Articles by Ed McKinley
It’s nearly impossible to teach fiscal responsibility to most consumers, according to researchers at universities and nonprofit agencies. But alternative small-business funders and brokers often manage to steer clients toward financial prudence, and imparting pecuniary knowledge can become part of a consultative approach to selling.
Still, nobody says it’s easy to convince the public or merchants to handle cash, credit and debt wisely and responsibly. Consider the consumer research cited by Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and co-director of the Common Cents Lab, which works to improve the financial behavior of low- and moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” Beasley says. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influences lower-income people even less.
The problem stems from trying to teach financial responsibility too late in life, says Noah Grayson, president and founder of Norwalk, Conn.-based South End Capital. He advocates introducing young people to finance at the same time they’re learning history, algebra and other standard subjects in school.
Yet Grayson and others contend that it’s never too late for motivated entrepreneurs to pick up the basics. Even novice small-business owners tend to possess a little more financial acumen than the average person, they say. That makes entrepreneurs easier to teach than the general public but still in need of coaching in the basics of handling money.
Take the example of a shopkeeper who grabs an offer of $50,000 with no idea how he’ll use the funds to grow the business or how he’ll pay the money back, suggests Cheryl Tibbs, general manager of One Stop Commercial Capital, Douglasville, Ga. “The easy access to credit blinds a lot of merchants,” she notes.
Entrepreneurs often make bad decisions simply because they don’t have a background in business, according to Jared Weitz, CEO of New York based United Capital Source. “Many of the people who come to us are trying their hardest,” he observes.
Weitz offers the example of his own close relative who’s a veterinarian. That profession attracts some of the brainiest high-school valedictorians but doesn’t mean they know business. “He’s the best doctor ever and he’s not a great businessman because he doesn’t think about those things first. What he thinks about is helping people. That’s why he got into his profession.”
Entrepreneurs often devote themselves to a vision that isn’t businesses-oriented. “They start a business because they have a great idea or a great product, and that’s what excites them,” Grayson says. “They jump in with both feet and don’t think much about the business side.” The business side isn’t as much fun.
Merchants also attend to so many aspects of an enterprise—everything from sales, production and distribution to hiring, payroll and training—that they can’t afford to devote too much time to any single facet, notes Joe Fiorella, principal at Kansas City, Mo.-based Central Funding. Business owners respond to what’s most urgent, not necessarily what’s most important.
For whatever reason, some business owners spiral downward into financial ruin, bouncing checks, stacking merchant cash advances and continually seeking yet another merchant cash advance to bail them out of a precarious situation, says Jeremy Brown, chairman of Bethesda, Md.-based Rapid Advance.
Weitz advises sitting down with those clients and coming to an understanding of the situation. In some cases, enough cash might be coming in but the incoming autopayments aren’t timed to cover the outgoing autopayments, he says by way of example.
Informing clients of such problems makes a demonstrable difference. “We can see that it works because we have clients renewing with us,” says Weitz. “We’re able to swim them upstream to different products” as their finances gradually improve, he says.
The products in that stream begin with relatively higher-cost vehicles like merchant cash advances and proceed to other less-expensive instruments with better terms, says Brown. Those include term loans, Small Business Administration loans, equipment leasing, receivables factoring and, ultimately the goal for any well-capitalized small business—a relationship with the local bank.
Failing to consider those options and instead simply abetting stackers to make a quick buck can give the industry a “black eye,” and it benefits none of the parties involved, Tibbs observes. But merchants deserve as much blame as funders and brokers, she maintains.
Prospective clients who stack MCAs, don’t care about their credit rating and simply want to staunch their financial bleeding probably account for 35 percent to 40 percent of the applicants Tibbs encounters, she says.
Just the same, alt-funders continue to urge clients to hire accountants, consult attorneys, employ helpful software, shore up credit ratings, keep tabs on cash flow, calculate margins, improve distribution chains and outline plans for growth. It’s what helps the industry rise above the “get-money quick” image that it’s outgrowing, Weitz, says. Many funders and brokers consider providing financial advice an essential aspect of consultative selling. It’s an approach that begins with making sure applicants understand the debt they’re taking on, the terms of the payback and how their businesses will benefit from the influx of capital. It continues with a commitment to helping clients not just with funding but also with other types of business consultation.
“It’s not so much selling as building a rapport with clients—serving as a strategic advisor or financial resource for them, identifying their needs and directing them to the right loan product to meet those needs,” says Grayson. “They should feel they can call you about anything specific to their business, not just their loan requests.” He also cautions against providing information the client will not absorb or will find offensive.
Justin Bakes, CEO of Boston-based Forward Financing also advocates consultative selling. “It’s all about questions and getting information on what’s driving the business owner,” he says. “It’s a process.”
Consultative sales hinges on knowing the customer, agrees Jason Solomon, Forward Financing vice president of sales. “Businesses are never similar in the mind of the business owner,” he notes. “To effectively structure a program best-suited to the merchant’s long-time business needs and set a proper path forward to better and better financial products, you need to know who the business owner is and what his long term goals are.”
“It’s taking an approach of actually being a consultant as opposed to a $7 an hour order taker,” Tibbs says of consultative selling. “I like to teach new reps to think of it as if you were a doctor. Doctors ask questions to arrive at a final diagnosis. So if you’re asking your prospective customer questions about their business, about their cash flow, about their intentions of how they’re planning to get back on track.”
Learning about the clients’ business helps brokers recommend the least-expensive funding instrument, Tibbs says. “I really hate to see someone with a 700 credit score come in to get a merchant cash advance,” she maintains. The consultative approach requires knowing the funding products, knowing how to listen to the customer and combining those two elements to make an informed decision on which product to recommend, she notes.
Consultative sales can greatly benefit clients, Weitz maintains. If a pizzeria proprietor asks for an expensive $50,000 cash advance to buy a new oven, a responsible broker may find the applicant qualifies for an equipment loan with single-digit interest and monthly payments over a five-year period that puts less pressure on daily cash flow.
It’s also about pointing out errors. Brokers and funders see common mistakes when they look at tax returns and financial records, says Brown. “The biggest issue is that small-business owners—because they work so hard— make a profit of X amount of money and then take that out of the business,” he notes. Instead, he advises reinvesting a portion of those funds so that they can build equity in the business and avoid the need to seek outside capital at high rates.
Another common error occurs when entrepreneurs take a short-term approach to their businesses instead of making longer-term plans, Brown says. That longer-term vision includes learning what it takes to improve their businesses enough to qualify for lower-cost financing.
Sometimes, small merchants also make the mistake of blending their personal finances and their business dealings. Some do it out of necessity because they’re launching an enterprise on their personal credit cards, and others act of ignorance. “They don’t necessarily know they’re doing something wrong,” Grayson observes. “There are tax ramifications.”
Some just don’t look at their businesses objectively. Take the example of a company that approached Central Funding for capital to buy inventory in Asia. Fiorella studied the numbers and then informed the merchant that it wasn’t a money problem—it was a margins problem. “You could sell three times what you’re wanting to buy, and you still won’t get to where you want to be,” he reports telling the potential customer.
Consultative selling also means establishing a long-term relationship. Forward Financing uses technology to keep in contact with clients regularly, not just when clients need capital, Bakes notes. That cultivates long-lasting relationships and shows the company cares. As the relationship matures it becomes easier to maintain because the customers want to talk to the company. “They’re running to pick up the phone.”
The conversations that don’t hinge on funding usually center on Forward Financing learning more about the customer’s business, says Solomon. That include the client’s needs and how they’ve used the capital they’ve received.
“We have our own internal cadence and guidelines for when we reach out and how often and what happens,” says Solomon. Customer relationship management technology provides triggers when it’s time for the sales team or the account-servicing team to contact clients by phone or email.
Do small-business owners take advice on their finances? Some need a steady infusion of capital at increasingly higher cost and simply won’t heed the best tips, says Solomon. “It’s certainly a mix,” he says. “Not everybody is going to listen.”
Paradoxically, the business owners most open to advice already have the best-run companies, says Fiorella. Those who are closed to counseling often need it the most, he declares.
Moreover, not everybody is taking the consultative approach. “New brokers are so excited to get a commission check they throw the consultative approach out the window,” Tibbs says.
Yet many alt-funders bring consultative experience from other professions into their work with providing funds to small business. Tibbs, for example, previously helped home buyers find the best mortgage.
Consultative selling came naturally to Central Funding because the company started as a business and analytics consultancy called Blue Sea Services and then transformed itself into an alternative funding firm, says Fiorella. Central Funding reviews clients’ financial statements and operations between rounds of funding, he notes.
Consultations with borrowers reach an especially deep level at PledgeCap, a Long Island-based asset-based lender, because clients who default have to forfeit the valuables they put up as collateral—anything from a yacht to a bulldozer—says Gene Ayzenberg, PledgeCap’s chief operating officer. Conversations cover the value of the assets and the risk of losing them as well as the reasons for seeking capital, he notes.
No matter how salespeople arrive at their belief in the consultative approach, they last much longer in the business than their competitors who are merely seeking a quick payoff, Tibbs says. Others contend that it’s clearly the best way to operate these days.
“The consultative approach is the only one that works,” says Weitz. “Today, everything is about the customer experience. People are making more-educated, better informed decisions.” What’s more, with the consultative approach clients just keep getting smarter, he adds.
The days of the hard sell have ended, Grayson agrees. Customers have access to information on the internet, and brokers and funders can prosper by helping customers, he says. “Our compensation doesn’t vary much depending upon which product we put a client in so we can dig deeper into what will fit the client without thinking about what the economic benefit will be to us.”
Even though the public has become familiar with alternative financing in general, most haven’t learned the nuances. That’s where consultative selling can help by outlining the differing products now available for businesses with nearly any type of credit-worthiness. “It’s for everybody,” Weitz says of today’s alternative small business funding, “not just a bank turn-down.”
Consumer debt has surpassed $4 trillion for the first time, and it’s continuing its ascent into the stratosphere. It’s getting big enough to trigger the next recession, and financial education isn’t changing the underlying consumer behavior.
Personal loan balances shot up $21 billion last year to close 2018 at a record high of $138 billion, according to a TransUnion Industry Insights Report. The average unsecured personal loan debt per borrower was $8,402 as of the end of last year, TransUnion says.
