Business Lending
Major Business Lending Fraud Has Consequences
September 15, 2015
It appears that commercial financing fraud is not limited to just the average $40,000 transactions typical in the merchant cash advance and non-bank business lending sector. Four executives for a small business named Projuban, LLC, DBA G3K Displays, Inc., were sentenced last week to serve time in prison for their role in an $18 million loan fraud.
G3K was a New Jersey-based company that provided in-store displays for retailers. According to a report published by the FBI, the execs “engaged in a scheme to falsely inflate G3K’s revenue and accounts receivable, and as part of the scheme, made and caused to be made materially false and misleading statements about G3K’s financial condition. To create the false impression of sales, the defendants created phony documents, including fake and falsely inflated purchase orders purporting to reflect sales to G3K’s customers.”
One of the lenders that fell victim to the fraud is Veritas Financial Partners LLC. Veritas is no stranger to the merchant cash advance industry, having financed at least one merchant cash advance funder themselves just a few years ago. They are regularly involved in multi-million business financing transactions, deals that are typically considered too large for merchant cash advance companies and other non-bank lenders.
In addition to the prison sentences which ranged from 4 months to 40 months, The FBI report says that, “STEVEN KAITZ, 56, of Jersey City, New Jersey, was ordered to forfeit $1,382,427 and pay $18,687,518 in restitution; LATCHMEE MAHATO, a/k/a “Robbie,” 50, of Jamaica, Queens, was ordered to forfeit $2,215,417 and pay $18,687,518 in restitution; JONATHAN WHEELER, 46, of Southport, Connecticut, was ordered to forfeit $957,435 and pay $18,687,518 in restitution; and ZACHARY KAITZ, 32, of Brooklyn, New York, was ordered to forfeit $100,000 and pay $18,687,518 in restitution.”
Perhaps the lenders working on really large transactions should heed the advice of those working on small transactions, and that’s to stop relying on paper statements. In this case, the perpetrators heavily relied on the use of fake documents.
“ZACHARY KAITZ, who was skilled in graphic design, helped carry out the fraud by creating fraudulent documentation, such as fake invoices, purchase orders, and bills of lading, to support the false representations to the lenders about G3K’s business,” the FBI report states.
Financing Not Really an Issue for Small Business According to the NFIB
September 11, 2015
Small businesses need money right? Well according to an August 2015 survey conducted by the National Federal of Independent Business, 21% of respondents said that taxes were the single most important problem facing their business today. That ranked highest on a list of ten issues. Only a minuscule 1% said that financing and interest rates were the most important problem. Even inflation was ranked as more important than financing.
Thirty-three percent of all owners reported borrowing on a regular basis and similarly, thirty-three percent reported all credit needs met. 49 percent however, explicitly said they did not want a loan. This data is based on a sample of 3,938 small-business owners/members that translated into 656 usable responses received for a response rate of 17%.
20% of respondents said that government requirements and red tape were the single most important problem they face, second to taxes.
One could infer from the data that access to capital is not a challenge for small business right now, which would make sense given how many non-bank alternatives are currently available. It also raises the question as to why regulations for non-bank alternatives would be considered a priority when small businesses seem to be pretty content with the way things are. If anything, the message here is that the best solution to grow small business is to lower their taxes. With that remedy being unlikely, a potential takeaway from this study then is that non-bank financing companies should consider ways to address their prospects’ two biggest pain points, taxes and government requirements. And if not those two, then the third issue that respondents said was the single most important problem, poor sales.
How can non-bank financing companies help small businesses address poor sales? This may be the key to long-term mutual success.
Competing Factions Hurt Alternative Lending’s Message
September 10, 2015
It’s over. Legislators and regulators in Washington DC know alternative lenders exist, and there’s no going back. There will be regulations that impact the industry in some way. That seems to be a definite at this point. What aspects will be regulated and to what extent however is yet to be determined.
And here’s the important thing you need to know about that impending conversation with folks in DC; They’re not up to speed on many of the issues being debated between industry insiders, and honestly probably won’t be for a long time, if ever.
They’re literally on square one. So if you were secretly hoping that regulators were on the verge of outlawing stacking, excessive broker fees, or high interest rates, you’re going to be very disappointed. I would argue that more than likely they’d have no idea what you were talking about if you broached these issues with them and it would come across like this:
And that’s because they’re trying to fully understand more basic things such as, why would a small business borrow money online as opposed to a bank? And what does marketplace lending really mean and how does it work?
