Business Lending
81% of Online Business Lending Borrowers Report Being Satisfied or Neutral
April 12, 2017The latest Small Business Credit Survey published by the Federal Reserve shows that 81% of small business borrowers were either satisfied or neutral about their online loan experience. Online lenders were defined as nonbank alternative and marketplace lenders, including Lending Club, OnDeck, CAN Capital, and PayPal Working Capital.
Of the 19% that were dissatisfied, nearly half cited transparency as a root cause. But that’s to be expected given that businesses dissatisfied with their loan from a large or small bank also cited transparency just as often.
While these charts indicate that there is still room for online lenders to improve, the 2016 report paints a more honest narrative than last year. Last year’s report used net satisfaction scores, which measured the difference between satisfied and dissatisfied borrowers. That methodology resulted in 15% net satisfaction for online lenders in 2015, which unless you read the fine print, easily misled even the most sophisticated of readers to conclude that only 15% of borrowers were satisfied. (Those readers included experts testifying in congressional hearings, the media, and government agencies, all of whom relied on that report to argue that online borrowers were terribly dissatisfied).
The 2016 report shows that businesses borrowing from an online lender were only slightly more likely to be dissatisfied than those that borrowed from a large bank (19% vs. 15%). And it’s the high interest rates that stand out to those dissatisfied online borrowers. 33% said that a high interest rate was the reason for their dissatisfaction. This is to be expected since non-banks inherently suffer from a higher cost of capital than banks.
Cash Advances?
Unfortunately, all of their data on “cash advances” is tainted. If they meant “merchant cash advances” or sales of future receivables, they should’ve specified such in the survey that went out to small businesses. Instead, the survey repeatedly asked about cash advances, a term most commonly associated with borrowing money through an ATM with a credit card. Those surveyed were also asked if they used personal loans, auto loans or mortgages so the multiple choice context suggests a credit card cash advance. Similarly, a cash advance could also mean a payday loan. With so many interpretations, the consequence is that it’s impossible to tell what the Federal Reserve meant or what those being surveyed thought they were being asked.
Notably, one question asked businesses if “portions of future sales” were used as collateral for a debt, but since merchant cash advances do not collateralize future sales (the future sales are actually sold, they don’t serve as collateral for a loan), it’s difficult to understand what they meant or how a respondent might interpret that.
Statistically representative?
The 2016 report also spends more time defending the Fed’s sampling methodology. Perhaps they are aware that their data is being put under the microscope.
Read the full Fed report here
Can Factors and MCA Companies Get Along?
April 7, 2017
At the factoring conference in Fort Worth, TX on Thursday, the 2 PM panel was officially called The Fintech Disruption. But it could’ve just as easily been named The MCA Disruption considering that the panelists all ran companies engaged in either unsecured business lending or MCA. The tension in the packed room was palpable. For some factors, the competitive pressure they feel with unsecured finance companies cuts deep, down to their soul. So naturally it only made sense, being that it’s Texas and all, that they lassoed a few of those unsecured guys up and put them on stage to explain theirselves.
So what’s the best way for an MCA company to make a peace offering to a room full of factors?
Sol Lax, the CEO of Pearl Capital Business Funding LLC, kicked it off by telling the audience that a small business customer might begin their quest for capital by searching the internet for a small business loan. “There’s no factoring companies that are going to pop up,” he exclaimed, suggesting that they were already losing when it came to the Internet to acquire customers and had little hope of catching up. But if you are a small factor, he conceded, you should continue generating leads through relationship building since the Internet is now so cost-prohibitive.
Dean Landis, the President of Entrepreneur Growth Capital, ran with that and asked attendees to raise their hands if they really pay attention to the cost of lead acquisition. While this was an informal survey, virtually no one raised their hand, seeming to confirm that deal flow for factors is largely acquired through relationships. Landis, who played the role of moderator and devil’s advocate, asked if MCAs and factors were really even targeting the same customers. Would you lend to someone who already has a senior lien? he asked. “These [MCA] guys figured out how to do that.”
Dan Smith, President of Fora Financial and Paul Rosen, Chief Sales Officer of OnDeck, explained that their customers often seek a fast-paced application-to-funding process, which drew a rebuke from an audience member who had a hard time believing that so many merchants truly needed that speed and simplicity. Smith and Rosen countered by saying that customers will choose whatever is best for them and that not every customer fits their boxes.