Much of the increase in consumer debt has emerged with the rise of fintechs— such as Personal Capital, Lending Club, Kabbage and Wealthfront—notes Rutger van Faassen, vice president of consumer lending at a U.S. office of London-based Informa Financial Intelligence, a company that advises financial institutions and operates offices in 43 countries.
In fact, Fintech loans now comprise 38% of all unsecured personal loan balances, a larger market share than any of the more traditional institutions, the TransUnion report notes. Banks’ market share has decreased from 40% in 2013 to 28% today, while credit unions’ share has declined from 31% to 21% during the same time period, TransUnion says.
Fintechs are also gaining at the expense of the home- equity market, van Faassen maintains. “They’re eating away at some of the balance that maybe historically was in home-equity loans,” he says. While total debt is increasing, the amount that’s in home equity loans is actually shrinking, he notes.
What’s more, fintechs are changing the way Americans think about credit, van Faassen continues. Until recently, consumers experienced a two step process. First, they identified a need or desire, like a washer and dryer or home renovation. Realizing they didn’t have the cash to fund those dreams, they took the second step by approaching a financial institution for a loan.
If consumers chose a home equity line of credit to procure the cash, they had to wait for something like 40 days from the beginning of the application process to the time they got the money, van Faassen says. “You really had to be sure you wanted something,” or the process wasn’t worth the effort, he says.
Fintechs have removed a lot of the “pain” from that process, van Faassen says. With algorithms helping to assess the risk that an applicant can’t or won’t repay a debt and digitization easing access to financial records, fintechs can quickly evaluate and make a decision on an application. Tech also helps assess applicants with thin or nonexistent credit files, which broadens the clientele while also contributing to total consumer debt.
Meanwhile, mimicking an age old process in the car business, merchants are beginning to make credit available at the point of sale. Walmart, for example, recently signed a deal with Affirm, a Silicon Valley lender, to provide point-of-sale loans of three, six or 12 months to finance purchases ranging from $150 to $2,000. Shoppers apply for the loans by providing basic information on their mobile phones and don’t have to talk to anyone in person about their finances. Affirm’s CEO Max Levchin has called the underwriting process ‘basically instant.”
If that convenience comes at too high a cost, it doesn’t matter much because borrowers can later find another finance vehicle with better terms, van Faassen says. “So if I get the money at the point of sale, which might have been zero for six months and then it steps up to 20-plus percent, there is no problem with refinancing that debt,” he says.
But there’s a downside to the ease of borrowing, van Faassen cautions. It could trigger the next recession, even though unemployment remains low. Despite modest recent gains, wages have remained nearly stagnant for years. That means an increase in interest rates could lessen consumers’ ability to pay off their debts, he says.
Meanwhile, at least some large mortgage lenders have begun running into problems, a situation that bears an eerie resemblance to the beginning of the Great Recession that struck near the end of 2007, notes a report in luckbox magazine, a publication for investors. Stearns Holding, the parent of Sterns Lending, the nation’s 20th largest mortgage lender, filed for bankruptcy protection just after the July 4 holiday, the luckbox article says.
Another worrisome sign with regard to the possibility of recession is emerging as institutional investors buy into the peer to peer lending market. Institutional investors bought batches of sliced and diced home mortgage securities that helped bring about the Great Depression.
Then there’s the nagging notion that the country and the world are becoming ripe for recession simply because no downturns have occurred for a while. Talk to that effect was circulating at the recent LendIt Conference, van Faassen observes. Fintech executives often come from the banking world and thus still find themselves haunted by the specter of the Great Recession. That’s why they’re already beginning to tighten underwriting for consumer credit van Faassen says.
One difference this time around lies in the fact that nothing about the increase in consumer debt appears to be hidden from public view, van Faassen says. Before, investors fell victim to the mistaken impression that risky mortgage-backed securities were rated AAA when they weren’t.
Plus, the increase in peer-to-peer lending could keep the economy going even if big financial institutions freeze the way they did during the Great Recession, van Faassen notes. “Hopefully, with the new structures that are out there, we can keep liquidity going,” he says. That raises key questions for the alternative small- business funding community. The industry came into being partly as a response to banks’ tightened lending policies during the Great Recession, so perhaps a downturn isn’t such a bad thing for the sector. But a downturn for the economy in general could cripple merchants’ ability to pay off debt.
But all bets are off during hard times. In the last recession the conventional wisdom that consumers make their mortgage payment before paying other bills was turned on its head. Instead of making the house payment—because foreclosure would take several months—people were choosing to make their car payments so they could get to work. Nobody really knows ahead of time what will happen in a recession, van Faassen notes.
After all, economics relies to at least some degree upon the often-irrational financial decisions of the general public. And science demonstrates that it’s no easy task to convince consumers to handle their cash, credit and debt responsibly, says Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and Co-Director of the Common Cents Lab (CCL), which works to improve the financial behavior of low- to moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” says Beasley. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influenced lower-income people even less.
Lots of other factors influence financial behavior, Beasley notes. How much a person saves, for example, depends upon how much they make, what their bank tells them and what practices they encountered at home as children, she says. The CCL has been finding out some other things, too.
In one example of its findings, it discovered that putting an amount for a minimum payment on a credit card decreases how much consumers pay. That happens because listing a minimum payment amount creates an anchor, and borrowers adjust their payment upward from there, Beasley says. If the card carrier doesn’t specify a minimum, consumers tend to adjust downward from the full amount they owe. “It turns out to be incredibly powerful,” she contends.
It’s the kind of problem that shows financial institutions haven’t devised many systems to reduce consumer debt by speeding up repayment, Beasley maintains. In this example, suggesting higher payments would prompt some consumers to pay off their debt more quickly.
In an exception to standard practice, a credit card company called Petal does exactly that by placing a slider on its website to help borrowers determine the amount of their payment, she notes.
Meanwhile, people tend to base financial decisions on the examples they see other people set, Beasley says. Problems arise with that tendency because they may see one neighbor spending money freely to dine in restaurants but don’t see any of the many neighbors eating at home to save money. They see a neighbor driving a new car but don’t know how much that neighbor is setting aside for retirement.
That’s why most people overestimate how much others spend to dine out in restaurants, Beasley says. When shown the error, most reduce their own spending in restaurants, she notes, but within two weeks their behavior returns to its original level, their newfound knowledge “drowned out by the noise in the world,” she says.
That’s not good for consumers or small businesses, but help is on the way, according to John Thompson, chief program officer of the Financial Health Network, a national nonprofit research and consulting firm that works with financial institutions and other companies to improve consumer financial health.
As part of that mission, the Network has formulated procedures to assess the financial health of individuals and small businesses, Thompson says. It’s too early to say whether the tool will help with loan underwriting, he notes, but financial wellness determines the ability to pay back debt, he notes.
The Network also publishes the U.S. Financial Health Pulse, which recently pronounced just 28% of Americans financially healthy, meaning that they have sufficient income, savings and planning to handle an unexpected expense and act on the decisions they make. About 55% are relegated to various stages of coping, and 17% find themselves in a vulnerable state.
So Americans aren’t feeling financially secure, and they’ve borrowed $4 trillion to reach that unenviable state. They’re borrowing more and learning virtually nothing useful about their financial errors. Thompson has a way of summing up the situation. “It’s crazy,” he says.
Most mornings, farmers and ranchers wake up worrying about uncooperative weather and volatile commodity prices. Just the same, they pull themselves out of bed to spend the morning tinkering with crotchety machinery or wrangling uncooperative livestock. When they break for lunch, the kitchen radio alerts them to trade wars with distant countries and the unintended results of federal regulation. As they make their way back outdoors for the afternoon’s work, they can’t help but notice another new house taking shape in the distance as suburban sprawl encroaches on the fields and pastures. By evening, their thoughts have turned to their need for short-term capital and how the local banker seems increasingly wary of providing funds.
It’s that last challenge where the alternative small-business funding industry might be able to help, says Peter Martin, a principal at K-Coe Isom, an accounting and consulting firm focused on the ag industry. “If you as a farmer need operating funds and you can’t get them from a bank, you don’t have a lot of options,” he says. “Historically, nobody outside of banks has had much interest in lending operating money to a farmer.”
The result of that reluctance to provide funding? “I can’t tell you the number of calls I get to say, ‘Hey, I need $100,000 and I need it in a couple of days because of X, Y, Z that’s come up,’” says Martin. “We don’t have a place that we can send those people to. You could make a lot of quick turnaround loans in rural America.” What’s more, it’s a potential clientele that makes a lot of money and prides itself on paying back what they owe.
Martin’s not alone in that assessment. While farmers enjoy abundant long-term credit to buy big-ticket assets, such as land and heavy machinery, they’re struggling to find sources of short-term credit for operating expenses like labor, repairs, fuel, seed, feed, fertilizer, herbicides and pesticides, notes Mike Gunderson, Purdue University professor of agricultural economics.
But remember that nobody’s saying it would be easy for alt funders to break into the agricultural sector. City folks accustomed to the fast-paced rhythms of New York or San Diego would have to learn a whole new seasonal business cycle. Grain farmers, for example, plant corn and soybeans in April, harvest their crops September or October, and may not sell the grain until the following January, says Nick Stokes, managing director of Conterra Asset Management, an alternative-funding company that places and services rural real estate loans.
That seasonality results in revenue droughts punctuated by floods of revenue – a circumstance far-removed from the more-consistent credit card receipt split that launched the alternative small-business funding industry. Alternative funders seeking customers with consistent monthly cash flow won’t find them in the agricultural sector, Stokes cautions.
And while the unfamiliarity of farm life might begin with wild swings in cash flow, it doesn’t end there. Operating in the agricultural sector would require urbanites to learn the somewhat alien culture of The Heartland – a way of life based on hard physical labor, the fickle whims of the weather, and friendly unhurried conversations, even with strangers.
Even so, the task of mastering the agricultural funding market isn’t hopeless, and help’s available. Experts in agricultural economics profess a willingness to help outsiders learn what they need to know to get involved. “Selfishly, the first place I’d love to have them reach out to is me,” Martin says of alternative funders. “I’ve been writing and thinking for years about the importance of getting some non-traditional lenders into agriculture.” He would have “no qualms” about featuring specific prospective funders in a column he writes for one of the nation’s largest farm publications.
It also requires meet-and-greets. During the winter, when farmers aren’t in the fields, funders could make connections at trade shows, Martin advises. “Word would get around rural America really quick,” he predicts. Networking with advisers such as crop insurance agents, agronomists and ag CPS’s – all of whom deal with farmers daily – would also help funders find their way in agriculture, he contends.
