much uncertainty right now.
deBanked: Several platforms have closed their doors in the past year or so. Do you expect to see this trend continue?
Renton: There are companies out there still trying to raise money and struggling to do so. That’s a healthy thing for an industry. You want the strong players to survive and thrive and for the weaker ones to go away.
deBanked: How big do you think an online lender has to be to thrive?
Renton: There’s no doubt that scale is important. If you’re a small player, you have to have some kind of niche in order to acquire customers. If you have that, you have the ability to compete. Even with that sometimes, it’s going to be difficult. It’s a pretty complex business. You need to have a lot of staff for compliance and operations and that can be expensive. When you have high fixed costs, you have to have scale to be able to make a profit. That said, I think there’s room for more than just the ultra-large players in the online lending space. I think there will be plenty of opportunity for strong, well-positioned medium-sized players to compete.
deBanked: What about M&A in the industry?
Renton: Valuations at many of the large platforms are way down from where they were several years ago. As long as valuations stay depressed, I think we could see a big acquisition of a major platform this year. Some of these platforms have millions of customers. Having the ability to pick up such a large number of customers instantly through an acquisition could be compelling for the right buyer, such as a large bank.
deBanked: Is this a good time or a bad time to be an online lender in your opinion?
Renton: It is still a good time to be an online lender. We are expanding access to credit and making the world a better place. I have never been more excited about the industry than I am today.
Research consistently shows that minority-owned businesses have a harder time accessing capital than other businesses. Online financing has the potential to change this.
Most of the online funding process is based on objective factors such as your business type and revenue. When you apply for funds online, it’s harder to discern things like the color of your skin or your ethnicity—factors which research shows can sometimes play into the face-to-face lending process, even though it’s illegal and immoral. What’s more, applying for funds online eliminates the stigma that keeps many minority-owned businesses from walking into a bank to apply for a loan, according to industry participants.
“Many minorities are hesitant to go into a bank,” says Louis Green, interim president of The National Minority Supplier Development Council, which provides business development opportunities for certified minority-owned businesses. He says the growth of online lending platforms will potentially open more doors for minority-owned businesses to get much-needed capital to operate and expand.
“The beauty of things on the Internet is that it has the ability to take away discriminatory issues,” says Green, who is also the chief executive of Supplier Success LLC, a Detroit-based business that offers online business financing solutions.
Certainly, minority-owned small businesses are a large and growing market. There were 8 million minority-owned firms in the U.S. as of 2012, according to U.S. Census Bureau data. Minority-owned firms represented 28.8% of all U.S. firms in 2012.
Historically, however, minority-owned businesses have had trouble getting access to credit for a host of reasons, and recent research suggests the problems persist.
A report published in November by the Federal Reserve Banks of Cleveland and Atlanta examines the results of an annual survey of small business owners. The report found that while many minority small businesses were profitable, a significant majority faced financial challenges, experienced funding gaps and relied on personal finances.
Some of the trouble obtaining financing may have discriminatory underpinnings. For instance, a recent working paper by researchers at Utah State University, Brigham Young University and Rutgers University, among others, suggests that minorities were more highly scrutinized for loans than other applicants. For instance, African American “mystery shoppers” underwent a higher level of scrutiny and received a lower level of assistance than their less-creditworthy Caucasian counterparts, according to the study.
Also, African American testers were asked significantly more often about their marital status and their spouse’s employment. This “marks another and even illegal differential experience for these minority entrepreneurial consumers compared with the Caucasian shoppers,” the study finds.
To be sure, other factors are also likely to blame. For instance, the average credit score of a minority small-business owner is 707, which is 15 points lower than the overall average for small-business owners in the U.S., according to a 2016 study by credit bureau Experian.
Even so, the bias issue remains a stark possibility in at least some cases. A 2010 report by the Minority Business Development Agency (MBDA) offers data to show that minority-owned firms are less likely to receive bank loans than non-minority-owned firms. Among all minority firms, 7.2 percent received a business loan from a bank compared with 12.0 percent of non-minority firms, according to the report. High sales minority-owned firms were more likely to receive bank loans with 23.3 percent receiving this source of startup capital. By contrast, 29.2 percent of high sales non-minority firms received bank loans, the data shows.
To be sure, it’s very difficult to prove discrimination when a bank loan is denied. A few years ago, a mortgage banker who asked not to be named, says he suspected discrimination when an Asian couple he worked with was denied a small bank loan. While he didn’t have rock solid proof, he felt the bank’s stated reasoning for turning down the loan was unjustified and he tried going to bat for the couple. His efforts were rebuffed, however, and the loan was denied.
