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‘Money, Money’ — How Alternative Lending Could Increase Your Company’s Revenue in 2013

‘Money, Money’ — How Alternative Lending Could Increase Your Company’s Revenue in 2013

By on May 30, 2013 in Project Financing | 0 comments

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Forbes’ Maureen Farrell took a skeptical view of merchant cash advance lending in her January 2008 article Look Who’s Making Coin Off The Credit Crisis, citing the rise of Merchant Cash Advance (MCA) shops as the recession started. In that report she pointed to predatory lenders relieving entrepreneurs of precious capital at annualized rates as high as 70-90%.

However, much has changed on the alternative lending landscape in the five years since Farrell’s opinion appeared. Analysts report that both the cash advance and the invoice factoring sectors are increasing in prevalence and popularity, with business growing in both sectors at double digit levels each year. The Green Sheet estimates the market for merchant cash advances is currently $500-$700 million, with the potential to reach $3-5 billion within the next several years. The market for “factoring” (B2B loans against outstanding invoices) is even larger:  Morgan Stanley estimates that factoring produces $13-15 billion per year.

The safeguards are increasing and the astronomical costs are abating as the market for these innovative lending sources continues to grow. Even the “loan shark” reputation is decreasing, experts note, as mainstream organizations such as eBay, Amazon and AmEx OpenExchange are now getting into the alternative merchant financing act.

This week I spoke to a leading provider in each of these two sectors: Merchant advance provider Stephen Sheinbaum, CEO and President ofMerchant Cash & Capital (MCC), of New York; and factoring provider and expert Tim Valdez, co-founder of Pavestone Capital, with locations in Fruitland, Idaho, and Salt Lake City.

Stephen Sheinbaum is the founder, CEO and President of Merchant Cash & Capital

I spoke first with Sheinbaum, who was also quoted in Farrell’s article in 2008. Shienbaum founded MCC in 2005 and has led the company to provide $500 million in loans of some 25,000 cash advances to approximately 12,500 customers so far. The company employees 100 people in New York, but provides advances to clients throughout all 50 contiguous U.S. states.

Why the need and the rapid growth of merchant advances? Shienbaum notes that his company is seeing small but steady increases in the strength of the economy, employment and consumer spending, yet lending policies from banks have not loosened. This means that financing to merchant vendors to fund expansion, equipment purchase or leases or to gain additional cash flow to fund operational growth remains incredibly tight. Furthermore, the kind of criteria banks and traditional sources look at – length of operating history, length of loan, and amount of collateral needed – is difficult or impossible for merchant vendors to meet.

“If someone has any kind of a credit issue, or if they need to borrow for 3-15 months as opposed to 5-10 years, the banks can’t help them,” he notes. “Small companies, with less than $5-10 million in annual sales, are particularly vulnerable right now.”

MCC has developed a variety of lending products to help these merchants by providing cash advance loans against their future credit card sales, to provide funds the merchants can use to purchase inventory, to manage cash flow to support staffing, or to accommodate growth such as opening up additional retail locations.

Sheinbaum has also been instrumental in helping to found and manage the primary association that works to ensure best practices in the merchant cash advance space, NAMAA (the National American Merchant Advance Association, at www.nationalamericanmaa.org). NAMAA provides education, training, and best practice guidelines to help ensure merchant advance providers are legitimate and trustworthy and that they provide needed assistance at reasonable prices that don’t “choke out” the merchant businesses they serve.

The Bar at Killarney received a cash advance from MCC to recover from the damage of Hurricane Irene

The company has ample examples of how their lending scenario works. For example, the Bar at Killarney, in Southern Vermont, experienced a severe downturn in 2011 due to damage from Hurricane Irene and the slow restaurant season that followed the storm. To survive, the restaurant obtained a business cash advance from MCC. The advance provided critical funding the business couldn’t obtain from traditional sources. The owner, Mark Verespy was so pleased he has returned to MCC again, to fund its current expansion. For him, the short term and structure of the cash advance was ideal.

