Track 6: Payments meets Small business finance

A timely and lively discussion about the state of lending to small businesses, and how the category is evolving in light of current economic trends — as well as the impact of faster payments and the recent banking crisis.

Transcript:

Daniel Wolfe (00:09):

All right. So as I said, I'm Daniel Wolfe, Content Director with American Banker covering Payments and Credit Unions, and I am here with two folks to discuss the intersection of payments and small business finance. So sitting directly next to me is, why don't you introduce yourself, Keagan?

Keagan Russo (00:26):

Sure. My name's Keagan Russo. I'm the President of the North America local fleet business for FleetCor, and I've been Fleet COR for about three and a half years. And as it relates to today's conversation, we run a fuel card portfolio for businesses of all size, but about 40,000 small businesses and medium sized businesses with vehicles. And we also operate a proprietary fueling network with about 62,000 fuel sites across the US.

Daniel Wolfe (00:56):

And Ben?

Benjamin Johnston (00:57):

Hi, I'm Ben Johnston. I'm the Chief Operating Officer at Capitus. We are a small business lender and provider of factoring products. We've been in business about 17 years. We provide capital in all 50 states to a wide range of industries, from healthcare to the contracting space to manufacturing and restaurants among many others. And we land in, if you're thinking about what is a small business, it's somewhere between half a million dollars in total revenue and about 10 million in total revenue. Some of them are banked but need a little bit of additional capital. Some of them are banked only in that they keep their deposits at a bank, but really are unable to access capital from a bank at all. And it's our role to step in and help those small businesses obtain growth capital in order to achieve their growth needs.

Daniel Wolfe (02:06):

So Ben, you were talking about just this range of sizes of small businesses. How does the size of that business, how small the small business is, how does that affect your approach to them?

Benjamin Johnston (02:17):

Sure. Well, we are first and foremost looking at the cash flow of the business. So we will look at a business if they have half a million dollars in revenue, we'll be looking at that on a monthly basis. We're looking at the industry that they're in and we're trying to understand what the consistency of that cash flow is likely to be. And then we are trying to determine how much of that cash flow they can reasonably be expected to repay over time. And that is how we factor what they're going to be eligible for. And of course, we're also looking at what they need the capital for and is this type of financing going to fit the needs of the business that they're working to execute.

Daniel Wolfe (03:02):

Okay. And Keagan also, how does the size of the customer matter and also just the nature of the fleet business itself, how is that different from other business categories?

Keagan Russo (03:12):

Yeah, that's a good question. So I think it changes the equation a little bit in the way that we look at the size of the business where before I was with Fleet Qure, I came from a company much more similar to where Ben is operating and the risk profile is a lot different. So for the fuel side, we look at the size of the business across a couple dimensions. One is the fleet size and a fleet size can come attached to all many, many different sizes of company. But what really is important to us is the amount of fuel that they're purchasing on a weekly, monthly, annual basis, and then how much of a percentage of their total expenses that line item translates to. Because the value of our product is pretty tied up in how fleet intensive the business is. So we'll look at all of those things and it's a pretty short term, so it's not a revolving line of credit. And when fuel's such an important part of a business for a fleet intensive business, the payback is very high. So we can go pretty deep in terms of credit profile on businesses.

Daniel Wolfe (04:32):

So we're having this conversation not just to discuss the overall topic of small business financing, but to discuss it at this particular moment in time. So you have pressures like inflation and economic uncertainty, liquidity and all of these things. How is that affecting your customers? How is that affecting your own approach to market and the decisions you make?

Keagan Russo (04:54):

So on for our business, I think the event that changed the profile of the customer the most and the behavior was the spike and fuel prices that happened a little over a year ago. And what happened there was in rush of new to category businesses, it came in where it wasn't the traditional 7, 8, 25 vehicle fleets. You had a lot of almost near consumer businesses where it was one, two, what we call micro fleets. And all of a sudden they needed working capital associated with their fuel expense. And they came in and acted very different from both a repayment perspective and kind of retention attrition perspective over the last year. And we've had to really refocus a lot of our sales engine to make sure that we're not only just serving that population that is very, very transient when it comes to fuel cards, but also meeting the needs of more traditional fuel card customers.

Daniel Wolfe (06:02):

How was there, can you talk more specifically about how their behavior was different from a larger customer?

Keagan Russo (06:06):

Sure. Yeah. There was a much higher percentage of customers who treated our fuel card like a prepaid gift card and would come in and we, they'd have a $500,000, $2,000 credit line and once they reached the limit of that line, they would go back to using a debit card or cash or check for fuel purchases and kind of walk away. So it's been a big challenge to try to figure out a customer who fully intends and understands the value proposition of a fuel card and will pay us back versus those that are looking for a way to minimize their fuel spend and don't care about the long-term.

Daniel Wolfe (06:50):

Okay. Benefits. And then what are you seeing in recent months or the past year?