Based on the size of the loan and the couple’s finances, the banker says the loan would have easily been approved by an online provider that was looking only at objective factors. “They see the numbers they’ve been given and calculate risk and make decisions based purely on numbers,” he says.
Indeed, this is where online lending has already shown significant potential. Alicia Robb, a research fellow at the Atlanta Federal Reserve who co-authored the November report by the Cleveland and Atlanta Federal Reserves, says when controlling for credit score and other business-related factors, the data shows that minority businesses have a better shot at getting loans approved online than they do at a large or small bank.
Industry participants say the online funding process can be a boon for minority business owners because it strips subjective reasoning out of the decision-making process. Instead of presenting themselves, applicants are presenting what their business looks like financially, and funders are making highly automated decisions based on the information provided.
“Humans make terrible decisions. The more you can eliminate human bias in the process the better,” says Kathryn Petralia, co-founder and president of Kabbage. She says 95 percent of the online lender’s customers have an entirely automated experience, which includes validating their identity using digital processes. “We never see a picture of them or know anything about their ethnicity or demography,” she says.
Even funders who do ask for photo identification say that doesn’t happen until after applicants have been approved. And even then, it’s just to “make sure that the person you are funding is actually the person you are funding and no one is trying to defraud you,” says Isaac D. Stern, chief executive of Yellowstone Capital LLC, a MCA funder in Jersey City, N.J. “Online financing is colorblind. It doesn’t matter if [you’re] white or Hispanic or black,” he says.
Dean Sioukas, chief executive of Magilla Loans, an online search engine that matches prospective borrowers and lenders, has hope that the anonymity of the online funding process could eventually make the off-line process more equitable for all applicants. After accepting a number of solid proposals from viable lending opportunities—without knowing any personal information about the applicant—his hope is that whatever biases a loan officer may previously have had will dissipate, he says. Funding decisions should only be made on objective criteria, he says. “The rest has no place in the process.”
While in theory online lending should improve access to funds for minority-owned businesses, several industry observers say barriers remain.
One major challenge is getting the news out to minority business owners, many of whom don’t know about the online funding opportunities that exist, says Lyneir Richardson, executive director of The Center for Urban Entrepreneurship and Economic Development, a research and practitioner-oriented center at Rutgers Business School in Newark, N.J.
He suggests online lenders and funders need to do a better job of connecting with minority-owned businesses and explaining what they have to offer. He works with about 300 entrepreneurs, 70 percent of whom are minority-owned businesses. He’s held this position for 10 years, but says he’s never been approached by an online lending company to market its services, speak at one of his events, provide funding advice to business owners or in any other capacity.
“There is an opportunity for online small business lenders to market and make known, particularly to minority business owners, that they have viable, market rate lending products that can help them grow,” he says.
One caveat is that rates online are often higher than traditional bank loans, so there is a trade-off for minority-owned businesses, says Brett Barkley, a senior research analyst in the community development department at the Federal Reserve Bank of Cleveland, who co-authored the November report.
Other research from the Federal Reserve shows that satisfaction levels were lowest at nonbank online lenders for both minority- and nonminority-owned firms compared with borrower satisfaction levels at small banks and large banks, he says. The satisfaction levels seem to be related to higher interest rates and “lack of transparency,” he adds. While the study doesn’t define the latter term, the findings could “point to confusion regarding the actual terms of the loan,” Barkley says.
Some online firms have taken steps to make pricing more transparent by using the SMART Box disclosure agreement, a comparison tool developed by the online lending industry to help small businesses more fully understand their financing options. There are currently three different versions of the SMART Box disclosure –for term loans, lines of credit, and merchant cash advances.
This “is a really important metric,” says Petralia of Kabbage, which offers the tool to customers.
Green, the interim president of NMSDC, says that helping its 12,000 minority-owned business members gain access to capital is a major goal for the organization. While online financing is still a largely “untapped resource” for minority businesses, it makes borrowing money easier and more appealing. “It holds great promise for minority-owned businesses, but I think the reality hasn’t met that promise yet,” he says.
Online technology, which paved new paths for consumer and small business lending, is making similar inroads with the commercial real estate industry.
Over the last few years, several online marketplaces have been established to try and match commercial real estate borrowers with lenders quickly and efficiently using technology. In the past, commercial real estate lending depended heavily on having local connections, but online platforms are blurring these lines—making geographical borders less relevant and opening doors for new types of lenders to establish themselves.