Investors who are curious about extending credit in the agricultural sector could rely upon Conterra to help them locate customers and help them service the loans, says Stokes. He can even help acclimate them to the world of agriculture. “If they’re interested in investing in agricultural assets – whether that be equipment, real estate or providing operating capital – we would enjoy the opportunity to visit with them,” he says.
Alt funders could begin their introduction to the agrarian lifestyle by taking to heart a quotation attributed to President John F. Kennedy: “The farmer is the only man in our economy who buys everything at retail, sells everything at wholesale and pays the freight both ways.”
“Agriculture is a very different animal,” Martin notes. He sometimes presents a slide show to compare the difference between a typical farm and a typical manufacturer of the same size. At the factory, revenue ratchets up a bit each year and margins remain about the same over time. On the farm, revenue and margins both fluctuate wildly in huge peaks and valleys from one year to the next.
The volatility makes it difficult to manage the risk of lending, Martin admits, while noting that agriculturally oriented banks still have higher returns than non-ag banks, according to FDIC records. “You have to go back to 2006 to find a time when ag banks didn’t outperform their peers on return on assets,” he says. “What this tells us is that, generally speaking, ag borrowers are better at repaying their loans,” he asserts. Charge-offs and delinquencies in ag portfolios are lower than in other industries, he says.
Many of the nation’s farms have remained in the same family for more than a century – a stretch of time that’s seldom seen in just about any other type of business. Besides making potential creditors comfortable that a particular operation will stay in business, the longevity of farms provides lots of documents to examine – not just tax records but also production history that’s tracked by government agencies. A particular farmer’s crop yields, for example, can be compared with county averages to calculate how good the borrower is at farming.
Debt to asset ratio on the nation’s farms stands at about 14 percent, which Martin views as “insanely low.” But that’s not the case on every farm. Highly leveraged farms have ratios of 60 percent or even 80 percent when farmers have grown their businesses quickly or encountered debt to buy land from their parents, he says. Commodity prices are low now, but farms with 14 percent debt to asset ratios still don’t have a problem, even in hard times. Farmers deeply in debt, however, have little ability to climb out of the hole. The latter are using operating capital to fund losses.
Farmers with debt to asset ratios of 10 percent have little trouble finding credit and aren’t going to pay anything other than bank rates, Martin says. The target audience for non-traditional funding are farmers who are having trouble but will be fine when commodity prices rebound. Another potential client for alternative finance would be farmers who are quickly increasing the size of their operations when opportunities arise to acquire land. Both groups need funders willing to contemplate the future instead of demanding a perfect track record, he maintains.
Farmers generally need loans for operating capital for about 18 months, according to Martin. “Let’s say I borrow that money, get my crop in the ground, harvest that and I may not sell my grain right after harvest,” he says. The whole cycle can easily take 18 months, he says. Shorter-term bridge lending opportunities also arise in situations like needing a little extra cash quickly at harvest time. Farmers usually have something to put up as collateral – like producing 50 titles to vehicles or offering up some real estate, he says.
An unsecured loan – even one with high double-digit interest – could succeed in agriculture because no one is offering that type of funding, Martin says. Small and medium-sized farms would probably benefit from funding of $100,000 or less, while larger farms might sign up for that amount but often require more, he notes.
LAY OF THE LAND
The Farm Credit System, a nationwide quasi-governmental network of borrower-owned lending institutions, provides more than a third of the credit granted in rural America. That comes to more than $304 billion annually in loans, leases and related services to farmers, ranchers, rural homeowners, aquatic producers, timber harvesters, agribusinesses, and agricultural and rural utility cooperatives, according to published reports.
Congress established the Farm Credit System in 1916, and the Farm Credit Administration was established in 1933 to provide regulatory oversight. “All they’re doing is lending money to agriculture,” says Martin.
However, the system can go astray in the eyes of some observers. An arm of the Farm Credit System called CoBank lends to co-operatives and other rural entities. At one point Verizon Wireless became a borrower from CoBank, which angered some observers because the system was supposed to be helping rural America, not corporate America, Martin says.
That anger arises partly because the federal government doesn’t require Farm Credit to pay income tax, which enables it to lend at lower rates, Martin says. “Part of the allure of borrowing from Farm Credit is you can typically borrow cheaper,” he notes. “You’d be very hard pressed to find a farmer who over the years hasn’t had some interaction with Farm Credit.”
Observers sometimes fault the system for what they perceive as a tendency to extend credit only to those who don’t really need it, notes Purdue’s Gunderson. People working for the system believe they’re doing a good job of supporting agriculture, he says, noting that the system is charged with the responsibility of helping new and young farmers.
Another entity, the Federal Agricultural Mortgage Corp., also known as Famer Mac, works with lending institutions to provide credit to the agricultural sector. It’s a publicly traded company that serves as a secondary market in agricultural loans, including mortgages. It purchases loans and sells instruments backed by those loans and was chartered in 1988. Conterra, the alternative-funding company mentioned earlier in this article, -works with Farmer Mac and financial institutions to make real estate loans to farmers and ranchers in financial distress. The loans are designed to help borrowers get back on their feet in three to five years so that they would then qualify for regular bank loans.
Then there are the ag lending divisions at the large banks such as Wells Fargo, Chase and the Bank of the West, Martin says. “Lots of these big national banks are doing at least some ag lending,” he says. “Some, obviously, have bigger ag portfolios than others.”
Some regional banks focus on agriculture, Martin continues. “When you get into the middle of the corn belt, there are going to be some regional banks where traditional ag lending’s a huge part of what they do,” he says. Local banks in small towns get involved, too. “Most small community banks are going to have some kind of ag lending portfolio,” Martin notes. Hometown bankers can provide operating capital to some farmers, but only to those who haven’t experienced recent hiccups in revenue or expenses.
“Then you get into the non-bank lenders,” Martin observes. “A really good example of this is John Deere,” the tractor and equipment manufacturer. The company provides a tremendous amount of capital to rural America through equipment lending and also through other credit facilities, he says. In fact some observers estimate that John Deere is the largest lender to agriculture. Even so, the company usually doesn’t provide enough non-equipment credit to become the only lender a farmer would use, he says.
The same holds true with other lenders to agriculture, Martin says. Co-operatives, for example, lend money to agriculture even though they’re not banks. Typically, they begin by extending credit for products like seed, fertilizer or pesticides and then start making additional credit available to farms and ranches. In recent years, a large co-operative called CHS loaned hundreds of millions of dollars in addition to selling products on credit. Some large CHS loans went bad caused a ripple effect throughout the cooperative structure, Martin maintains. Other co-ops have looked at CHS and wondered if they’re moving too far outside their core competency. So now many co-ops are tying funding to products they’re selling.
Some other non-bank lenders have shown up in agriculture, and they fall into two categories, Martin says. One group is making real estate loans in agriculture, so their loan programs are geared to farmers looking to buy land or anything that can be secured by land. Conterra and Ag America are examples. Farmer Mac lends a lot of money against farmland, as well. So farmers who have agricultural land have a lot of access to capital and a lot of lenders who want to provide it, he says.
The second group of non-bank lenders is providing operating capital. “That is a very, very small club,” Martin says. “There’s really not anybody doing this on a regular basis – with just one or two exceptions.” Probably the biggest name among the exceptions is Ag Resource Management, usually known as ARM, he continues. ARM places a value on the potential productivity of a famer’s land. Then it looks at the crop insurance the farmer’s able to buy to protect the investment in that crop. ARM then lends part of the value of that crop insurance.
Let’s say a farmer can grow $10 million worth of crops, according to ARM’s projection,” Martin says. “You can get crop insurance to cover 80 percent,” he continues. “For a total crop failure, you will get $8 million for that crop.” Using a formula based on type of crop, location and type of crop insurance, ARM will lend some amount less than $8 million. “Their collateral is pretty rock solid,” Martin observes.
ARM uses a system to make sure farmers use the funds only for expenses related to growing the crop they’re using as collateral. “Their risk of not getting a crop in the ground that qualifies for the insurance is next to nothing,” Martin says. ARM offers differing interest rates, depending upon risk, in at least the high single digits or double digits, and they also charge fees. “So you’re going to be paying a lot, but they are the lender of last resort in agriculture right now,” he says, adding that ARM operates multiple offices has grown quickly.
Through lenders like ARM, the agricultural sector’s becoming familiar with alternative finance. But much remains to be done if alt fin pioneers want to venture into the sector. Those who do will encounter a complicated credit landscape, but one that offers opportunities for anyone willing to learn about unfamiliar business cycles and lifestyles.
The political, cultural and economic abyss that separates the heartland from the coasts seems to grow deeper and wider with each passing day, and trying to reconcile the disparities can feel nearly hopeless. But differences among geographic locations aren’t nearly so well-defined or as troubling in the alternative small-business funding industry. What’s more, business opportunities can arise when localities differ.
First the lay of the land: Members of the alt finance community agree that funders and brokers are concentrated in just a few geographic locales—Greater New York City, Southern California and South Florida. Those three areas probably generate more than 75 percent of the industry’s volume, according to Jared Weitz, CEO of United Capital Source and one of three co-chairs of the broker council recently formed by the Small Business Finance Association (SBFA).
Sorting out how the industry differs in various regions can prove challenging. The Internet is erasing regional quirks and alleviating the need for physical proximity, says Steve Denis, SBFA executive director. What’s more, every ISO and funder develops a slightly different way of doing business regardless of location, he notes.
However, to a great degree it’s a matter of tweaking a single general outline for navigating the industry no matter where the office or client is based. That’s partially because many members of the industry conduct business in every state or nearly every state.
That said, old-fashioned, small-town ethics can sometimes seem closer to the surface in shops operating far from the coasts. “We’re focused on the values of our organization—like doing what we say we’re going to do, maintains Tim Mages, chief financial officer at Expansion Capital Group, a funder and broker based in Sioux Falls, S.D. “Some of that maybe comes from the Midwest culture or upbringing.”
Outside the major population centers, the industry occasionally seems a little more “laid-back.” In a light-hearted example of a relaxed heartland approach to the alt funding business, Lance Stevens, an attorney who’s a co-founder of Brandon, Miss.-based TransMark Funding, claims he can underwrite a deal while driving his golf cart and listening to Bon Jovi—all while maintaining his under 5 handicap.