While MCC specializes in retail merchants, Tim Valdez, of Pavestone Capital, provides factoring loans of up to 90% of the amount of invoices due to his client customers in industries such as transportation or service. Founded in 2012, Pavestone has grown rapidly (due in part to a fortuitous acquisition) to an anticipated $30 million in 2013. By managing the invoices of its clients, Pavestone also takes over the work and process of credit analysis and receivables collection, helping customers to conduct their business processes more efficiently and quickly.

Tim Valdez is co-founder of Pavestone Capital, based in Salt Lake City and Idaho (photo courtesy of PavestoneCapital.com)

As to the interests and rates Pavestone charges–rates will vary, but in a current example we discussed in our interview, Pavestone charged a lending customer 9.5% interest, annualized, along with fees for the confirmation, management and collection of the client’s invoices. All combined, the customer is paying an annualized rate of interest and fees in the mid to high teens, depending on average invoice size and level of administration–not cheap, but no more expensive (and probably less) than the debt service on a typical credit card, and with the added benefit of taking the back office functions of bill collection and several other administrative tasks off of the customer’s desk.

My attention was piqued and as a service business, I realize I am potentially interested in engaging Pavestone myself. Valdez also discussed an innovative option his firm is pioneering to give clients an alternative to the typical operating line of credit: In these cases, Pavestone will pool the customer invoices into a fund that becomes the functional equivalent of a traditional line of credit. The customer can “draw funds” from the pooled invoices as needed up to 90% of their sum, but pays interest and fees on only the portion it draws and only for the period of time the funds are outstanding. The result: a functional line of credit without the onerous approval requirements and covenants of a traditional bank. (When the invoices are collected, Pavestone rebates the 10% back to the customer, minus the contractual fees.)

Valdez advocates the formation of strong associations to police and advance the business practices for his industry sector as well. In the case of factoring, the primary association is IFA, the International Factoring Association (www.factoring.org), where he served as an officer until April 2012 and periodically publishes articles on factoring and financing trends.

To keep alternative financing safe, Valdez advises the following precautions:

  1. Does the funding provider understand your business? Transportation, construction, energy, for example—different vertical niches have vastly different business processes that require high understanding and precision in order for the working partnership between business and factoring partner to succeed.
  2. Look closely at the management team of your funding partner. What do they know about the industry and how reliable are they? What is their source of capital? These precautions could have done much to eliminate the bad experiences and bad reputation merchant advances and factoring loans acquired during 2008-2009.
  3. Location isn’t a big deal. Industry specialization and experience is a far bigger criteria to consider in selecting a funding partner, Valdez says.
  4. What are the terms of the transaction? Examine all aspects of the funding agreement in careful detail. What portion of the cost is interest (the money cost) and what will you pay for the service component? How will these costs compare with your other funding alternatives? How will they be offset by the business growth and revenue security the funding will help you achieve?

John Tozzi, of Businessweek, provides this advice for companies considering cash advance or factoring funding as well:

  • Understand the full contract before you proceed. Tougher lending standards are helping to curb the abuses as these alternative lending industries grow, but careful understanding of the terms of the contract is the best way for prospective merchants to ensure they’ll be pleased.
  • Get a copy of the actual contract you’ll be expected to sign in advance. This will help determine if you’re dealing with the actual advance provider or with a broker. Know who you’re dealing with and vet the management team and the length of time the provider has been in business. Talk to other customer references who’ve worked with the provider as well.
  • Ensure a good company fit. Do they understand your particular sector or market? Will they be seamless and cohesive in the work they do in collecting invoices due from your company’s customers? This will be vitally important to protecting the valued relationships your company has worked to achieve.

Complaints about these kinds of firms and their practices, while growing more rare, are continuing to happen, industry experts affirm. However, responsible merchant lenders are doing much to make their practices self-policing, as Sheinbaum and Valdez attest. Having access to these innovative services at today’s competitive rates can make the difference between not only growing or not growing, but even between life and death.

In summary: while alternative lenders can provide the means for growth and cash flow salvation to a growing venture, entrepreneurs should examine these lending products and partnerships with both eyes open, to stay both sharp and aware. Have you used an alternative lending provider to grow your company? Who did you use, and what has your experience been? I welcome your thoughts.

Author: Cheryl Conner | Google+

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