Lax advised factors to look at the bigger picture, that one big lender on their own might not seem like a threat but that a company like OnDeck could license out their scoring model to banks and banks could adapt that to make loans to companies they have otherwise been ignoring (the same ones that go to factors) and compete against the factors directly.
As the audience chipped away with questions about the soundness of these scoring models and fintech, Smith of Fora reminded everyone that they still have underwriters that are manually overseeing deals, rather than let computers do everything entirely on their own. “You can literally fintech yourself out of the business,” Smith cautioned lenders who might overzealously replace their core competency with algorithms that don’t perform as well.
But even then, do these scoring models work when merchants gets stacked on? This question was asked and it suggests that stacked merchants have a higher risk of default. Rosen of OnDeck confirmed that when he said “customers that stack on us have much higher loss rates.” Meanwhile, Smith said that when customers are doing something that affects their model, they just need to improve their model, just like they would if there was a recession or some other economic event underway. “All of our models are built on lifetime value,” he said. They want to grow and nurture their clients, he explained.
While factors fear that MCA companies could stack on their clients, there are signs that a path forward exists. An informal poll of the room indicated that not only are factors referring prospects to MCA companies but that MCA companies are returning the favor and sending prospects to them. The former was more prevalent.
Lax of Pearl, was more pointed about the future for factors. “You either need to evolve or become a phone booth,” he proclaimed. He prefaced that with a story about a child who was absolutely befuddled by an old Superman movie, as in ‘what were all these ridiculous random booths doing in the city that enabled Clark Kent to go around changing his clothes?’ The concept of a phone booth could hardly even be explained to the next generation. “Your industry is suffering a phone booth moment,” Lax said to the factors.
Is he right?
To the unsecured lenders and MCA companies who attend the factoring conference, they invariably see value in partnerships. And for the factors still hesitant to take that step, is it really the MCA model that’s causing friction? Or is it the evolution of the way that businesses interact with financial technology, i.e. fintech? And might fintech disrupt everyone in the end?
Only time will tell.
Quotes and paraphrases were derived from the panel. The summary is my own analysis of it and much of the 90-minute discussion was omitted here for brevity.
StreetShares Reports $2.8M Loss on Just $277,000 in Revenue For Last Six-Month Period
March 30, 2017
StreetShares, an online small business lender that is self-described as proudly veteran-run, published their most recent financial statements with the SEC earlier this week. For the six-month period ending December 31st, 2016, StreetShares recorded a $2.8 million loss on $277,883 in revenue. Over the same period in the prior year, they recorded a $1.35 million loss on $145,019 in revenue. To-date, the lender has issued $20 million in loans since they first began in July 2014.
StreetShares has so far charged off 23 loans for a combined principal balance of $380,804. Charge-off determinations are made after 150 days of delinquency.
The company made history last year by becoming the first lender in the US to be approved by the SEC to use funds from public investors to back loans to small businesses. This was done through Regulation A+ of the Jumpstart Our Business Startups (JOBS) Act. Reg A+ investors make up $656,675 of StreetShares’ liabilities on the balance sheet.
StreetShares currently makes loans to small businesses between $2,000 to $500,000 for terms of three months to three years.
The company also spent more than 5x their revenue on payroll and payroll tax for the six-month period and more than 3x their revenue on marketing expenses.
Earlier this month, StreetShares announced a partnership with Nor-Cal FDC “to assist small business and veteran business owners in obtaining funding needed to win new opportunities.”
In the release, StreetShares CEO Mark Rockefeller said, “we’re eager to provide veteran-owned small businesses with the funding solutions they need to grow.”
Enrolling a Merchant’s “Debt” May Be Harmful… to the Merchant
March 29, 2017
How would you like to make $12,000 on a single referral?, a flyer directed at business finance brokers asks. This ad wasn’t offering a commission for brokering a loan or advance, but rather for enrolling a merchant’s debt into the company’s restructuring program. Debt restructuring, negotiation, or settlement is a booming cottage industry these days. Some of these debt restructuring companies promise ISOs that they will be completely discreet with referrals. Others offer them commission bonuses for achieving certain enrollment targets. It’s a way to monetize declined deals, they typically say.