Everything can seem a little more slow in the heartland, where people have time to stop and say hello to strangers, says Weitz. “Some folks are like, ‘Hey, my mailbox is three miles from my house, I check my mail once a week. I do not email. I do not fax,’ ” he observes. “It’s a nice change.”
Interactions are often more informal between the coasts. “Being in the Midwest we don’t use a lot of the lingo and terminology from this space, such as ‘stacking,’” says Austin Moss, a managing partner at Strategic Capital in Overland Park, Kan. That lack of jargon may be good or bad, he admits, but instead the staff speaks in a more general, even “holistic,” financial language.
Then there’s the occasional need for the human touch in the heartland. Deals there are sometimes sealed in person, with an office-park conference room substituting for the community bank building on the town square where merchant used to take out loans. “It’s not a widespread trend, but a handful of the ISOs we do business with actually do face-to-face solicitation,” says Mike Ballases, CEO of Houston-based Accord Business Funding.
In line with that mini-trend, an ISO based in Southern California operates a Texas office that specializes in face-to-face encounters, according to Aldo Castro, Accord’s former vice president of sales and marketing. “It’s rather meaningful here,” he says of using the practice in Texas. “You get on the road and shake a hand. They put a face to a name.”
The process can work in reverse, too. A few of the larger local companies seeking funding from Strategic Capital make the journey to the broker-funder’s Overland Park, Kan., offices, Moss says. Bankers who serve as referral partners also like the opportunity to meet in person, he observes.
The personal encounters often strike Moss as “refreshing,” he admits. That’s because the vast majority of the company’s deals occur online and by phone and fax—all without ever seeing the client in person.
Although the desire for personal contact arises from time to time, most heartland deals don’t hinge upon it. “It’s not a big number, but we see it,” Ballases says of face-to-face meetings. “Could it be the wave of the future? Absolutely not.”
Moreover, for some in the industry, the need for face-to-face discussions barely registers. It’s just not about meeting in person, according to Mages. Instead, he cites the importance of other factors. “Speed, convenience and service are the key differentiators, and that’s all driven by data and analytics,” he declares. Partnerships also drive the company’s business, he notes.
Luck outweighs geography, too, in Mages’ view. “It’s more an issue of right place, right time,” he contends. Deals occur primarily when funders manage to attract business owners’ attention at exactly the time when capital’s needed, he contends.
Besides, lots of people tend to think in wide-ranging ways these days instead of in narrow, provincial modes, Mages continues. At Expansion Capital Group, he notes, executives have differing points of view because they come from commercial banking, investment banking, the Small Business Administration lending program and the credit card industry.
At the same time, people tend to take an increasingly cosmopolitan approach to their jobs, according to Mages. He notes that executives at his company maintain contacts across the continent, often forged in earlier chapters of their careers.
Meanwhile, well-trained employees can use a phone call to gather the details they need and establish a consultative relationship without a thought for geography or the need for face-to-face meetings, Mages says.
However, geography can indeed play a role at least once in a while. In a few cases merchants prefer a funder with an address across town or at least in the home state. Sometimes business owners and referral partners choose local brokers or funders simply because their names sound familiar.
Strategic Capital, for example, does more business at home than anywhere else, Moss says. The company’s headquarters is in the portion of greater Kansas City that spills over from Missouri into the state of Kansas, making the location convenient to a major population center.
But despite the massive size of greater Kansas City, Strategic Capital remains the only alternative small-business funding option in the area—there just aren’t any other local providers, Moss says. It’s not like New York, where banks and merchants can choose from among many brokers and funders, he says.
That trend toward being the only game in town or one of just a few can hold true for most companies in the heartland, Moss maintains. A broker or funder based in Denver, for example, would probably have higher volume there than anywhere else, he notes.
Several reasons explain that geographic bias, Moss continues. “The employees live there and have contacts, and we’re part of the local associations and chambers,” he notes. “We work with just about all the banks in the area, and everyone knows who we are.” The company also handles local government bonds and local construction projects, he says.
Mages offers a different perspective. Only a few small-business owners in South Dakota choose Expansion Capital Group because they prefer dealing with a Midwestern company or because they’ve seen local press coverage or heard Expansion’s recruiting ads on the radio, he maintains.
Hometown, home state or regional preferences aside, executives at Accord emphasize the importance of the small-town approach of knowing their customers as well possible. For Ballases—the Accord chairman who started the company with Adam Beebe, who now serves as CEO—that means combining personal and impersonal approaches to underwriting.
Ballases views funders and brokers as falling into three categories. Some choose a personal, hands-on approach and don’t rely upon algorithms. A second category emphasizes automation. A third blends the personal and the automated. His organization falls into the latter, he says
For Accord, the personal comes into play because of what Ballases has learned in his decades in the banking business. He knows margins and growth rates in his applicants’ industries, and those factors aren’t often incorporated into algorithms, he says.
In fact, commercial banks have failed to learn to evaluate small businesses on their true merits, Ballases continues. Banks tend to underwrite small businesses, which he defines as those in need of $100,000 or less, by using a “skinnyed-down” version of how they underwrite big companies, which they base on general financial information. Instead, he counts on discipline, data and his 50 years of experience in commercial banking to evaluate a merchant on an individual basis.
At another company, TransMark Funding, Stevens and his partner draw upon legal and small-business experience to evaluate potential customers’ creditworthiness. “That causes us to focus on an applicant’s business model and their sustainability, which may boil down to personalities,” Stevens says. Transmark combines those factors with “a little bit of credit metrics” to come to decisions on applications.
The company’s mix of objective and subjective reasoning differs starkly from the thought process at most coastal funders, Stevens says. While his company gives most of the weight to the subjective and just a bit to the objective, big-city competitors tend to do the exact opposite, he says.
Of the last five MCA deals that Transmark funded, the merchants averaged 12 checks returned for insufficient funds per month, Stevens says, noting that he can make that statement “with a straight face.” Sometimes it’s been as high as 35 NSF checks per month for successful applicants. “Those people would not even get into the parking lot of a bank and would not get through the door of any MCA funder who’s using any sort of reasonable metrics,” he adds.
An anecdote helps explain the thinking. Suppose a restaurant has been operating for several years in a town of 50,000 and has amassed 2,200 “likes” on its Facebook page, Stevens suggests. “I’m in,” he exclaims, noting that it would take compellingly negative numbers to convince him that the business won’t survive if he helps it obtains capital to improve its positioning in its market.
The vignette illustrates that a business can do well in the community despite the merchant’s financial difficulties, Stevens says. However, the story doesn’t mean Facebook becomes the only determining factor, he continues. Positive factors for success include good location and marketing, he notes.
The principals at many companies funded by TransMark have credit scores in the low 500’s, Stevens continues. “That’s tough,” he says, “because they’re going to have a lot of history of not living up to their financial obligations.” But if someone with that credit score has personally guaranteed a lease on a storefront for the next two years, they may be unlikely to abandon the business. A big bank might look upon that merchant as insufficiently nimble because of the lease, but TransMark takes the opposite view, he says.
Even if a store, restaurant or contractor is “circling the drain” and about to shut down, TransMark may simply believe the owner has the character to make the business work. “Given our minute default rate, we’re right most of the time,” Stevens maintains, adding that banks see applicants as customers, and TransMark sees them as partners.
The business model requires peering into the future to see how the merchants will look after using perhaps $25,000 in capital to make improvements and while dealing with 18 percent holdback for the next six months, Stevens observes. “If they look strong, I need to fund them,” he says of the company’s prognostications.
To find ISOs who appreciate the TransMark model, the company seeks out purveyors of credit card merchant services, Stevens says. They encounter those merchant-services providers at trade shows and through “some general poking around,” he notes.
The merchant-services people often have long-standing relationships with merchants and thus can feed information into the TransMark way of viewing deals. “Tell me what it looks like when you walk into their store at 11 a.m.,” Stevens says to illustrate the kind of conversation he has with ISOs. “How is their signage?”
Besides understanding clients, it also pays to understand markets, and proximity can help with the latter, according to Ballases and Castro in Houston. “We have an affinity for Texas,” Castro says.
Many of the businesses based in Texas are vendors to people—like mechanics who fix cars or restaurants that feed people—not vendors to businesses, Ballases notes. Vendors who cater to people are better candidates for merchant cash advances than business-to-business companies are, he maintains.
“It’s just a huge state,” Castro declares. “We’ve got a thousand new residents moving to Texas every day.” Nearly 10 percent of the nation’s small businesses operate in The Lone Star State, he notes.
“There’s a convergence of the population growth, a low tax rate, low regulations, low cost of running a small business relative to national levels, and a great small-business environment,” Castro says of the Texas scene. “In addition, the healthcare industry is exploding here, and there are the ancillary businesses to healthcare.”
Meanwhile, the state’s Hispanic entrepreneurs remain under-served by alt funding ISOs, which presents a great untapped opportunity, Castro maintains. Funders who cater to those Hispanic merchants will find them loyal, he predicts. In Texas alone, Hispanic consumers spend half a billion dollars annually, he says.
To capitalize on that burgeoning market, Accord has assembled a team that can help Anglo ISOs bridge the cultural and linguistic gap, Castro says. “We do that every day,” he maintains. “We’re jumping on the phone with merchants and helping them get the funding they need to support the growth of their operations.” Those conversations with merchants do not put Accord in competition with ISOs, Castro notes. Accord does not maintain an inside sales staff and does all of its business through ISOs, he says.
Only a few of those ISOs are based in Texas, according to Ballases. Most of Accord’s ISOs operate from offices in the Northeast, with many in the other common geographic spots of South Florida and Southern California, he says. So that makes Accord a national company despite its emphasis on Texas, Ballases says.
Accord’s experience at home, combined with nationwide contacts in the industry, have convinced the company’s leadership that too many brokers remain unaware of the opportunities in Texas.
That’s why Accord is producing ads, videos, infographics, blogs and social media posts to alert those coastal ISOs to opportunities in Texas. The company even offers a tab called “FundTEX” on its website. “We’re getting the word out,” Castro says of the company’s effort to publicize his state.
Besides operating in areas sometimes overlooked on the coasts, heartland brokers and funders sometimes have to reinvent the industry almost from scratch. Brokers can find themselves teaching the business to potential investors outside the Big Three geographic locations, Moss says. In New York, investors already know the industry and use that familiarity to evaluate brokers, he says.