Benjamin Johnston (06:55):

Well, consumer spending is the lifeblood of small businesses, and so we keep a very close eye on what's going on with the consumer and thus far the consumer's been able to hang in there pretty well. I mean the unemployment rate remains incredibly low. However, I do think we're starting to see some cracks in the overall consumer capability. Consumers had a ton of savings coming out of the pandemic, they've been eating away at that savings, cash out refis on homes are pretty much gone at this point. And so some of that cash flow that's been running into small businesses, I am definitely being constrained. And I think honestly, I think that's the design of the Fed. I think the Fed has wanted it to be that way and they've been raising interest rates and are getting what they're asking for. So it is still an area that we've focused very, very closely on because obviously that's critical to the future health of small businesses.

Daniel Wolfe (08:06):

So I haven't forgotten that. The word payments is in the title of our session and our conference and it's on my business cards. So there are trends going on in payments that affect everything. We've been talking about how folks repay. There was actually, this is talking about consumers, but at this morning session there was the example of a consumer who needed to get their electricity turned back on and the speed of the payment mattered because once that those funds went through, then their power could come back on right away. So faster payments, immediate real-time payments. That definitely is a part in any kind of cash flow conversation, especially today and especially in the context of systems like Fed Now expected to launch this year and so forth. Ben, how do you see that affecting any aspect of this repayments or any other aspect of small business finance?

Benjamin Johnston (09:03):

Well, it's something that we've been preparing for quite a while and we're really excited to have it because speed is the essence of our business. We pride ourselves in being able to underwrite a file in under two hours and being able to fund same day or next day with a customer as is. But in order to fund that quickly, we need to rely on the wiring system if it's going to be done the same day, otherwise we can associate it for the next day. But with this new technology, being able to provide instant delivery of funds is going to be really exciting. And I think potentially game changing. What I think will also be really exciting is being able to clear payments in a single day because we have a very high frequency of when we take payments, we're not generally a monthly payer type financing institutions, so we often have daily or weekly payments that we are taking.

(10:10)

And we also have a high frequency of small businesses that throughout the life of their financing with us, they might miss a payment or two because of the high frequency and just because there isn't always cash in the bank every day for small businesses. And so knowing exactly when that happened and not having to wait three days to know that answer really helps our customer service agents who are reaching out to them and saying, Hey, is there an issue here? How can we help you? Let's get to the root of the issue. If you've changed banks, if you've changed merchant processors, we want to help you figure that out. Or if you need some payment assistance, we want to know that too. So that's all really important for us. Okay.

Daniel Wolfe (11:03):

Kegan, did you have anything you wanted to add on

Keagan Russo (11:05):

That? Yeah, I think that last piece is also very critical to what we are planning from a product perspective in the back half of this year, especially the change in behavior that I talked about a little bit earlier has led to some pretty significant credit tightening, kind of both within our business and in the fleet card business kind of in general. And we have a lot of very critical businesses out vehicles out on the road. So fire departments, police departments, emergency medical services, and they can't afford to have their cards shut down because they missed a payment. So a lot of what we're working towards in the second half of the year is to build up our ability to clear transactions like ACH and create a near debit product that we're settling every single day on the backend so that we can continue to go out and have those cards opened up so that they can continue to fuel.

Daniel Wolfe (12:11):

Okay. So on the topic of small business financing, merchant cash advances are a big term in the space. Could either of you talk about where that fits in the range of options that you support and how that has affected the market?

Benjamin Johnston (12:27):

Sure. So we offer two primary products. A term loan or a Ford purchase agreement. And a forward purchase agreement is a factor, and it's also sort of considered an MCA in the market. And what that gives you is you're buying future receivables at a discount and you are in turn getting a right to a certain percentage of the company's revenue until that purchase is paid. So when we underwrite the file, as I said, we're looking to understand exactly what the cash flow of that business is, and then we want to structure something that allows us to take the appropriate amount of capital from them on a periodic basis. So if we have a longer term that we are anticipating than paying back over, we can take a little bit less of that. And if we are thinking that they're going to pay back in a much shorter term for a much shorter opportunity, then you can take a little bit more.

(13:34)

However, when you're doing a forward purchase agreement, you do not have an absolute right to that money the way you would if you did a term loan. And so if their revenue were to fall, they have the right to for us to take less until that they've had sufficient revenue at that percentage that we've identified upfront to pay off the entire obligation. And so we've set up a servicing structure so that if their revenue were to fall during the life of the outstanding obligation, they call us up. They let us know that the business has taken a turn for the worse. They provide bank statements to show us that this has occurred and we reduce the payment commensurately. Now interestingly, we actually treat our term loan customers in the exact same way because if a business falls on hard times, we want to, even though we have the contractual right to be able to go out and take that payment, we want to be able to work with them to work through a difficult time. And we understand how volatile the cash flows of those businesses are. And so we have the same system in place for our term loans, even though contractually we're not required to do that. But that's generally how a forward purchase agreement, a factor or an MCA would work.