While banks remain the largest source of commercial real estate mortgage financing, non–bank players—including credit unions, private capital lenders, accredited and non–accredited investors, hedge funds, insurance companies and lending arms of brokerage firms—have become more formidable opponents in recent years. Online platforms offer even more opportunity for these alternative players to gain a competitive edge.
At present, most of these commercial real estate marketplaces are purely intermediaries—they’re matching borrowers and investors, not actually doing the lending. Certainly, it’s an easier business model to develop than a direct lending one, but things could change over time, as borrowers become more comfortable with the online model and develop confidence that these platforms can perform, industry participants say.
“You have to be viewed as credible with a certainty of funding for borrowers to come to you. You can’t just put up a flag and say ‘Hey we’re making loans’ because borrowers won’t trust you and they won’t have the confidence that the loan is going to close,” says Evan Gentry, founder and chief executive of Money360, one of the few online direct lenders in this space. “However, once you develop a reputation of strong performance, the tide turns very quickly and that confidence is established,” he says.
For now, however, many of the marketplaces say they are content to remain intermediaries and offer business opportunities to lenders instead of competing with them. The sheer size of the market— commercial/multifamily debt outstanding rose to $3.01 trillion at the end of the first quarter, according to data from the Mortgage Bankers Association—and the fact that is an enormously diverse industry with no plain vanilla product makes it more likely that several platforms can co–exist without completely cannibalizing each other’s business, observers say.
Each of the online marketplaces has a different business and pricing model. Some marketplaces focus on small loans, while some have larger minimums; some focus on just debt; some focus on a mixture of equity and debt. Some sites cater to institutional lenders and accredited investors to help fund loans. Other sites invite non–accredited investors who meet certain criteria to participate in loans, opening doors to a segment of the population which previously had minimal access to commercial real estate deals. While the sites differ in their approach, the upshot is clear: banks—while still formidable competitors in commercial real estate lending—are no longer the only game in town for funding these deals.
The struggle for lenders is how to work most effectively with these marketplaces. “If you can acquire customers through only your own channels, then of course you’re going to do that,” says David Snitkof, chief analytics officer at Orchard Platform, which provides data, technology and software to the online lending industry. Otherwise, these marketplaces present a viable opportunity to expand distribution, he says.
GROWTH OPPORTUNITIES ABOUND
The surge of new companies acting as marketplaces between borrowers and lenders of all kinds comes as the commercial real estate industry is finally coming up to speed with respect to technology. The commercial real estate business has been static for decades in terms of how loans are processed and originated, according to industry participants.
“The use of technology is going to be an enormous disrupting force in that space,” says Mitch Ginsberg, co–founder and chief executive of CommLoan, one of the newer marketplaces for commercial real estate lending. Commercial real estate lending is “probably one of the last industries that hasn’t been touched by technology, and it’s ripe for massive disruption,” he says.
CommLoan of Scottsdale, Ariz., was founded in 2014, but the marketplace has only been fully operational since 2016. The platform targets borrowers seeking $1 million to $25 million of capital for all types of commercial real estate loans. It works with more than 440 lenders—including banks, credit unions, commercial mortgage companies, private money lenders and Wall Street firms. Altogether, CommLoan says it has processed more than $680 million in commercial transactions.
Online marketplaces can help make the commercial real estate industry more efficient and transparent, says Yulia Yaani, co-founder and chief executive of RealAtom of Arlington, Va., another new online commercial real estate marketplace. “People are tired of paying huge fees as a result of the market being so opaque,” she says.
RealAtom began operating in 2016 and targets borrowers who are seeking commercial real estate loans from $1 million to $70 million. The lenders on the platform include banks, alternative lenders, insurance companies, pension funds, hedge funds and hard money lenders. The company processed $468 million in commercial loans in its first 11 months of operating, according to Yaani.
Another benefit of online marketplaces is that they “create a liquid, national marketplace where lenders all across the U.S. can bid on a borrower’s business,” says Ely Razin, chief executive of commercial real estate data company CrediFi, which operates the upstart CredifX marketplace. Historically people who own commercial real estate have only been able to get financing through a local relationship with a bank or broker. “For borrowers, this means more certainty of obtaining a loan and optimized capital not limited by the relationship with the local lender,” he says.
CredifX started operating earlier this year to match commercial real estate borrowers, brokers and lenders including banks, finance companies, mortgage companies, hard money and bridge lenders. The platform is for loans of $1 million to $20 million across all major property types in the commercial space. It matches borrowers with appropriate lenders using the information that parent company CrediFi collects and analyzes. The company declined to disclose how much it has processed in commercial transactions.