For merchants, the allure of a restructuring company’s help might just be payment terms tied to their monthly budget. That’s allegedly what one NJ firm’s agreement says, in fact. “I hereby authorize [the company] to negotiate my unaffordable business debts and to enter into affordable repayment terms on my behalf based on my monthly budget,” reads a document submitted in a New York Supreme Court case involving Creditors Relief. And based on the marketing materials deBanked has reviewed from several similar companies, their definition of debt is so broad that it can even include things that aren’t debt, like merchant cash advances, for example.
Even if the restructuring company held a critical view of MCAs and believed them to be loans, treating them as such for the purpose of negotiation might actually cause harm to their customers. That’s because a well-formed MCA contract already offers payment adjustments at regular intervals to appropriately match a merchant’s sales activity. Depending on what the language says, a merchant might just have to call their funder and ask them to reduce the debits to reflect their current sales activity. And yes this goes for ACH-only deals. Even ones that could appear to have fixed payments do not actually have fixed payments. This is basically how all MCAs work by the way, so if you are a broker or funder and this all sounds foreign to you, you need to take this course ASAP.
The point is this: a merchant need not pay a fee to an outside company to restructure anything when sales drop because a free remedy already likely exists and is a key benefit to MCAs in the first place. And yes, I’m talking about MCAs with daily ACH debits. If you’re confused by this, you need to take this course ASAP.
The best advice a restructuring firm can give a merchant struggling with an MCA due to slow sales is to tell them to look for a reconciliation clause in their contract that explains how to get the payments reduced. Once the merchant finds it, have them call the funder and execute it. There’s no need to enroll anything, negotiate anything, risk breaching a contract, or pay a broker tens of thousands of dollars in commissions. The debt restructuring firm might not want merchants to simply take advantage of what they’re already entitled to however, because they stand to make no money that way. In this regard, mischaracterizing future receivable sales as loans only serves to carry out their agenda to confuse merchants about what their rights might be under those agreements.
I myself, am occasionally contacted by merchants who claim to be facing hardship and in one instance where a merchant had spoken to a negotiator, the negotiator didn’t tell him that the remedy he sought was already a natural provision of his contract. I helped him find it. He didn’t have to pay any fees which would’ve gone to pay someone a huge commission or end up in some crazy situation where he’s being sued for breach of contract. Think about this the next time you encounter a distressed merchant. Not everything is debt and that can be very much to the merchant’s benefit.
If you work for a debt restructuring, settlement, or negotiation company, you should probably take this course too. It will help you understand MCA agreements and what remedies merchants already have at their disposal.
Amazon Sure is Making a Lot of Small Business Loans
March 26, 2017
Amazon had $661 million in seller receivables at the end of 2016, according to their earnings report, nearly double from the year before. These receivables are from loans made to small businesses (primarily to purchase inventory) who are sellers on their platform.
Apparently the lending business is going well for them too, since they claim the allowance for loan losses is so small that it’s not even material enough to report. And similar to Square Capital, Amazon incurs virtually no cost to acquire these borrowers.
One year ago, company CEO Jeff Bezos said in a letter to shareholders that “there are over 70,000 entrepreneurs with sales of more than $100,000 a year selling on Amazon.” By then the company had already lent more than $1.5 billion to small businesses across the US, UK and Japan.
“We wanted to bring the same shopping experience that you have on amazon, which is the one-click shopping experience, to the lending program,” a spokesperson says in a 2014 video about the program. “Instead of going to a bank, having interviews, audited financial statements, a 3 week process and then only a small fraction of people getting approved, our process is literally 3 fields and 3 clicks.”
If Kabbage Wanted to Buy, Would OnDeck Sell?
March 24, 2017
A single line in a Reuters story was enough to cause OnDeck’s stock to jump by as much as 11% on Thursday. Industry blogs and news outlets had reacted pretty quickly to word of an unnamed source claiming that OnDeck is a potential acquisition target if Kabbage raises a new equity round. OnDeck closed for the day up only 6.5%.
