IMGCAP(1)]
This story appears in the Nov. 20, 2008, issue of ISO&Agent Weekly.
When Wall Street sneezes, Main Street catches a cold. It is an old aphorism, but it still rings true for merchants finding themselves increasingly locked out from traditional forms of financing. That is creating opportunities for merchant cash-advance firms, which provide an alternative source of funding, and for ISOs that sell cash-advance services to merchants.
Cash-advance firms assess the merchant's past credit and debit sales—and, in some cases, check, automated clearinghouse and electronic benefits transfer transactions—to forecast their future sales. Then they purchase a portion of those future sales at a discount: for example, giving the merchant $20,000 in cash for $25,000 worth of sales.
The North American Merchant Advance Association estimates that in 2008 the industry will fund about $1 billion in advances. The group also says the sector is growing at about 25% to 40% annually. Yet only about 5% to 7% of retailers currently use merchant cash advances.
However, the economic downturn may boost the number of merchants using cash advances. "Even really great business owners with great FICO scores are finding that they're getting letters from the bank saying your home equity line has been pulled or credit card level is reduced," says Diane Naczi, senior vice president of marketing at AdvanceMe Inc., a Kennesaw, Ga.-based merchant cash advance company.
Assessing Risk
"We're going to see in the banking side a return to stricter underwriting standards," says Michael Berman, chief operating officer of Outside Ventures LLC, the New York-based parent of Tribul Merchant Services. "All of the predictions suggest that Q4 retail sales will not be robust. [Financial institutions are] going to be somewhat conservative and wait until the Q4 checks are in before they decide what to do with merchant America."
By legal definition, merchant cash advances are not loans. But the inherent risk of buying future transactions sees cash-advance companies doing their best to quantify just how much risk a particular merchant holds.
For example, AdvanceMe typically considers approximately 70 factors, including recent credit card-processing histories, the industry that the merchant is in and its geographic location. It uses that information to forecast the applicant's credit card sales flow during the payback period, which usually is 12 months, and to calculate the discount at which AdvanceMe buys a portion of those sales.
AdvanceMe also looks at the owner's FICO credit score, although the company says that figure is not necessarily a deal-maker or -breaker. "It doesn't kick you out," Naczi says. "We've done fundings to business owners who have a FICO score of 410, and we've denied business owners who have a FICO score of 800."
For merchants, part of a cash advance's appeal is that, unlike a conventional loan, they do not pay a set amount each month regardless of whether business is good or bad. So if the economy remains sluggish longer than the merchant or cash-advance company expected, the latter bears the brunt.
"The merchant repays his advance automatically, via our deducting a fixed, daily percentage of his transactions," says Nancy Drexler, vice president of marketing at SignaPay Ltd., an Irving, Texas-based ISO. "So if consumers are spending less at a location, and the merchant's daily transaction volume is down, the fixed percentage will remain the same, and the processor will simply recoup a smaller amount that day. That means that the advance takes longer to pay off, perhaps hurting the advance company a bit, but not likely the merchant."
Vetting The Providers
As the variety of merchants using cash advances increases, these firms could wind up with stronger portfolios.
"I see [more] better-credit merchants taking the product than previously because they're going to be shut out from traditional loan sources for quite some time," David Goldin, president and CEO of AmeriMerchant LLC, a New York-based cash-advance company. "It's going to be an opportunity for [cash-advance] companies to have an even stronger portfolio than they did in the past."
A strong portfolio is one thing for ISOs and agents to consider when assessing cash-advance firms. So is the stability of the firm's funding sources. Yet another is how successful the firm is in retaining merchants that get advances, says Naczi.
Besides retaining merchants, the cash-advance firm also should have a good track record of keeping ISOs. "Ask for references: How long have different ISOs worked with you?" says Jeremy Brown, president and chief operating officer of Bethesda, Md.-based RapidAdvance LLC.
The bottom line is that, although cash advances are a growth market, it takes some homework to be successful. That is because as capital markets tighten further, so do the guidelines for who gets the cash. "It's a great revenue opportunity [for ISOs]," Brown says. "But the ISO and agent have to recognize that they're going to get fewer deals approved and funded than two or three months ago."
