Two companies are trying to bring the decade-old merchant cash advance concept into new — and starkly different — markets.
Swift Financial Corp. and Kabbage Inc. are taking the product, in which small businesses receive short-term capital for pledging future credit and debit card receivables, in opposite directions. Swift is focusing exclusively on prime customers, while Kabbage is targeting online-only merchants, a category that has previously been considered too risky even for conventional merchant advance providers.
Merchant cash advance providers are known for catering to businesses with poor credit with what's tantamount to the business equivalent of a payday loan. Loss rates at many providers skyrocketed during the recession as businesses struggled to say afloat. As a result, several providers either went out of business or were forced to restructure. Today the industry is leaner and more responsible, participants say.
"The industry's corrected itself," said David Goldin, president of the North American Merchant Advance Association and the chief executive of the merchant advance provider AmeriMerchant LLC. "The days of just giving a merchant that had a pulse [an advance] … are over."
Analysts say that with traditional banks keeping a tight lid on small-business lending, now is an opportune time to expand merchant advance products.
"It's not a surprise to me that you see new entrants trying to get into the market," said Gwenn Bezard, a research director at Aite Group LLC in Boston. "That type of lending is not something that banks are doing or are prepared to do."
Despite its frequent comparison to payday lending, by definition a merchant advance is not a loan. Rather, it is a transaction that involves the purchase and sale of an account, similar to traditional factoring or the trading of financial receivables (credit cards, auto loans, mortgages, etc.) in the secondary market. As such, it is regulated mainly by the Uniform Commercial Code as adopted in each state.
Because it is a commercial transaction, it does not come under the purview of lending regulations or consumer-focused rules like the Truth in Lending Act.
Kabbage's focus on e-commerce is noteworthy because even among merchant cash advance providers, online retailers were seen as particularly precarious, and therefore have been largely underserved.
"The merchant cash advance companies that are still active in the market have typically aimed their services at segments where the payment card is present at the point of sale, primarily restaurants," said David Fish, senior analyst at Mercator Advisory Group Inc., a payments consulting firm in Maynard, Mass. "There's a greater risk to the merchant for accepting card payments remotely."
But Kabbage, a startup based in Atlanta, said it has found a way to manage some of that risk.
"My theory was that the data we can obtain online can be utilized to assess risk in a transaction," said Robert Frohwein, Kabbage's co-founder and CEO. "You can obtain this information pretty quickly. You create a cash advance system where sellers come online and go through an underwriting process and [can] be funded pretty quickly."
To start, Kabbage is focusing specifically on merchants who sell on eBay Inc.'s online auction site. It expects to expand to other online-only retailers in the future.
Prospective customers go to Kabbage's website and enter their eBay seller ID. In seconds, Kabbage's technology platform can determine if a merchant has sufficient selling history to qualify for an advance. If the merchant qualifies, he or she will be prompted to complete a short application and can have cash sent to his or her account with eBay's payments unit, PayPal Inc., in minutes. By tapping directly into a merchant's eBay and PayPal accounts, Kabbage gains access to unique transaction data like monthly sales volume and chargeback rates. Kabbage also pulls standard credit information on the business owner.
"The online small-business market hasn't been focused on necessarily because it's perceived as this box of trouble," Frohwein said. "Access to their ongoing performance only further reduces risk over the term of the relationship."
Ed Harycki, founder and CEO of Swift Financial, said he is trying to be even more selective than his peers in making advances to appeal to higher-caliber businesses.
"We're not aware of anybody else offering this product exclusively targeting the prime customer," he said. "We're looking to price ours somewhere around a 15% discount."
Merchant advance providers generally purchase future receivables at a discount of between 20% and 30%, but they can command even higher discounts depending on the health of the business and the size of the advance. Though it's a costlier proposition for a business than a conventional bank loan, it tends to be quicker and easier to get. It also does not require the business owner to put up any collateral and there is no requirement to repay the advance if the business goes under unless there was some type of fraud committed, said Joseph Looney, chief operating officer and general counsel of RapidAdvance, a merchant advance company in Bethesda, Md., that has a referral partnership with Swift.
Swift provides capital in amounts ranging from $5,000 to $100,000, with repayment terms typically ranging from six to nine months. The company takes a percentage of the business's daily credit and debit card receipts, which ensures that "repayment ebbs and flows with the sales of the business," Swift says.
To apply for an advance from Swift, a business typically needs to supply four months' worth of transaction statements and two to three months of checking account history. Swift only makes advances to companies that have been in business for at least a year.
"You're not betting on their personal credit profile. … What you really care about is what is this guy's track record in his business," Harycki said.
The Wilmington, Del., company said it plans eventually to form partnerships with banks, which have tended to shy away from merchant advance because of the risk, as a way to promote the service. Any business turned down by the bank partner for a conventional loan would be referred to Swift for a merchant advance. The advantage to the bank is that it could offer those businesses additional services — and potentially, down the line, a commercial loan.
"No banks are in. It's still a wide-open field," Harycki said. Frohwein, too, said he envisions partnerships with third parties and financial institutions.
In this time of increased scrutiny of high-interest, short-term loans, however, industry observers are doubtful that any merchant advance company would be able to persuade banks to get on board.
The NAMAA estimates that only $600 million in merchant advances were made in 2010, down from around $1 billion in 2008. With the average advance around $20,000, Goldin said, that comes to roughly 30,000 advances.
"It could be a very valid product that the customer might really benefit from, but the banks are going to be incredibly careful about compliance, about regulation, about image, because they just had a boot on their throat for about a year," said Charles Wendel, president of Financial Institutions Consulting in New York.
Harycki, who previously ran the $2.5 billion business-lending division at the credit card company MBNA, now owned by Bank of America Corp., acknowledged that getting banks' buy-in will be a challenge, but only at first.
"We'll see banks step up and adopt this over the next three to five years," Harycki said. "This isn't a product that they offer, and it's something we think will help their customer base."