BloombergGadfly columnist Gillian Tan, wrote that a deal was not very likely because of how much investors are already down since the IPO. “Assuming Kabbage were to propose a traditional takeover at a standard premium, it probably would be swiftly rejected by On Deck’s earliest investors, who still own a combined stake of more than 45 percent, according to data compiled by Bloomberg,” she wrote. “With the stock trading at less than a quarter of its 2014 initial public offering price, it would take a generous premium to get them interested.”
OnDeck also lent nearly twice as much as Kabbage last year and obviously still has faith in leadership considering that their pre-IPO CEO is still in charge. There’s little to suggest at this time that OnDeck would be willing to throw in the towel and sell out to a smaller, younger competitor and book a big loss for shareholders who have been with them since the beginning.
The day before the rumor started, OnDeck actually announced that it had increased its asset-backed revolving credit facility with Deutsche Bank by approximately $52 million to a total of up to approximately $214 million.
Citing Unnamed Sources, Reuters Reports Kabbage Possibly Looking to Acquire OnDeck
March 23, 2017
Reuters is reporting that Kabbage is in talks to raise equity capital to potentially use for acquisitions and that OnDeck is one of several targets under consideration. As Reuters attributed the OnDeck portion to just one of their multiple unnamed sources, it’s entirely speculative at this point.
From a theoretical perspective, would such a thing make sense?
Kabbage has momentum on their side right now. Their recent half billion dollar securitization that was finalized earlier this month was oversubscribed. Although they only originated about half the loan volume of OnDeck last year, Kabbage’s last private market valuation ($1 billion in Oct 2015) is nearly 3x as large as OnDeck’s current market cap.
Valuations in the industry have changed a lot over the last 18 months but there’s no doubt that Kabbage has become a unique competitor. At LendIt, company CEO Rob Frohwein revealed a bit of their secret sauce when he said that their customers borrow from them on average 20-25 times over the course of 4 years, whereas their competitors make only 2.2 loans to their customers on average.
There is a general view in this industry that acquiring a competitor adds little value other than more marketshare. Kabbage, however, may potentially believe that (1) OnDeck is too undervalued to pass up (2) That OnDeck could generate better margins using Kabbage’s strategy (3) That OnDeck’s partner relationships would add additional value (4) That the company cultures are compatible enough to make an acquisition work (5) that the combined entity would allow them to better align their political and regulatory agendas.
We mustn’t forget however that a single unnamed source is pretty weak to go off of. One possible reason that someone would want to report that OnDeck is an acquisition target is to cause a temporary spike in their stock price. (and I certainly do not have any position in the stock)
For now, it’s fun to think about such an acquisition scenario and we’ll report more, if and when we hear anything.
Managing Risk in Small Business Lending
March 16, 2017
Two years ago, I left a promising career at PayPal, a major technology giant, for what some considered a risky move: I joined BlueVine, a young fintech startup. My title: vice president of risk.
This year, I took on an even bigger role when I was named chief risk officer of the Silicon Valley company, which offers working capital financing to small and medium-sized businesses.
My promotion comes at a time when risk is becoming a bigger concern in fintech, which is ushering in big changes in banking and financial services.
Fintech revolutionizes financial services
Data science technology has dramatically improved access to financing and the way we manage our money. The fintech wave that began with my former company, PayPal, and the world of payments, has spread to other aspects of personal finance, from mortgages to student and auto loans to investing.
This expansion was accompanied by growing concern that the fintech boom is fraught with risks that, if left unchecked, could lead to a major bust in the financial services industry that could in turn cause harm to the broader economy.
In a speech in January, Mark Carney, the governor of the Bank of England, cited the need to “ensure that fintech develops in a way that maximises the opportunities and minimises the risks for society.” “After all, the history of financial innovation is littered with examples that led to early booms, growing unintended consequences, and eventual busts,” he said.
Risk management as key to success
Risk management certainly has been a focus area for BlueVine from the beginning.
BlueVine joined the revolution in small business financing in 2014 when it rolled out an innovative online invoice factoring platform.
Factoring is a 4,000-year old financing system that allows small businesses to get advances on their unpaid invoices by providing easy, convenient access to working capital. BlueVine transformed what had been a slow, clunky, paper-based solution into a flexible and convenient online financing system that enables entrepreneurs to plug cash flow gaps that often hamper business growth.