Folks in DC are genuinely curious about the basics. They want to understand because they don’t want to be caught not understanding and ignorantly lead the nation into another financial crisis. That’s why the Treasury recently issued a Request For Information. You should notice how there’s nothing about stacking in it, but rather more fundamental issues like whether or not marketplace lending is helping borrowers that were historically underserved.
You have to applaud the Treasury’s approach because informed regulations, if that’s what this all leads to, would be much better than uninformed regulations.
The process could easily be jeopardized however if everyone’s so caught up in choosing teams, sides, and points of view that they believe are the “right” ones with the hope of scoring nothing other than perceived political points.
If this is what folks in DC see while they are in the information gathering stage, well then it’s probably not going to be a good outcome for anyone:
Companies that buy future receivables with daily payments and lenders originating 3-year loans with monthly payments actually have a lot in common on the fundamental level. They’re both bank alternatives. And for a number of reasons, small businesses are choosing them over more traditional sources. That’s where the conversation needs to begin.
The opportunity to communicate with rule-makers shouldn’t be squandered on complaints about what other people are doing, but rather on the what, why, and how for small business.
The worst thing that could happen is that divisive language within the industry leads to a regulatory result that negatively impacts all the parties involved, including the small businesses that benefit from this improved system of accessing capital.
Surely there is a way forward for everyone…
Qwave Capital Steps Up Pressure to Acquire IOU Financial
September 2, 2015
The nuclear scientists in venture capital clothing have laid out their case to IOU Financial’s shareholders that they would be better served if they were running things. In a letter distributed on Monday by Qwave Capital, the firm trying to acquire IOU, they criticized the lender’s state of affairs.
In all, IOU continues to demonstrate that it cannot grow profitably and compete effectively within its current model. This is made worse by the fact that, because IOU does not have sufficient capital, conservative lenders are reluctant to provide IOU access to capital at competitive rates. In comparison, OnDeck, IOU’s major online lending competitor, had raised far more capital when at the same stage of development that IOU is at today. OnDeck can now attract the lower interest funds it requires to lend out to customers and support its profitable growth in the U.S. and Canada.
Qwave chastised IOU’s board members for decisions it didn’t feel aligned with the best interests of the company.
“IOU transactions have allowed Board members and insiders to maintain their dominant interest in IOU and purchase shares for below-market value,” they wrote.
And continued:
“For instance, IOU recently completed a private placement financing at $0.40 per share, a 20% discount to Qwave’s Offer and the private placement’s original $0.50 per share price. IOU completed the $0.40 per share offering even though Qwave’s offer was on the table and IOU had confirmed offers at $0.50 per share on its books. Parties related to IOU management subscribed to approximately 17% of the offering at the discounted offer price.”
Judging by the rest of the letter, IOU shareholders will certainly have a lot to consider. You can read a full copy of it here.
Dealstruck’s Response to the Treasury RFI
September 1, 2015
The Treasury Department has extended the comment deadline on the Marketplace Lending Request for Information until September 30th. In the meantime, one well known lender, Dealstruck, has already submitted their response. A few excerpts of their comments are below, but you can view their response in its entirety here.
We encourage the Treasury to weigh stated use of proceeds and debt service coverage ratio heavily when considering factors important in extending credit for alternative online lenders.
We have no opinion or recommendation as to whether lenders should have skin in the game. If there is a seller and a buyer for an asset, a market exists, and the United States promotes open markets. At Dealstruck, we have chosen to take balance sheet risk because it helps us to position ourselves for a longer-term sustainable model across economic cycles, and allows us more flexibility in riding out potential future economic downturns.
we believe that the best way for banks to participate in the alternative online lending space is to offer financing to the innovative lenders, rather than attempt to change underwriting procedures and processes to facilitate smaller, riskier loans themselves
The federal government can also take a substantial role in leveling the regulatory playing field in pricing and access to SMB capital. Each state has substantially different regulations over commercial transactions, including lender licensing and usury caps. This has created perverse and unintended consequences, hampering both small businesses and transparent lenders
Should Alternative Lenders Reconsider IPOs?
August 31, 2015
OnDeck has gotten very quiet over the past month as the stock hovers near its all time low, and down more than 50% from its IPO price. The only updates related to them on the news wire lately are reminders from law firms to join in on the existing class action lawsuit. One has to wonder if they regret going public.