To be sure, it’s hard to say how the marketplace model will evolve over time and which players will withstand the test of time. Certainly a similar model has faced challenges on the consumer and small business lending side.
“I think the pure marketplace will become more rare as time goes on,” says Peter Renton, founder of Lend Academy, an educational resource for the P2P lending industry. “There are examples of successful companies with a pure marketplace, but they are rare and difficult to scale. The only well-established company that seems completely wedded to the pure marketplace is Funding Circle; pretty much all other companies have switched to a hybrid model of some sort,” he says.
Commercial vs Residential
While much of the recent growth has been within commercial real estate, there are also some marketplaces that cater to residential borrowers or offer a mix of commercial and residential opportunities.
Magilla Loans, for instance, started out in 2016 as a solely commercial marketplace, but expanded outside this silo because customers were asking for residential and other types of loans, says Dean Sioukas, the company’s founder. The company now connects borrowers with lenders for a whole host of loan types—commercial, residential and others like franchise loans and equipment loans. Lenders on the platform include roughly 130 banks, mortgage loan originators, accredited investors, credit unions and online non-depository institutions. The average loan size is $1.4M for business loans and $500K for home loans. Nearly $4 billion in loans has been channeled through the platform since January 2016; of that 70 percent is tied to commercial real estate, according to the company.
While there are marketplaces that focus on residential mortgage lending, some industry participants say that side of the business isn’t as appealing to new online entrants in part because the cost to acquire customers is really high and there are more challenges to working on a national scale.
“It may not be that commercial is more attractive. It may just be easier. Going directly to borrowers in the residential space has proven harder than many companies expected,” says Brett Crosby, co-founder and chief operating officer of PeerStreet, a marketplace for accredited investors to invest in high-quality private real estate backed loans. Experience seems to suggest that for residential mortgage origination, “it’s much better to have a good ground game and know your local market,” he says.
To be sure, as the online market for real estate matures, it’s not so surprising that companies would shift business models to find their own sweet spot. RealtyMogul.com is one example of a company that has morphed over time. The online platform began operating in 2013 in both the residential and commercial space, but has since moved away from the residential business. Accredited investors, non-accredited investors and institutions can use the platform to find equity or debt-based commercial real estate investment opportunities, and borrowers can apply for private hard money loans, bridge loans and permanent loans.
Money360 is another example of a company that has shifted gears. It started out as a pure marketplace, but changed its business model to become a lending platform in 2014. Now the online direct lender in Ladera Ranch, Calif., provides small-to mid-balance commercial real estate loans ranging from $1 million to $20 million. It’s one of the only companies targeting the commercial real estate space in this way and has closed nearly $500 million in total loans since 2014.
Gentry, the company’s founder, says he would expect to see more industrywide changes as the online commercial real estate business continues to evolve. The key to success, he says, is executing well and “knowing when to pivot when you realize something’s not working just right.”
Ultimately, Gentry predicts more online lenders will target the commercial real estate space. He says technology-based alternative lenders have an advantage because they can operate more quickly and efficiently while still being very competitive from a pricing perspective.
“You put all those things together (speed, efficiency and competitive pricing) and that’s what borrowers are looking for,” Gentry says.
Lead generators for alternative funders are facing stronger headwinds these days. The business has gotten tougher for a whole host of reasons. A pullback in alternative lending necessitates fewer leads. On top of that, funders, ISOs and brokers have gotten pickier about the types of leads they’ll accept. What’s more, stricter application of the Telephone Consumer Protection Act (TCPA) is hampering lead generators’ ability to solicit business owners. As a result, some lead generators have faded away, while others have been developing additional business lines or are broadening their reach to other areas within financial services to buoy earnings.
“I don’t see any growth in the space for the next six months, or maybe a year,” says Michael O’Hare, chief executive of Blindbid, a lead generation company in Colorado Springs, Colorado. “It’s really unclear right now what’s going to happen, but we’ll see.”
The alternative funding industry has been in somewhat of a funk since spring 2016 when Lending Club grabbed headlines with a scandal that spooked the industry and also took out several senior managers, including the company’s then-CEO.
It was the first time in the industry’s relatively short history that people realized “it wasn’t all puppy dogs and ice cream,” says Justin Benton, a partner at Lenders Marketing in Santa Monica, Calif., a lead generator in the alternative funding space.
Since that time, there’s been a lot of movement in the market, including companies that are consolidating or exiting the business, pumping the brakes or making shifts in product lines, Benton says. These developments have all had a big impact on the sheer number of clients that are looking for leads, he says.