Brokers and funders also have to deal with the heartland’s lack of workers with industry experience. As the lone company in the market, Strategic Capital, for example, can’t find many prospective employees with previous jobs in the business, Moss notes. “There is no OnDeck or Yellowstone or RapidAdvance down the street to provide a talent pool for hiring,” he says.
That’s good and bad, Moss maintains. New hires don’t require re-training to lose habits that don’t fit the Strategic Capital way of working. But it’s difficult to find underwriters, accountants and other prospective employees with the right background. It doesn’t work to put new salespeople on straight commission because the “ramp-up” period takes longer with employees unfamiliar with the industry, he says.
The lack of local experience sometimes prompts brokers in the heartland to tap the Big Three areas for talent. Expansion Capital Group, for example, has a business development director in New York who came from another ISO, Mages says. Besides cultivating relationships in NYC, the business development expert makes frequent trips to Southern California and South Florida.
Meanwhile, members of the industry who tire of the rapid pace on the coasts might want to consider moving inland to fill the vacant jobs, sources suggest. After all, the heartland has its advantages, according to Moss. “Most people here have houses, and the cost of living is lower than in places like New York,” he says. A spacious five-bedroom house in Kansas City might cost less than a cramped apartment in New York, he notes.
To commute to the company’s suburban office, his typical employee jumps into a car in a climate controlled attached garage, cruises for half an hour or so on roads relatively free of traffic and parks in the lot a few steps outside his office building. It’s less stressful than crowding into a subway car, he notes.
The hinterland’s not as culturally barren as some might believe, Moss continues. The public hears “Kansas City” and they think of tornadoes, cows and the Wizard of Oz, he says. But the reality includes a downtown replete with skyscrapers and pro sports, not to mention lots of tech, healthcare and aerospace companies. “It’s like a mini-Chicago,” he notes.
But a retreat from the coasts may not be in the offing. Ballases expects that the majority of ISOs will continue to concentrate on the East Coast and West Coast because that’s where population growth remains strongest and thus provides the most opportunities. “It’s a numbers game,” he observes.
An often-overlooked national network of nearly a thousand Small Business Development Centers has the potential to help alternative funders cement relationships with existing clients and locate new ones. The centers, known as SBDCs, offer free or low-cost training and consultation to established and aspiring merchants and manufacturers.
The earliest SBDCs have been around for four decades. The centers operate in conjunction with the Small Business Administration as public-private partnerships and serve about 1.5 million clients annually.
Centers help small-business owners evaluate ideas, organize companies, find legal assistance and obtain operating capital.
But not everyone knows all that. “The network is underutilized,” says Donna Ettenson, vice president of operations for Washington-based America’s SBDCs, which functions much like a trade association for the centers scattered across the nation. “We’re one of the best-kept secrets in the United States federal government.”
That means alternative funders can assist customers by simply informing them that the centers exist and can offer potentially beneficial services. Providing basic information on the SBDCs could become part of a consultative approach to selling that brings repeat business, especially with merchants who lack business skills or experience, observers suggest.
What’s more, alt funders who want to increase their chances of benefitting from SBDCs can go beyond merely providing clients with a rundown on the centers. The funders can become actively involved with the work of carried out at the centers.
One way of taking part is to contact nearby centers and offer to make presentations at seminars or workshops, Ettenson says. Funders could provide information to fledgling business owners on the instruments available through the alternative-funding industry, such as cash advances, loans and factoring, she suggests.
To get started, alternative funders can visit the America’s SBDC website, where they’ll find a search tool that provides contact information for their nearest centers, Ettenson says. From there, they could discuss possible connections with officials at the local centers, she advises.
That involvement would not only provide exposure to merchants in need of capital but also to center officials who point merchants toward capital sources. If enough members of the alt funding industry took part, their work could eventually give rise to something akin to the lists of attorneys that some centers maintain, Ettenson says.
Centers often tap attorneys—perhaps quarterly—to lecture on a rotating basis on what type of business to form. That could mean organizing as a corporation, limited-liability partnership or some other form. In much the same way, funders could share their knowledge of instruments for obtaining capital.
Funders could emulate the lawyers who use the centers as a forum for soft marketing, Ettenson says. The speaker becomes a familiar face and can leave business cards that students could use to contact them as questions arise. However, speakers must provide general information and are prohibited from using speaking opportunities as blatantly self-promotional unpaid advertisements, she cautions.
What’s more, the centers have to exercise caution to avoid recommending specific attorneys, accountants or sources of capital because they could incur liability if events go sour and a service provider absconds to Bogata, Columbia, Ettenson points out. That keeps the centers “ecumenical,” in that they provide a list of professionals for clients to interview and rather than pointing to a single source.
Alternative funders can explore other ways to become involved with SBDCs, too. The national organization presents an annual trade show and professional development conference for service-center directors and service-center staff members who teach or consult with clients. Alternative funders who have taken booth space on the exhibition floor or made presentations in the accompanying conference include RapidAdvance, Breakout Capital, Kabbage and Newtek Business Services.
When America’s SBDCs issues a call for presentations at the annual conference, it receives approximately 300 applications for about 140 speaking slots. Some of the speakers come from the rosters of presenters at past shows, while companies newer to the trade show can purchase an entry-level sponsorship that includes booth space and the right to conduct a workshop.
The attendees at those annual conferences can tell their clients about the funders they encounter there. Attendees can also find out more about the alternative- funding industry and then pass that information along to merchants.
Some regional centers in states with large populations—such as California—can also hold conventions for their officials, says Patrick Nye, executive director for small business and entrepreneurship at the Los Angeles Regional SBDC Network, which is based at Long Beach City College. His state was planning its second statewide gathering this year and intends to do it again every other year. Alternative funders could participate, he says.
With so much going on at the centers, someone has to front the cash to keep the lights on. Local organizations are funded partly through federal appropriations administered by the SBA. “In order for the federal money to be pulled down, a matching non-federal dollar must be provided as well,” Ettenson says. The federal funds are apportioned based on the amount of matching funds the centers provide.
The matching funds usually flow from colleges, universities and state legislatures. “It’s a mix,” Ettenson says of the sources. Institutions of higher learning often meet part of their matching-fund goals by providing “in kind” resources—such as classrooms, services and instructors—instead of cash.
In the six states that administer the centers through their economic development departments, the state legislatures generally appropriate matching funds. In Texas, the representatives of the state’s four regional programs combine forces to lobby the legislature for matching funds, and that teamwork reduces the cost of their efforts in Austin.
The federal funds and matching funds support local and regional centers that belong to a network based on 62 host institutions. Of the 62, six operate through the economic development departments of state governments. They’re in Indiana, Illinois, Ohio, West Virginia, Minnesota and Colorado. The rest of the host institutions are mostly universities or community colleges. Some are based in economic development agencies.
One can think of the regional centers as something akin to corporate headquarters and the local centers as retailers, says Nye, who administers the Southern California regional center. The local centers under his regional’s jurisdiction are located in only three counties but pull in the sixth-largest share of funding because of Southern California’s huge population, he notes.
The local service centers provide training and consulting for entrepreneurs starting or expanding their enterprises. About 60 percent of the clients are already in business. Of the 40 percent who don’t own a business, about half launch one after receiving assistance from an SBDC, Ettenson says.
The centers don’t charge for consulting services, and the fees for training are just large enough to cover expenses. The training fees usually remain in the centers that provide the instruction where they’re used to cover expenses like buying computers.
In Southern California centers, the business advisors are usually under contract and have knowledge to share from their experience in business, marketing, banking, social media, consulting or other realms, says Nye. Not many college instructors work in the centers, he notes, adding that the centers are monitored to avoid conflicts of interest among advisors.
To track how well advisors are performing, the national organization produces economic impact statements by interviewing thousands of clients. Interviews generally take place two years after consulting sessions. That should provide enough time to get results, Ettenson says
Thus, America’s SBDCs this year surveyed clients who received services in 2016. Those long-term clients received $4.6 billion in financing, while last year the clients surveyed who got underway in 2015 had received $5.6 billion in financing. She could not break down that financing by categories like banks and non-banks.
Discussing those surveys, Ettenson offers some details. “If you talk to us for two minutes, we don’t consider you a client,” she emphasizes. The SBDC definition of what constitutes a client calls for at least one hour of one-to-one consulting or at least one two- hour training session, she says. The organization defines “touches” as people with less exposure, such as those who call on the phone with a question.
When an SBDC client needs funding, officials at the centers have no qualms about including alternative funders in their recommendations to clients who are seeking funds, says Ettenson. “We don’t exclude anybody in any way, shape or form unless there’s some reason to think they’re fraudulent,” she notes.
But malfeasance isn’t the worry it once was, Ettenson asserts, noting that alternative funders have gained credibility in the last five or so years as they began policing their own industry. “They’ve learned to keep track of who’s in their space and how they’re operating,” she says.
Alternative financing has established a niche that benefits small-business people who know how to use it, Ettenson maintains. “They understand that they’re borrowing money for a short period of time and it’s going to cost you a fair amount,” she says. “It’s a short-term bridge to get to whatever your goal is.” Merchants seeking funders should learn the differences among alternative funders—whom she says all operate a little differently from each other—to choose their best option.
And opportunity for alternative funders may abound at the centers in the near future. Nye cites the two biggest goals for his centers as new business starts and capital infusion. Center advisors help develop business plans that aid clients in obtaining financing, he says. Last year, his region received a little over $4 million from the SBA and used it to help start 365 new businesses and raise $148 million in capital infusions. Those efforts created 1,700 jobs, he says.
That bit of intelligence comes from the National Small Business Association‘s 2017 Year End Economic Report, the most recent from the Washington-based trade group. Thirteen percent of the entrepreneurs who responded to the survey received loans from family or friends in the preceding 12 months, while 3 percent obtained funding from online or non-bank lenders, the report says.
But some variables come into play. Shopkeepers and restaurateurs are more likely to rely on friends and family for financing during their first five years in business, says Molly Brogan Day, the NSBA’s vice president of public affairs and a 15-year veteran of the survey. The association’s members, who account for many – but not all – of the respondents tend to have been in business longer than non-members so the actual percentage of all owners receiving funds from family or friends could well be higher than the survey indicates, she notes.