To make the things murkier, the Madden v. Midland decision effectively makes it illegal in a handful of states for alternative lenders to rely on chartered banks to originate loans for them at interest rates that violate state usury laws. In states such as New York, that’s a big problem for OnDeck, but fortunately for them and other lenders like them, they can still fall back on a choice of law provision to still be able to make the loans.
Combine that landmark ruling with the Treasury RFI, The Dodd Frank Section 1071 Reg B rule that everyone wants enforced all of the sudden, and a chorus of lenders calling for regulatory action, and we don’t exactly have an ideal environment for other alternative lenders considering an IPO.
But does an IPO really matter?
I am reminded of a long email that Elon Musk sent to employees of SpaceX two years ago regarding their aspirations to go public so that they could monetize their stock options and get rich.
“Some at SpaceX who have not been through a public company experience may think that being public is desirable. This is not so.”
“Another thing that happens to public companies is that you become a target of the trial lawyers who create a class action lawsuit by getting someone to buy a few hundred shares and then pretending to sue the company on behalf of all investors for any drop in the stock price.”
“Public companies are judged on quarterly performance. Just because some companies are doing well, doesn’t mean that all would. Both of those companies (Tesla in particular) had great first quarter results. SpaceX did not. In fact, financially speaking, we had an awful first quarter. If we were public, the short sellers would be hitting us over the head with a large stick.”
“Public company stocks, particularly if big step changes in technology are involved, go through extreme volatility, both for reasons of internal execution and for reasons that have nothing to do with anything except the economy. This causes people to be distracted by the manic-depressive nature of the stock instead of creating great products.”
“It is important to emphasize that Tesla and SolarCity are public because they didn’t have any choice. Their private capital structure was becoming unwieldy and they needed to raise a lot of equity capital.”
“Those rules, referred to as Sarbanes-Oxley, essentially result in a tax being levied on company execution by requiring detailed reporting right down to how your meal is expensed during travel and you can be penalized even for minor mistakes.”
Any other alternative lenders possibly considering an IPO should strongly evaluate whether or not it’s necessary to go public to carry out their objectives. Surely the folks at OnDeck must be at least a little bit distracted by the manic-depressive nature of their stock price, the class action lawsuit, reactions to their quarterly reports, and the unyielding scrutiny by analysts and pundits. Surely it could be argued that they’ve lost some of their PR mojo in the mix.
It’s not easy running a public company, especially a lender in a post-financial crisis world where Wall Street hatred still runs hot. Hopefully if you are in this industry, you are in it for the long haul and not just for an IPO to cash out and give up…
Expansion Capital Group Crosses $50 Million Milestone
August 27, 2015
Move over New York and Silicon Valley, Expansion Capital Group (ECG), a young Sioux Falls, South Dakota-based business lender is quickly rising up the ranks. Founded just two years ago, a company representative has confirmed to deBanked that they’ve already funded more than $50 million to small businesses nationwide.
While South Dakota might be better known as the home state of Mount Rushmore, they have made a name for themselves in an industry largely centered around New York, California, and South Florida.
Jay Larson, ECG’s COO, shared with deBanked, “We are definitely excited to cross the $50 million deployment milestone. First and foremost, we’d like to thank all of our industry partners for all their help and support in getting us here. Second, this is only the beginning of ECG’s journey [and] as such we’re looking forward to reaching the $100M milestone in a much shorter period of time.”
On the industry leaderboard, ECG is not that far behind competitors that have been in the industry for much longer. Credibly, for example, has reportedly funded more than $140 million since inception but that’s spread out over a period of more than four years.
Alternative Lending Becoming Less Alternative
August 23, 2015
Alternative funders are looking a little more like bankers these days, but that’s not to say they’re developing a taste for pinstriped three-piece suits and pocket watches on gold chains. They’re promoting bank loans, applying for California lending licenses and contemplating the unlikely possibility that one day they’ll obtain their own bank charters.
“It’s what everybody’s talking about,” said Isaac Stern, CEO of Yellowstone Capital LLC, a New York- based funder. “If it’s not in their current plans, it’s in their longer-term plans over the next three to five years.”
Funders promote bank loans to drive down the cost of capital, sell a wider variety of products, offer longer terms and bask in the prestige of a bank’s approval, said Jared Weitz, CEO of United Capital Source.