Late last year, for instance, CAN Capital Inc. stopped funding for several months, though it’s back in business as of early July. This summer, Bizfi, one of the stalwarts of the alternative financing space, began giving pink slips to staff and in August the company sold the servicing rights to its $250 million loan portfolio to rival Credibly.
There aren’t as many start-up ISOs or companies entering the alternative funding space—meaning more leads for existing funders—which, of course, is a boon for them.
“There are still roughly 75,000 business owners every week who meet the criteria for an [MCA]. Now instead of there being 5,000 options in the space, there are 2,000, so those 2,000 are gobbling it all up,” Benton says.
At the same time, however, TCPA regulations have gotten more stringent, making it dangerous to solicit businesses, says O’Hare of Blindbid. “Any phone call you make, you can get sued,” he says.
Large funding companies generally take TCPA very seriously—especially if they’ve gotten hit with violations, O’Hare says. Smaller funders and brokers, however, aren’t always as familiar with the restrictions; they think it’s only an issue if you’re calling consumers, as opposed to calling businesses, but that’s not the case. “A lot of businesses today are using their cell phone as a main business line and also for personal use. If you call a cell phone that’s on the DNC [Do Not Call Registry], you can potentially get sued.”
Last year, he had a situation where a plaintiff pretended to be an interested business. When he passed along the referral, the plaintiff’s attorney claimed TCPA violations and ultimately sued the funder. The funder balked, and it created numerous issues for his company.
His company now tries to educate funders about how to protect themselves from TCPA litigation. He sends out emails to funders with information about TCPA and provides contact information of attorneys who are well-versed in TCPA rules. He also provides funders with risk mitigation tactics and shares his list of known TCPA litigators so funders won’t accidentally call them. He also provides direction to clients that receive a demand letter or complaint on how to respond and offers a list of TCPA defense attorneys, if they need.
“We’ve become almost extreme in how we try to avoid problems related to TCPA,” O’Hare says.
To be sure, some of the changes lead generators are experiencing are indicative of a maturing industry.
A few years ago, lead generators could be less selective who they approached initially because the concept of alternative funding was so new to merchants, says Bob Squiers, chief executive of Meridian Leads, a lead generator in Deerfield Beach, Fla. Now, however, the cat is out of the bag, and, with business owners getting multiple calls a day, it’s harder to get their attention, he says.
“They know, they’ve heard, they’ve been pitched. There’s not too many unturned business owners. It’s about getting them at the right time.”
As a result, lead generation today requires more data to discern the good leads from the bad. Instead of going after half a million restaurants, lead generators are targeting the 20 percent that data suggests are the most viable funding candidates. “It’s more of a sniper approach than a shotgun approach,” Squiers says.
Rob Buchanan, senior sales executive at Infogroup in Papillion, Nebraska, who focuses on lead-generation for the fintech space, notes that within the past 18 months or so, clients have been going after “low-hanging fruit” when it comes to leads. They are looking for leads where business owners are actively looking for financing as opposed to relying primarily on UCC data. They are still using UCC data, but to a lesser extent than they were in the past, he says.
Not only do clients want very targeted and specific types of companies—but they are changing their minds more frequently about the types of businesses they’re looking for, says Matthew Martin, managing director and principal at Silver Bullet Marketing, a lead-generating and marketing company in Danbury, Conn. They might ask for businesses of a particular size or credit quality—they are even seeking to exclude businesses within certain zip codes. They are also more amenable to leads from industries they deemed too risky a few years ago.
“I have clients that are constantly changing the parameters of what they want,” Martin says.
The problem is that once you start narrowing the leads of possible merchants that can be funded, lead costs go up and many funders don’t want to pay for that, says O’Hare of Blindbid. “The glory days when everything was wide open and you could generate leads really cheaply are pretty much gone.”
Meanwhile, as some lead generators have faded into the sunset, others are forging ahead in search of new opportunities.
Benton of Lenders Marketing, for instance, says his company has started to focus its efforts in other areas of lending, including SBA, new business, mortgage, commercial, residential, auto and student loans.
Digital marketing is another area experiencing increased demand. Business owners that need money tend to use Google to find funding companies. Infogroup’s digital marketing leads these businesses directly to funders, ISOs and brokers, Buchanan says.
“More and more funders, brokers and ISOs are leaning toward doing digital marketing,” he says.