In fact, the average NSBA member started his or her business 11 years ago – a fairly long time for the sector, Day says. The association attracts well-established merchants partly because the trade group concentrates on advocacy and lobbying in the nation’s capital, Day notes. “There’s not a lot of networking, there’s not a ton of resources or educational offerings,” she says of the association. In other words, the organization’s emphasis tends to attract prospective members who have been in business long enough to see the results of laws and regulation instead of newcomers still struggling daily to establish themselves, she observes.
Anyway, it’s also worth noting that small-business owners appear nearly as likely to approach family or friends for cash as to petition large banks for funding, Day says, noting that 13 percent turn to friends and family, while 15 percent manage to obtain loans from large banks. To her, that indicates that banks just aren’t lending to small businesses as frequently as they should – a notion that should sound familiar to anyone in the alternative small-business funding industry.
Unsurprisingly, the association’s research indicates bank lending declined as the Great Recession made itself felt in 2007 and 2008. Before that, nearly 50 percent of merchants responding to the survey reported they had recently qualified for loans from big banks, small banks or credit unions, the research shows. “Now it’s pretty consistently a percentage in the low 30’s,” Day says. “People really need these loans.”
Lending by banks hit another snag in 2012 when new regulation and legislation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, made itself felt. “There was such a massive overcorrection in the banking industry that it’s still really difficult for small businesses to get loans,” Day says.
Moreover, banks were granting fewer “character-based” loans even before the double whammy or recession and regulation, Day observes. Instead of employing the older practice of assessing the intangible virtues of a business owner well-known in the community, bankers began applying a more formulaic approach to evaluating loan applications based on credit scores and other quantifiable variables, she says.
That switch to numbers-oriented decisions proved detrimental for many entrepreneurs. “A lot of small business owners don’t look great on paper,” Day admits. Even a great business plan might not convince bankers to loosen their purse strings these days, she notes.
That’s where the alternative small-business funding industry comes into the picture. NSBA researchers began including the category of online and non-bank lenders in their surveys in 2013 and have seen the percentage of respondents using them grow each year to its current level of 3 percent.
“It’s not huge growth, but it’s notable,” Day says. Notable enough to achieve importance, she continues. “It’s an important opportunity for your readers to fill that void,” she says of the shortfall of adequate small business funding. “They’ve been doing a pretty good job of doing it.”
In fact, the NSBA research indicates that alternative funding and other sources have tended to take up the slack created by the banking industry’s decision to exercise extreme caution when evaluating small business loans. Some 73 percent of small business owners are obtaining enough financing these days, according to the survey.
Yet hiccups have occurred, like the decline to only 59 percent finding adequate funding in 2010, Day points out. And the fact that two-thirds to three fourths are generally securing adequate funding means that a fourth to a third aren’t, she notes, adding that she urges focusing on the latter group. “It’s concerning,” she says.
Inadequate funding can prove especially challenging for newer businesses that don’t have a track record, haven’t stockpiled proceeds from past operations, don’t own stock to leverage and aren’t savvy enough to finesse placement of debt, Day maintains. More-established businesses have greater access to those resources or have honed those skills, she notes.
And much is at stake. Lack of funds not only hurts that significant portion of small-business owner but also prevents hiring workers, stymies economic growth and hinders community development, Day maintains. She points to research that shows the nearly direct correlation between availability of capital and increases in hiring. (See Chart A.)
Other NSBA findings include the fact that in July of 2017 merchants reported having debt that averaged $496,000. Some 73 percent of those reported had at least some debt. Some 40 percent of survey respondents, the largest category have debt of $50,000 or less. (See Chart B.)
Financing most often comes from funds the business has earned, the trade group says. Some 32 percent of merchants cite that source. Yet simply pulling out a credit card remains a common way to make ends meet, with 31 percent saying they did that to meet capital needs in the last 12 months. (See Chart C.)
While most (57 percent) say that lack of capital hasn’t hurt their enterprises recently, 31 percent say a dearth of capital prevented them from expanding their operations, 14 percent report they weren’t able to expand their sales because they lacked funding, and 13 percent admit they laid off employees because it was difficult to find the cash to meet the payroll. (See Chart. D)
The availability of credit hadn’t changed much in the year leading up to the survey, the association says. About 77 percent reported no change in their lines of credit or credit cards, while 18 percent saw their perceived creditworthiness increase and 5 percent saw it decline.
Those results come with a bit of history. The NSBA has been surveying small-business owners since 1993. At first, the trade group hired polling companies to perform the task and cooperated on the report with the Arthur Andersen accounting firm. Computerization enabled the association to take the project in house beginning in 2007. It works on the survey with ZipRecruiter, an online employment marketplace.
Some 1,633 small-business owners participated in the research for the 2017 Year End Economic Report by answering 42 questions online in December 2017 and January 2018. Many of the survey questions have remained the same over the years to facilitate comparisons and tracking.
Small businesses on the list of members and the list of non-members receive two email messages alerting them to the survey and providing an online link to the questions. The surveys take place twice a year.
As mentioned earlier, some survey respondents belong to the association and some don’t, but Day was unable to pinpoint the percentages. In response to a question from deBanked, she said she may begin tallying how many respondents are members and non-members because non-members tend to have been in business for a shorter time than members. Non-members also tend to differ from members because political engagement often brings the former to the association’s attention.
Participating merchants come from every industry and every state, Day says. Manufacturing and professional services are very slightly overrepresented, while mining is the only category that’s scarcely represented, she admits. Not many small businesses operate in the mining sector, she adds.
The best sales reps have a lot in common – they’re smart, honest, likable, well-organized, thick-skinned and hungry for success. They navigate the difficult early days of their careers in the alternative small-business funding community by persevering despite long hours, countless outbound telephone calls and meager commissions.
“Persistency is really, really the key – putting in the time,” says Evan Marmott, CEO of Montreal-based CanaCap and CEO of New York-based CapCall LLC. “It’s not always easy, but you’ve got to stay late, make the phone calls, send the emails and do the follow-ups. It’s a numbers game.”
Being relentless counts not only when pursuing merchants but also when matching merchants with funders, Marmott emphasizes. “If they can’t get an approval one place, they’re going to shop it out until they get approval someplace else so they can monetize everything that comes in,” he says.
“It’s all mindset and work ethic,” in sales, according to Joe Camberato, president at Bohemia, N.Y.-based National Business Capital. His company works to create a culture that supports the right mindset by working with a firm called “Delivering Happiness.” Together, they forge to a set of core values based on integrity, innovation, teamwork, empathy, and respect for fellow employees, clients and clients’ businesses.
National Business Capital employees learn to live those ideals by working and playing together on the company volleyball team, through work with local and national charities, and at company mixers and staff picnics, Camberato maintains. “We adapt and change, and we’re committed to helping small businesses grow,” he says of the company culture, “and we have fun while doing all that.”
Likeability helps build relationships with customers, says Justin Thompson, vice president of sales for San Diego-based National Funding. “People will do business with people they like and trust,” says Thompson. “It’s really about establishing a relationship first and then establishing quality discovery.” From there, presentation and execution become paramount, he says.
Methodology can make the difference between success and failure in sales, observes Justin Bakes, co-founder and CEO of Boston-based Forward Financing LLC. “Have a defined process and stick to it,” he advises. A well-organized approach inspires trust among clients, establishes and maintains a great reputation; and fosters understanding of the customers’ needs, wants and business operations that help the rep choose the right financing option and appropriate funder. Using technology to wrangle multiple leads and high volume counts for a lot, too, he says.
It’s all part of the consultative approach to sales, says Jared Weitz, CEO of Great Neck, N.Y.-based United Capital Source. Long ago, sales reps may have succeeded by mimicking carnival barkers, sideshow pitchman and arm-twisting medicine-show peddlers. Thankfully, those days have ended – if they ever really existed. Most of today’s successful salespeople earn clients’ respect by becoming knowledgeable, trusted business consultants, says Weitz.
THE CONSULTATIVE SALE
“Someone calls, and there are two ways of handling a deal, right?” Weitz asks rhetorically. Using one method, a salesperson can say, “We’ll fund you this much at this rate today – are we good?” he says. The other way calls for understanding the client’s business – how long has it been open, does it make more cash deposits or credit card deposits, would it be best-served by an advance, a loan, an equipment lease or a line of credit, how much can it afford in monthly payments?
Establishing how the merchant intends to use the funding plays a crucial role in the consultative sale, Marmott agrees. Objections can arise when a merchant learns that receiving $100,000 this week will require paying back $150,000 in four or five months, he notes. So it’s essential to demonstrate that using the money productively will more than pay for the deal. A trucking company can realize more income if it deploys two more trucks, or a restaurant can increase revenue by placing another bar outside for the summer, he says by way of example.
“A lot of salespeople ask a business owner what they need the money for,” observes Thompson. “The merchant says, ‘Inventory,’ and the rep stops right there. I train my reps at National Funding to go two or three clicks deeper.” Examples abound. When does the merchant need the inventory? From whom do they order it? How long does it take to ship? How long does it take to turn it over? What are the shipping terms?
The consultative approach can require salespeople to pose a lot of open-ended questions that can’t be answered yes or no, according to Thompson. Ideally, the conversation should adhere to the 80-20 rule, with the client talking 80 percent of the time and the sales rep speaking 20 percent, he asserts, adding that “a lot of times it’s reversed in this industry.”
Sometimes, however, salespeople should set aside the time-consuming consultative approach and instead find funding for a merchant as soon as possible. That’s true when the business owner can make an opportune purchase of inventory or when it’s time to acquire a competitor quickly. More often, however, it pays to take the time to understand the merchant’s needs and search out the best type of funding for that particular case, top sales people maintain.
Much of the alternative small-business finance industry has caught on to the importance of the consultative approach to sales as the array of available alternative financial products has grown beyond the industry’s initial offerings of merchant cash advances, according to Weitz. The days of scripted pitches and preplanned rebuttals to objections have ended, he says. Today, management trains reps for success.
THE RIGHT TRAINING
Are top salespeople born that way? “Some people hit the ground running, but sales can be taught – that’s for sure,” Weitz says. “The tougher thing to teach is integrity.” Much of the training process focuses on learning the products to enable a rep to make a consultative sale and shoulder financial responsibility, he maintains.
Believing that some people are born to sell provides a crutch to avoid learning what really works, according to Bakes. Training can teach a smart, motivated person how to succeed, he maintains. They don’t have to be born that way.
However, some people do seem born to exert influence, which can translate into sales prowess, says Thompson. Still, those born with a strong work-ethic can overcome other deficiencies, he notes. The work ethic drives them to “come in every day,” he notes. “They’re organized and disciplined. They follow the National Funding philosophy, and they make a ton of money.”