Because the BlueVine platform is based on cutting-edge data science technology that can process and analyze information to make quick funding decisions, managing risk inevitably became a major challenge in building our business. As Eyal Lifshiftz, our founder and CEO, recalled in a recent column, in BlueVine’s first month of operation, almost every other borrower defaulted.
In fact, that was partly the reason Eyal invited me to join his team. BlueVine serves small and medium-sized businesses seeking substantial working capital financing of up to $2 million. To succeed, we needed to build a robust data and risk infrastructure.
Small startup with big data needs
Joining BlueVine also posed a personal challenge.
At PayPal, where I started as a fraud analyst and then moved into the company’s data science division where I helped develop behavior-based risk models, I had enormous amounts of data to work with to do my job. Now, I was joining a young startup with very limited data history, but with big data needs.
This meant putting together exceptional and experienced teams of data scientists and underwriters and developing a technology that becomes progressively more precise and accurate as it draw lessons from our steadily expanding data and underwriting decisions. It was important for us to have a group of super smart, highly-motivated and technologically-strong people working closely with a team of experienced and sharp underwriters.
Here’s how the process works: Our underwriters develop a robust methodology which is then translated into detailed logic decision trees.
Each decision tree includes dozens, even hundreds of branches, made up of question sets on different underwriting situations.
For example, a decision tree could focus on approving new clients coming from a specific industry, such as transportation or construction, or on increasing the credit line for a client with a specific financial profile.
A typical decision tree would drill down on further financial questions: What’s the expected cash-flow of the business in three to six months? What’s the pace at which it has accumulated debt over the past year? Are the business sales seasonal in a material way?
The questions could also focus on non-financial areas: Does the company’s website look professional? How does it compare with major companies in its industry? Does the business actively maintain its Facebook and Twitter accounts?
The goal is to build a risk infrastructure that steadily becomes more efficient in answering questions in an automated, large-scale and highly accurate manner. Our data scientists leverage multiple external data sources and use dynamic advanced machine learning models to answer these questions pretty much in real-time and with a high degree of accuracy.
So it’s a combination of technology and human input. There will always be gray areas, questions and situations that cannot immediately be addressed by our computer models.
But as the models get better and more robust, the gray areas will shrink. Our models are constantly and automatically enhanced, re-trained and expanded by the most recent data and input from our underwriters.
Think of it as the fintech version of Deep Blue and AlphaGo, the powerful computer programs that famously outplayed topnotch chess grandmasters. Both programs were based on similar principles: the more they played, the more knowledge they absorbed and the more formidable they became at chess.
Technology and teamwork
An even better example is the self-driving car powered by Google’s artificial intelligence technology. Human input is still required, but the more driving the car does, the smarter and more autonomous it becomes.
Building our risk infrastructure is an ongoing process for BlueVine. But it already has helped us steadily expand our reach, making us stronger, smarter and even faster in financing small and medium-sized businesses.
In just a couple of years, the strides we’ve made in managing risk more effectively enabled us to increase our credit lines to $2 million for invoice factoring and $100,000 for business lines of credit, which means we’ve been able to serve bigger businesses with bigger financing needs.
While we initially focused mainly on small businesses with annual revenue of under $250,000, today we have an increasing number of clients with annual sales of more than $1 million and increasingly, we’ve been able to serve clients with revenue of more than $10 million a year.
By the end of 2016, BlueVine had funded roughly $200 million. We’re on track to fund half a billion dollars by the end of this year.
We’ve accomplished this in a time of heightened skepticism about fintech in general and alternative business lending in particular. But rather than scoff at this skepticism, I’d point out two things.
First, fear often accompanies the rise of a new technology. Second, in the wake of the 2009 financial crisis, it’s prudent to raise hard questions about the rapid emergence of new financial technologies.
While building technologies and companies that can provide financial services faster and easier is a laudable goal, It’s wise to move cautiously and with humility.
The BlueVine experience underscores this.
Risk is still a challenge we take on every day. But we have found ways to take it on confidently and effectively with a vigorous combination of technology and teamwork.
Ido Lustig is Chief Risk Officer of BlueVine.