Small business owner Jim Moseley is inundated with calls from online funders—and he hates it. They frequently use unscrupulous tactics to try and get his attention. More than one has claimed to be a close friend so his assistant transfers their call. Then they try to reel him in with stories they’ve concocted about past personal connections. The unprofessional-sounding calls also irk him—where a salesman insists he’s local, but his voice sounds muffled and distant. In these instances, Moseley usually hangs up within a few seconds.
“The layer of sleaze is as thick as lard in the calls that I get,” he says.
Like many small business owners, Moseley, the chief executive of TransGuardian Inc., a shipping solutions company based in Petersham, Massachusetts, finds these types of calls extremely off-putting. In fact, it’s what made him hesitant to do online funding to begin with—until it became absolutely necessary since he couldn’t get a bank loan.
He’s not alone. As online financing proliferates, several small business owners say they are increasingly being bombarded with stacks of snail mail, multiple cold calls a day and numerous unsolicited emails offers—many of which they don’t understand and therefore won’t accept. Rather, small business owners say they prefer to work with companies that are forthcoming, provide sound advice and have taken steps to prove their credibility. They offer several tips on how funders can win more of their business.
Tip No. 1: Can the cold-calls
Several small business owners say they don’t mind when lenders follow up with them after a legitimate interaction. But they could do without the boiler-room tactics.
“It feels like a loan shark situation,” says Sean Riley, co-founder of DUDE Wipes, a Chicago-based company that makes flushable wipes for men. Riley, who has several good experience obtaining loans through Kabbage, finds the constant phone calls from firms he doesn’t know particularly vexing. He suggests lenders drop the high-pressure routines and find more effective ways to promote their services to small businesses. “These companies could be very credible. I don’t know. But I don’t perceive them as credible—and perception is reality,” he says.
Tip No. 2: Step up legitimate marketing efforts
Donna Cravotta chief executive and founder of Social Pivot PR, a Bedford, New York social media and marketing communications firm, says online funders should seek out simple, cost-effective ways to get their name in front of small businesses. For relatively little money they can sponsor local small business events. She also suggests that online lenders volunteer to speak at small business events and teach small businesses how to leverage online lending opportunities. They could also appear as guests on financial podcasts or broadcast Webinars to the small business community, says Cravotta, who has taken a few loans to fund her business, two of which were with Lending Club.
R.T. Custer, co-founder and chief executive of Vortic Watch Company in Fort Collins, Colorado, offers some additional advice: Customers don’t believe when you self-publish your testimonials. When he sees a review on a website, he wants to know how much a company has paid for that review. Instead, he relies on third party confirmations of a company’s worth. “When it’s clearly something that is not paid for, that is the best kind of advertising,” says Custer, an OnDeck customer whose business turns antique pocket watchers into wrist watches.
Tip No. 3: Deliver personal attention
As much as they hate aggressive salespeople, small businesses love personal attention from their lenders. Dana Donofree, founder and chief executive of AnaOno Intimates, a Philadelphia-based company that designs and sells apparel for breast cancer survivors, appreciates the stellar customer service she gets with OnDeck. The sales rep follows up appropriately to make sure everything is going well, but doesn’t bombard her constantly. She gets an occasional email asking if she needs more funds—but the communications aren’t overly aggressive. “Some institutions can really be sales pushy and call you several times a day. I’ve blocked more numbers than I would like to admit,” she says.
Tip No. 4: Be a resource for small business owners
Online lenders can also gain traction by helping customers better understand the financing process; many small business owners often don’t know much about financing and would appreciate getting sound advice from lenders, according to Sandy Lieberman, who co-owns Artemis Defense Institute in Lake Forest, California.
She and her husband started the business a few years ago to offer reality-based training to law enforcement, military personnel and civilians. When the business needed cash, Lieberman began searching online for a bank loan, but wound up taking a merchant cash advance instead. After a few rounds, she started getting bombarded with solicitations. “I think the stacks of mailings from companies must have been four-inches thick,” she recalls.
After additional research, she reached out to Lendio to broker an $85,000 term loan; she later took another loan for $204,000 through Lendio. While these funds have brought her business to a better place—and she has learned a lot in the process—she feels online lenders are missing out on a prime teaching opportunity.
“Some lenders think business owners know more than they already do. Some really don’t know a lot and could use more hand-holding,” she says.
In hindsight, Lieberman—who nearly destroyed her personal credit while trying to run her business—wishes a funding company had offered her a short class on financing; she would have attended, even for a small cost. Access to a finance coach—someone at the lending company who could help business owners plan proactively without ruining their personal credit—would also be a boon, she says.