National Funding trains salespeople to view their craft as being defined by two broad elements – art and science, Thompson continues. The science proves easier to master and includes asking the right questions to learn about the customer and the deal. The hard part, the art of the sale, consists of getting to know the business owner, building a relationship and demonstrating expertise. In one example, that’s based on learning how many trucks are in the fleet, whether they’re long-haul or short haul and whether they use dumpsters versus box trailers, he says.
Beyond those important basics, training should be ongoing because selling techniques change slightly as new products and systems emerge, according to Weitz. “One of the things I like about being a broker is the ability to pivot and add another arrow to your quiver,” he says.
Salespeople at United Capital Source talk sales among themselves almost nonstop, which amounts to daily sales training, Weitz observes. That can take the form of describing a challenge and explaining how to overcome it, he notes. A particularly good idea merits an email to the group to share the new piece of wisdom. It’s a matter of constantly refining the approach.
Training can help sales reps understand the businesses their clients run, according to Marmott. Knowing the margins in a restaurant, for example, can help the salesperson explain that the increase in revenue from an expansion will quickly pay the cost of capital, he notes.
Training should teach new employees how business works because common elements arise in enterprises ranging from dog grooming to asphalt paving, Thompson notes. There’s inventory, marketing, employee expense, payroll taxes, insurance and 401k’s in almost any business. “We teach all that to the reps,” he says. Then after conversations with thousands of merchants, reps have a solid foundation in the workings of businesses.
National Business Capital’s formal two-week classroom training usually lasts three hours a day, focusing on systems, guidelines, product, general business principles and the company’s processes, says Camberato. Teachers include the sales management team, company culture leaders and the managers of IT and Tech, Marketing, Processing, and Human Resources.
New hires spend much of their time working with mentors for the first six months and a team leader who works with them indefinitely, Camberto continues. The company sometimes hires in groups and sometimes hires individually, he notes.
National Funding provides three eight-hour days of regimented classroom training on the fundamentals to each of the four groups of 12 to 17 hired each year, says Thompson. The classes cover processes, sales strategy, marketing and the lender matrix. Next comes three months of working with a sales manager dedicated to working with the class. After a total of nine to 12 months, management knows which reps will succeed.
Some shops operate on the opener-closer model, with less experienced salespeople qualifying the merchant by asking questions like how long they’re been in business and how much revenue they bring in monthly, Marmott says. If the merchant qualifies, the newer salesperson who’s working as an opener then hands off the call to an experienced closer to complete the deal. Good openers become closers, but opening isn’t easy because it requires lots of calls, he notes.
National Funding doesn’t use the opener-closer approach because the company believes reps should Participate “from cradle to grave,” Thompson says. “They hunt the business down, build the relationship and handle the transaction from A to Z.” East Coast shops often focus on cold calling and use the opener-closer model, while West Coast shops tend to invest more in marketing and reject the opener-closer method, he noted.
But where do these top salespeople come from?
THE RIGHT BACKGROUND
Prospective sales reps who have just finished college should have a grounding in communications or business, Weitz believes. Experience in sales and a familiarity with dealing with merchants helps prepare reps, he notes. Job history doesn’t have to be in the finance industry. Someone who’s sold business services in a Verizon store or worked for a payroll company, for instance, has been dealing with small-business owners and may succeed more quickly than those without that background.
Sales experience in other industries counts, Bakes agrees, especially in businesses that require dealing with a large number of leads. “Organization and process is just as important as being born with the traits of a salesperson,” he opines.
Life experience that breeds a positive attitude can prove vital, says Marmott. That’s especially important in the beginning when a new rep might take home a paltry $300 in the first month. Later, when the rep has a $50,000 month, he or she will see that their optimism wasn’t misplaced, he declares.
GUYS WHO ARE HUNGRY”
“The biggest thing I look for is guys who are hungry,” Marmott maintains. I don’t need somebody with a doctorate or a master’s degree or even a degree,” he says. “I need somebody who is going to put the work in.” Of a roomful of 25 new reps, two or three will succeed and stay on the job, he calculates. “You get to eat what you kill. If you’re not killing anything, you don’t get to eat.”
“We look for potential candidates who come from backgrounds of rejection,” says Thompson. Their previous sales experience has taught them not to take the answer “no” personally. “It’s part of the business and you continue to move on.”
Although most regard the financial services industry as a white-collar pursuit, “it has blue collar written all over it,” Thompson says, referring to the work ethic required for success. But it’s not just the volume of work. Sixty good phone calls generate more business than 300 mediocre calls, he emphasizes.
GETTING UP TO SPEED
Succeeding at sales requires taking the time to form relationships, understand guidelines, become familiar with lenders and acquire a working knowledge of how clients’ businesses operate, Camberato says. How long does it take? “It’s a solid year,” he contends while conceding that most who succeed operate at a fairly high level before then.
Others disagree about what constitutes being up to speed and how much time’s necessary to achieve it. “I’ve seen it take 30 days, and I’ve seen it up to 120 days,” says Weitz. “The hope is that it’s within 60.”
A salesperson should start feeling better after 30 days and should start feeling good after 60 days, Marmott says. Management can usually identify the strong and the week reps within two to three weeks, he says. “You get the lazy ones that drop out, the guys who aren’t making any money, the ones who aren’t putting the effort in,” he says. “The first two weeks are the toughest because you’re learning the product and how to sell it.”
“It depends on the person,” Bakes says of the time needed to begin selling successfully. “It takes time. It is not something that will just happen overnight.” About six months should suffice to become confident as a closer, he estimates.
Even when sales reps hit their stride, some outsell others, Marmott notes, citing the 80-20 rule that 80 percent of the business comes from 20 percent of the salesforce. Outbound sales to merchants who may feel beleaguered by offers of funding requires more effort than when a merchant makes an inbound call to seek funding, he adds.
And even the best salespeople need great marketing and tech support from the their companies, sources agree.
INVESTING IN SALES
A shop just starting out might have a marketing budget as low as $2,500 a month, which won’t do much more than pay for direct mail pieces that might prompt a few potential clients to pick up the phone, Weitz says. With a little more money to spend, a shop can begin buying leads, he notes. “Don’t break the bank before you understand what formula works for you,” he advises.
“The key to sales is marketing,” says Marmott. “You can be the best sales guy but if you don’t have anything qualified to call or follow up with, it’s a waste of time.” Social media doesn’t work as well for business-to-business contact as it does for business-to-consumer marketing, he says. Pay per click and key words have become more expensive and isn’t as cost-effective as it once was, especially for smaller shops, he contends. Mailers can work but require heavy volume and repetition, he says, adding that could mean at least 25,000 pieces and at least three mailings.
Besides allocating marketing dollars, companies can invest in sales by paying new sales staffers a salary instead of forcing them to rely on commissions to eke out subsistence during the tough early days. National Business Capital pays a salary at first and later switches reps to commissions and draw, Camberato says. “An energetic person interested in sales can plug into our platform, get trained and do very well,” he continues. “We believe in you, as long as you believe in us.”
National Funding provides recruits with a salary and commissions so that they have enough income to get by and still reap rewards when they help close a deal, Thompson says.
Investment in technology can help salespeople set priorities, eliminate some of the drudge work in the sale process, measure the sales staff member’s success or lack of success, and provide a consistent experience for customers, notes Bakes. “Because of the way our technology is set up we can hold people accountable,” he adds.
Every salesperson and every shop should organize the workflow by using a lead-management system or customer relationship management tool (CRM) – such as Zoho or Salesforce –instead of operating with just a spreadsheet, Weitz says.
Brokers can invest in sales through syndication, which means putting up some of the funds involved in a deal. Forward Financing favors syndication in some cases because it aligns the salesperson and the funder, thus demonstrating the sales rep’s belief in the validity of the deal and ensuring a willingness to continue servicing that customer, Bakes says.
Some shops offer monthly bonuses for outstanding sales results, but Weitz believes awarding incentives weekly makes more sense. With a monthly cycle, some reps tend to slack off for the first week or so because they believe they can make up for lost time later. With weekly rewards, there’s not much room for downtime, he notes.
Whatever form investment takes, it can help build a sterling reputation and a free-flowing “pipeline.”
THE RIGHT REPUTATION
“Reputation is huge,” especially for repeat business and referrals, Marmott says. Once a merchant has received funding, a blizzard of sales call can follow. Treating customers right by maintaining ethical standards and helping them during hard times can guard against defection to a competitor touing low prices, he says.
Reputation requires differentiation, which usually occurs online, by email or over the phone, notes Bakes. Factors that enhance reputation include referrals by satisfied customers and real-world testimonials from actual customers and good ratings on social media sites, he says.
While it’s still uncertain what role social media plays in the industry’s reputation-building efforts, it appears that text messages elicit quick responses if the client has agreed to communicate with the company via that format, Bakes says. He notes that unwanted text messages won’t work. Email messages provide more information than text messages but seem less likely to prompt response, he says.
THE RIGHT GOAL
So, where does the effort to succeed at sales lead? It’s the foundation for building “the pipeline” – the name given to the flow of renewals, referrals and leads that makes every day not just busy, but busy in a productive and profitable way. As a rep’s pipeline takes shape, the cost of acquiring new business also goes down, Marmott says. “It just grows from there,” he says of the successful salesperson’s endeavors at building a pipeline of business. It’s what successful salespeople seek.
Wayward merchants and outright criminals are continuing to bilk the alternative small-business funding industry out of cash at a dizzying pace. In fact, an estimated 23 percent of the problematic clients that funders reported to an industry database in 2017 appeared to have committed fraud, up from approximately 17 percent in the previous year. That’s according to Scott Williams, managing member of Florida-based Financial Advantage Group LLC, who along with Cody Burgess founded the DataMerch database in 2015. Some 11,000 small businesses now appear in the database because they’ve allegedly failed to honor their commitments to funders, Williams says.
Whether fraudulent or not, defaults remain plentiful enough to keep attorneys busy in funders’ legal departments and at outside law firms funders hire. “I do a lot of collections work on behalf of my cash-advance clients, sending out letters to try to get people to pay,” says Paul Rianda, a California-based attorney. When letters and phone calls don’t succeed, it’s time to file a lawsuit, he says.