Loans allow for much more customization than is possible with merchant cash advances, noted Glenn Goldman, CEO of Credibly, which was called RetailCapital until a little less than a year ago. The name changed as the company began offering loans in addition to it original advance business. It’s now working with three banks.
While the terms don’t vary much with advances, borrowers can pay back loans daily, weekly, semi-monthly or monthly, Goldman said. Loans can also include lines of credit that borrowers draw down only when they choose. Interest rates on loans can vary, too, he said, and loans can come due after differing periods of time.
Besides that flexibility, loans also offer familiarity among merchants and sales partners – unlike the sometimes baffling advances, Goldman said, adding that “everybody knows what a loan is, right?”
Loans have so many advantages over advances that Credibly expects its loan business to grow more quickly than its advance business, said Goldman, who was formerly CEO of CAN Capital.
Those advantages are also encouraging other advance companies to form partnerships with banks to provide merchants with loans that aren’t subject to state commercial usury laws, said Robert Cook, a partner at Hudson Cook LLC, a Hanover, Md.-based financial services law firm.
The advance company markets the loan to the customer, the bank makes the loan, and the advance company buys it back and services it at the rate the bank is allowed under federal law, Cook said. The bank doesn’t lose any capital, it takes on virtually no risk and it profits by collecting a few days’ interest or a fee, he noted.
Where the bank’s located can make a big difference. A bank based in New York, for example, can charge only 25 percent interest no matter where the customer resides, while New Jersey allows banks to collect unlimited interest anywhere in the country, Cook said.
But the partnerships funders are forming with banks could face a threat. The United States Court of Appeals for the Second Circuit ruled in May in Madden v. Midland Funding LLC that a non-bank that buys a loan cannot charge interest set where the bank is located but must instead charge interest according to the laws of the state where the consumer is located, Cook noted. That could mean a lower rate.
In Cook’s view the case was poorly argued, the decision was wrong and the ruling may be reversed, “but it has to trouble someone who is thinking about starting up a bank partnership,” he said.
The court was asked whether the rules that apply to a national bank also apply to the non-bank that bought the loan, Cook maintained. That’s not the question, he asserted. The argument should have been that the idea of “valid when made” should take precedence. It states that a transaction that’s not usurious when it’s made doesn’t become usurious if a party takes action later – like reassigning the note, Cook said.
Meanwhile, offering bank loans isn’t the only way alternative funders are coming to resemble banks. Some are obtaining what’s formally called a California Finance Lenders License that enables them to make loans in that state.
California began requiring the license in response to lawsuits over the cost of advances. The state has published a licensee rulebook that’s about the size of an old-school New York phone book – the kind kids sat on to reach the dining room table, according to Yellowstone’s Stern, who completed the licensing process three years ago.
Getting the license took 15 or 16 months and required lots of help from the legal team at Hudson Cook, Stern said. The state investigated his back- ground and fingerprinted him. The cost, including lawyers’ fees came to about $60,000, he recalled.
“Man, it was like pulling teeth to get that license,” Stern said. Keeping it’s not easy, either. “We guard that thing fiercely,” he maintained. “They’ll take away your license if you even sneeze the wrong way.”
The hassles have paid off, though, because Yellowstone now deals directly with California customers instead of sharing the profits with other companies licensed to operate there. What’s more, companies that don’t have licenses are sending business Yellowstone’s way.
Retaining the profits from loans is also prompting some funders to contemplate applying for their own bank charters. But Cook, the attorney from Hudson Cook, sees little or no chance of that happening.
Federal bank regulators are reluctant to grant charters to mono-line banks – institutions that perform only one financial-services function, Cook said. “It’s risky to put all your eggs into one basket,” he maintained.
Regulations make forming or acquiring a bank so difficult for businesses that want to make small loans at high rates, Cook said. “If that’s going to be their business plan, they’re not going to get a bank.” A state charter requires the approval of the Federal Deposit Insurance Corp., which isn’t likely, he noted.
Utah industrial banks and Utah industrial loan companies are insured by the Federal Deposit Insurance Corp. but aren’t considered bank holding companies, Cook said. However, that’s a regulatory loophole that may have closed and thus may no longer offer a way of becoming a bank, he noted.
Clearly, the complications surrounding bank loans, lending licenses and bank charters mean that becoming more bank-like requires more than a pinstriped suit.