“Small business owners are wearing many hats—customer service, payroll, financing, strategic planning. In the midst of all that they don’t know necessarily know how to make wise funding decisions,” she says.
Tip No. 5: Advertise
There are plenty of small businesses that need funds, but many simply don’t know where to turn. Consider a TD Bank survey of 553 small business owners in late March that found 21 percent have or will seek a loan or line of credit in the next 12 months. While the majority of these businesses plan to try their bank first, a sizeable number—11 percent—don’t know how to seek credit when they are ready. While many small businesses have found lending partners by Googling for information, others simply feel stymied by the process.
Take the case of Scott Deuty, who is having trouble obtains funds for Coolbular Inc. in Cheyenne, Wyoming, which serves as an umbrella for his kiddie ride business and his writing and publishing services. He wants to raise funds but has bad credit and doesn’t meet the revenue requirements for certain lenders. There are so many lenders; he doesn’t know how to find the right one—or one that might be willing to take a chance on him. “It’s very difficult,” he says.
Deuty’s case is an example of the paralysis that can happen when small businesses don’t know where to turn. It’s an opportunity for alternative funders to gain a leg up by marketing more appropriately to small businesses that may not know they exist—or how to find them.
Custer, of Vortic Watch, reached out to OnDeck for a bridge loan after seeing a television ad that ran during an episode of Shark Tank. He also suggests funders use online advertising to gain broader exposure. “If a business owner is trying to find a loan, they are going to Google, ‘I need a loan,’” he says.
Tip No. 6: Ramp up business referrals
Another way small businesses hear about lending opportunities is through business referrals. Azhar Mirza, founder of SomaStream Interactive, an e-learning solutions provider in Berkeley, California, says funders should actively seek out more referral partnerships. In 2015, his company couldn’t afford its online marketing costs. Then a lifeline came its way. Mirza received an offer from Google telling him his company was eligible for a loan to help finance the online advertising it was doing through the Google AdWords program. The offer was part of a new pilot program between Google and Lending Club to extend credit to smaller companies that use Google’s business services. SomaStream got access to the funds it needed, but in lieu of cash, the company received advertising credits with Google.
The pilot program between Google and Lending Club ended in the first quarter of 2016, but Mirza believes similar partnerships would be a great tool for online lenders. Certainly for Mirza, the timing was precipitous, he says.
Push notifications from trusted business partners can also be an effective marketing tool, when used in moderation. When Yvonne Denman-Johnson, co-founder of HootBooth Photo Booth, a Lago Vista, Texas, manufacturer of photo booth kiosks, needed money, she happened to receive a notice from Shopify, the company’s e-commerce software and hosting provider, talking about its merchant cash advance services. She has one outstanding advance through Shopify, which she is working to pay off.
Tip No. 7: Be transparent
Denman-Johnson got the funds she needed, but she feels MCA providers need to be more transparent about the effective interest rate—at the advertising stage, not at the approval stage—so small businesses can make more informed decisions without having to do all the calculations themselves. Otherwise, some small businesses might decide not to pursue this form of funding because of the unknowns. Her company almost walked away, but decided to go through the full application process. At this point, Shopify provided the effective interest rate, which was in the 12 percent range. Other funders she researched were in the 30 percent range—which she describes as “outrageously” expensive.
Indeed, small business owners want to work with funders that outline the terms clearly and offer comparisons. Lisa Ayotte, founder of Soul’y Raw, a specialty pet food provider in San Marcos, California, has had good experiences with Kabbage, On Deck and Fundbox.
She wishes, however, that all online lenders offer more detailed information about the loan programs they offer on their website—so small businesses can weigh their options before they go through the actual application process. Small businesses want to know, for instance, whether a lender offers debt consolidation. They also want funds to spell out clearly on their websites the various types of loans offered and the underwriting criteria. Ayotte also suggests lenders provide links to online loan calculators so small businesses can understand what the terms mean to them.
Small business owners want to be told like it is. That’s one major appeal of online lending—if you’re going to be turned down, you typically know right away says Ricardo Picon, the co-owner of The Sandwich Shop, a restaurant and catering business in Williamsburg, New York.
He took an $88,000 loan in February issued by Excelsior Growth Fund, a U.S. Treasury-certified Community Development Financial Institution, but in the future, he says he would consider using a different type of online lender. It would depend on the rates, the economic times, monthly payments and closing fees, among other things. “I want transparency. I want to know if they are going to give me the money or not so I can move on. This way there are no false hopes,” he says.