Lawsuits become necessary more often than not by the time a funder hires an outside attorney, according to Jamie Polon, a partner at the Great Neck, N.Y.- based law firm of Mavrides Moyal Packman Sadkin LLP and manager of its Creditors’ Rights Group. “Typically, my clients have tried everything to resolve the situation amicably before coming to me,” he observes.
That pursuit of debtors isn’t getting any easier. These days, it’s not just the debtor and the debtor’s attorney that funders and their attorneys must confront. Collections have become more difficult with the recent rise of so-called debt settlement companies that promise to help merchants avoid satisfying their obligations in full, notes Katherine Fisher, who’s a partner in the Maryland office of the law firm of Hudson Cook LLP.
Meanwhile, a consensus among attorneys, consultants and the funders themselves holds that the nature of the fraudulent attacks is changing. On one side of the equation, crooks are hatching increasingly sophisticated schemes to defraud funders, notes Catherine Brennan, who’s also a partner in the Maryland office of Hudson Cook LLP. On the other side, underwriters and software developers are becoming more skilled at detecting and thwarting fraud, she maintains.
Digitalization is fueling those changes, says Jeremy Brown, chairman of Bethesda, Md.-based RapidAdvance. “As the business overall becomes more and more automated and moves more online – with less personal contact with merchants – you have to develop different tools to deal with fraud,” he says.
A few years ago, the industry was buzzing about fake bank statements available on craigslist, Brown recalls. Criminals who didn’t even own businesses used the phony statements to borrow against nonexistent bank accounts, and merchants used the fake documents to inflate their numbers.
Altered or invented bank statements remain one of the industry’s biggest challenges, but now they’ve gone digital. About 85 percent of the cases of fraud submitted to the DataMerch database involve falsified bank documents, nearly all of them manipulated digitally, Williams notes.
Merchants alter their statements to overstate their balances, increase the amount of their monthly deposits, erase overdrafts, or hide automatic payments they’re already making on loans or advances, Williams says. Most use software that helps them reformat and tamper with PDF files that begin as legitimate bank statements, he observes.
To combat false statements, alt funders are demanding online access to applicants’ actual bank accounts. Some funders ask for prospective clients’ usernames and passwords to examine bank records, but applicants often consider such requests an invasion of their privacy, sources agree.
That’s why RapidAdvance has joined the ranks of companies that use electronic tools like DecisionLogic, GIACT or Yodlee to verify a bank balance or the owner of the account and perform test ACH transfers – all without needing to persuade anyone to surrender personally identifiable information, Brown says.
Other third-party systems can use an IP address to view the computing device and computer network that a prospective customer is using to apply for credit, Brown says. RapidAdvance has received applications that those tools have traced to known criminal networks. The systems even know when crooks are masking the identity of the networks they’re using to attempt fraud, he observes.
RapidAdvance has also developed its own software to head off fraud. One program developed in-house cross references every customer who’s contacted the company, even those who haven’t taken out a loan or merchant cash advance. “People who want to defraud you will come back with a different business name on the same bank account,” Brown says. “It’s a quick way to see if this is somebody we don’t want to do business with.”
Sometimes businesses use differing federal tax ID numbers to pull off a hoax, according to Williams at DataMerch. That’s why his company’s database lists all of the ID numbers for a business.
All of those electronic safeguards have come into play only recently, Brown maintains. “We didn’t think about any of this five years ago – certainly not 10 years ago,” he says. In those days, funders were satisfied with just an application and a copy of a driver’s license, he remembers.
Since then, some sage advice has been proven true. When RapidAdvance was founded in 2005, the company had a mentor with experience at Capital One, Brown says. One piece of wisdom the company guru imparted was this: “Watch out when the criminals figure out your business model.” That’s when an industry becomes a target of organized fraud.
As that prediction of fraud has become reality, it hasn’t necessarily gotten any easier to pinpoint the percentage of deals proposed with bad intent. That’s because underwriters and electronic aids prevent most fraudulent potential deals from coming to fruition, Brown notes. The company looks at the loss rates for the deals that it funds, not the deals it turns down.
Brown guesses that as many as 10 percent of applications are tainted by fraudulent intention. “It’s meaningful enough that if you miss a couple of accounts with significant dollar amounts,” he says, “then it can have a pretty negative impact on your bottom line.”
Some perpetrators of fraud merely pretend to operate a small business, and funders can discover their scams if there’s time to make site visits, Rianda notes. Other clients begin as genuine entrepreneurs who then run into hard times and want to keep their doors open at all costs, sources agree.
Applicants sometimes provide false landlord information, something that RapidAdvance checks out on larger loans, Brown notes. Underwriters who call to verify the tenant-landlord relationship have to rely upon common sense to ferret out anything “fishy,” he advises.
Underwriters should ask enough questions in those phone calls to determine whether the supposed landlord really knows the property and the tenant, which could include queries concerning rent per square foot, length of time in business and when the lease terminates, Brown suggests. All of that should match what the applicant has indicated previously.
Lack of a telephone landline may or may not provide a clue that an imposter is posing as a landlord, Brown continues. Be aware of a supposed landlord’s verbal stumbles, realize something’s possibly amiss if a dubious landlord lacks of an online presence, note whether too many calls to the alleged landlord go into voicemail and be suspicious if a phone exchange with a purported landlord simply “feels” residential instead of commercial, he cautions.
Reasonable explanations could exist for any of those concerns, but when in doubt about the validity of a tenant-landlord relationship it pays to request a copy of the lease or other type of verifications, according to Brown. Then there are the cases when the underwriter is talking to the actual landlord, but the applicant has convinced the landlord to lie. It could happen because the landlord might hope to recoup some back rent from a merchant who’s obviously on the verge of closing up shop.
Occasionally, formerly legitimate merchants turn rogue. They take out a loan, immediately withdraw the funds from the bank, stop repaying the loan, close the business and then walk or run away, notes Williams. “We view that as a fraudulent merchant because their mindset all along was qualifying for this loan and not paying it back,” he says.
Collecting on a delinquent account becomes problematic once a business closes its doors, Rianda notes. As long as the merchant remains in business, funders can still hope to collect reduced payments and thus eventually get back most or all of what’s owed, he maintains.
In another scam sometimes merchants whose bank accounts are set up to make automatic transfers to creditors simply change banks to halt the payments, Brown says. That move could either signal desperation or indicate the intent to defraud was there from the start, he says.
Merchants with cash advances that split card revenue could change transaction processors, install an additional card terminal that’s not programmed for the split or offer discounts for paying with cash, but those scams are becoming less prevalent as the industry shifts to ACH, Brown says. Industrywide, only 5 percent to 10 percent of payments are collected through card splits these days, but about 20 percent of RapidAdvance’s payments are made that way.
Merchants occasionally blame their refusal to pay on partners who have absconded with the funds or on spouses who weren’t authorized to apply for a loan or advance, Brown reports. Although that claim might be bogus, such cases do occur, notes Williams of DataMerch. People who own a minority share of a business sometimes manipulate K-1 records to present themselves as majority owners who are empowered to take out a loan, Williams says.
In a phenomenon called “stacking,” merchants take out multiple loans or advances and thus burden themselves with more obligations than they can meet. Whether or not that constitutes fraud remains debatable, Rianda observes. Stacking has increased with greater availability of capital and because some funders purposely pursue such deals, he contends.
Some contracts now contain covenants that bar stacking, notes Brennan of Hudson Cook. As companies come of age in the alt-funding business, they are beginning to employ staff members to detect and guard against practices like stacking, she says.
Moreover, underwriting is improving in general, according to Polon “The vetting is getting better because the industry is getting more mature,” he says. “The underwriting teams have gotten very good at looking at certain data points to see something is wrong with the application – they know when something doesn’t smell right.” They’re better at checking with references, investigating landlords, examining financials and requesting backup documentation, he contends.
Despite more-systematic approaches to foiling the criminal element and protecting against misfortunate merchants, one-of-a-kind attempts at fraud also still drive funders crazy, Brown says. His company found that a merchant once conspired with the broker who brought RapidAdvance the deal. The merchant and the broker set up a dummy business, transferred the funds to it and then withdrew the cash. “The guy came back to us and said, ‘I lost all the money because the broker took it,’” he recounts. “Why is that our problem?” was the RapidAdvance response.
Although such schemes appear rare, some funders are developing methods of auditing their ISOs to prevent problems, notes Brennan. They can search for patterns of irregularities as an early-warning system, she says. It’s also important to terminate relationships with errant brokers and share information about them, she advises, adding that competition has sometimes made funders reluctant to sever ties with brokers.
Although fraud’s clearly a crime, the police rarely choose to involve themselves with it, Brown says. His company has had cases where it lost what it considered large dollar amounts – say $50,000 – and had evidence he felt clearly indicated fraud but the company couldn’t attract the attention of law enforcement, he notes.
Rianda finds working with law enforcement “hit or miss,” whether it’s a matter of defaulting on loans or committing other crimes. In one of his cases an employee forged invoices to steal $100,000 and the police didn’t care. In another, someone collected $3,000 in credit card refunds and went to jail. If the authorities do intervene, they may seek jail time and sometimes compel crooks to make restitution, he notes.
“Engaging law enforcement is generally not appropriate for collections,” according to Fisher from Hudson Cook. However, notifying police agencies of fraud that occurs at the inception of a deal can sometimes be appropriate, says Fisher’s colleague Brennan, particularly when organized gangs of fraudsters are at work.
At the same time, sheriffs and marshals can help collect judgments, Polon says. He works with attorneys, sheriffs and marshals all over the country to enforce judgments he has obtained in New York State, he says. That can include garnishing wages, levying a bank account or clearing a lien before a debtor can sell or refinance property, he notes.
When Rianda files a lawsuit against an individual or company in default, the defendant fails to appear in court about 90 percent of the time, he says. A court judgment against a delinquent debtor serves as a more effective tool for collections than does a letter an attorney sends before litigation begins, Rianda notes.
But even with a judgment in hand, attorneys and their clients have to pursue the debtor, often in another state and sometimes over a long period of time, Rianda continues. “The good news is that in California a judgment is good for 10 years and renewable for 10,” he adds.
So guarding against fraud comes down to matching wits with criminals across the country and around the world. “It makes it hard to do business, but that’s the reality,” Brown concludes. Still, there’s always hope. To combat fraud, funders should work together, Brennan advises. “It’s an industrywide problem … so the industry as a whole has a collective interest in rooting out fraud.”