Tip No. 8: Make the process as easy as possible
Small business owners also prefer to work with online lenders that make the process seamless. AJ Saleem, founder of Suprex Learning, a Houston-based private tutoring and test prep company, was proactive about searching for online lending options. He chose a loan with Lending Club in part because the process was so easy. Some applications he started, but never finished because the process was too onerous. With Lending Club, the process was quick, there were fewer questions asked and the funder asked for less documentation than some competitors, Saleem says.
To be sure, rates are really important to small businesses, but they also want to work with funders they feel are on the up-and-up. “We want a square deal,” says Moseley, the chief executive of TransGuardian. “Tell us what the deal is in an honest and professional way and if we like it we’ll do business.”
CAN Capital is back in business, thanks to a capital infusion by Varadero Capital, an alternative asset manager. Terms of the capital arrangement were not disclosed.
CAN Capital stopped funding late last year and removed several top officials after the company discovered problems in how it had reported borrower delinquencies. The discovery also resulted in CAN Capital selling off assets, letting go more than half its employees and suspending funding new deals, among other things.
Now, however, the company has a new management team and its processes have been revamped and staff retrained in anticipation of a relaunch, according to Parris Sanz, who was named chief executive in February. He was the company’s chief legal officer before taking over the helm after then-CEO Dan DeMeo was put on leave of absence.
As of today (7/6), CAN Capital has resumed funding to existing customers who are eligible for renewal. Within a month, the company plans to resume providing loans and merchant cash advance to new customers. It will have two products available in all 50 states—term loans and merchant cash advances with funding amounts from $2,500 to $150,000.
To be sure, getting back into the market after so many months will be a challenge. “I think we’re absolutely going to have to work hard, no doubt about it. In many ways, given our tenure and our experience, the restart may be easier for a company like us versus others. Based on the dynamics in the market today, I see a real opportunity and I’m excited about that,” Sanz said in an interview with DeBanked.
Since its founding in 1998, CAN Capital has issued more than $6.5 billion in loans and merchant cash advances. It’s one of the oldest alternative funding companies in existence today, and, accordingly, it shook the industry’s confidence when the company’s troubles became public late last year.
The new management team includes Sanz, along with Ritesh Gupta, the chief operating officer, who joined CAN Capital in 2015 and was previously the firm’s chief customer operations officer. The management team also includes Tim Wieher as chief compliance officer and general counsel; he initially joined the company in 2015 as CAN Capital’s senior compliance counsel. Ray De Palma has been named chief financial officer; he came to CAN Capital in 2016 and was previously the corporate controller. The management team does not include representatives from Varadero.
Varadero is a New York-based value-driven alternative asset manager founded in 2009 that manages approximately $1.3 billion in capital. In the past five years, Varadero has allocated more than $1 billion in capital toward specialty finance platforms in various sectors including consumer and small business lending, auto loans and commercial real estate. In 2015, for instance, Varadero participated in separate ventures with both Lending Club and LiftForward.
Varadero began working with CAN Capital as part of its efforts to pay down syndicates. Varadero bought certain assets from CAN Capital last year and provided enough funding to allow CAN Capital to recapitalize. “The recapitalization enabled us to pay off the remaining amounts owed to our previous lending syndicate and provided us with access to additional capital to resume funding operations,” Sanz says. He declined to be more specific.
“We were impressed with the overall value proposition of CAN’s offerings as evidenced by the strength of its long standing relationships, the company’s core team, sound underwriting practices, technology and the strong performance of their credit extension throughout the cycle,” said Fernando Guerrero, managing partner and chief investment officer of Varadero Capital, in a prepared statement. “We’re confident the company’s focused funding practices will allow it to serve small business customers for many years to come.”
Guerrero was not immediately available for additional comment.
DLA Piper served as legal counsel for, and Jefferies was the financial advisor to, CAN Capital, while Mayer Brown was legal counsel to Varadero Capital, L.P.
Since its troubles last year, CAN Capital had been working with restructuring firm Realization Services Inc. for assistance negotiating with creditors. It also worked with investment bank Jefferies Group LLC for advice on strategic alternatives.
Sanz declined to discuss other options CAN Capital considered, noting that the Varadero deal provides the firm the opportunity it needs to jump back into the market—this time with “tip top” operations in place.
He declined to say how many employees the firm still has, other than to say it is now “appropriately staffed.” In addition to getting rid of the prior management team, CAN Capital reduced staffing in numerous parts of its business. That includes nearly 200 positions at its office in Kennesaw, Ga, according to published reports.
The company will still be called CAN Capital. “We feel that that brand has a recognition in the market, in particular with our sales partners,” Sanz says.