Daniel Wolfe (15:13):

Okay. And there's a lot of folks offering MCA, right?

Benjamin Johnston (15:18):

It's a wide industry, but actually what I would say is that there are only a few large firms that have been around for a long time that are operating in what I would consider the most reputable manner. We've been around for 17 years, we serviced customers through 2008 in the financial crisis all the way through the pandemic, and we're here for our customers now. We've done that by building strong customer loyalty over that period of time, approximately, maybe a little bit more than 50% of our customers come back to us for additional financing at some point in their life cycle. Although many of them take it, repay it, go on with their lives, I identify that they need it again and come back to us and take it again. And so that it's a very valuable customer base and a loyal one

Keagan Russo (16:22):

And it is a great tool in the kind of financing toolkit of a small business, or it can be when used effectively. I think one of the more interesting things that we do is I mentioned before we have a proprietary fuel network. So we went out and we negotiated the deals with about 8,000 merchants that represent 60 plus thousand sites out there from pilot loves TA to ExxonMobil and thousands of kind of independent, and we actually offer a merchant cash advance to those merchants. And it kind of harkens back to the early days of MCA when there was generally an agreement with the processor where you would do a split settlement with the merchant and a certain percentage would go to the MCA company and the respite process regularly. Well, we actually own the network and we do the settlement. So we actually do a split processing where we'll buy the rights to the kind of future revenue at a discount.

(17:35)

And it's a real small part of our business right now. We do about a million dollars in funding for those merchants a month. We've been doing it for a little over a year. And because we own the flow of funds and the settlement, it's quite a bit. So we do a weekly settlement, not daily, and we're able to go out to a demographic of folks who own convenience stores, gas stations that typically are not having their financing needs met by traditional banks, and they're very rational actors. They know I need to have our car wash fixed by the busy season and it's going to take me $15,000 to do that. I can go get that $15,000 and I'll repay it over the next nine months. And we're able to do that at a fair price and we treat it as a little bit of an ancillary business to what our core business is. But those customers, and right now, I mean we haven't been doing it for that long, like I said, but of the customers that have been eligible to come back and take additional funds, almost two thirds of them have.

Daniel Wolfe (18:55):

So this isn't necessarily the fleet operators, these are the gas station!

Keagan Russo (19:00):

The gas station owners.

Daniel Wolfe (19:01):

Is there any overlap in those customer bases or is it a totally new business?

Keagan Russo (19:05):

Very little overlap. Right. Okay. So I'd come from a small business financing background and saw the opportunity to leverage the systems that we had in place already for, and even in my prior role, gas stations was in a market that we necessarily would go after because the margins tend to be a little bit tighter than many of the other businesses that are in the traditional sweet spot of the mca. But since we have such great data about the volumes that were coming through their pumps and what their fuel revenue were, we saw that the risk was pretty minimal. And it's been a good part of growing part of our business.

Daniel Wolfe (19:44):

 That's always fascinated by just the data that comes in through the fleet card operation. This was something, I know you just kind of said it, but just to emphasize that this was something that at least as my conclusion of what you said that came from the data that you saw that there was a need based on the data you were already collecting through this totally separate product.

Keagan Russo (20:06):

So we get all the transaction data of the amount of volume that's flowing through the network. We can see who the customers are and the stability of those customers. So you can look at a gas station and in general, the fuel man volume that comes through is about two and a half or 3% of their total fuel revenue, but it makes a difference whether it's five very large regional businesses that have been fueling at this station for a really long time, or the volume can be pretty spiky as we may sell to a lot more small businesses that churn out of our fleet business a little bit faster. And we can pretty accurately predict how stable that revenue stream's going to be.

Daniel Wolfe (21:01):

And then how do you make contact with them about that?

Keagan Russo (21:06):

A lot of times they make contact with us because, so we already are talking to them on a weekly basis, at least through our settlement process. So they're looking at their volumes and they'll look at their MasterCard, their Visa, their volumes kind of every week, and fuelman is another one of those. So they'll reach out if they have any questions. And a lot of what we do is just part of that regular cadence of settling with the merchant, letting them know that they can qualify for around this amount, and we can be pretty aggressive and at rates that are higher than bank loans, but still much lower than a lot of your traditional MCA providers can be. Okay.

Daniel Wolfe (21:52):

Then I think I sensed you wanting to jump or two here.

Benjamin Johnston (21:55):

Yeah, I was just going to say that we also have a merchant split credit card factoring product as well. It is, I think like you, a very small percentage of our business or how, however, originally it was a hundred percent of our business. And what we found was that the merchants often need to switch the processing in order to take that capital. And so a more traditional aching, their bank account on a periodic basis was preferable to them. So we set up the system of allowing them to true up if their revenue were to drop. But that is sort of the core, original way to perform this product. And we still do it, especially with a few very high credit card volume customers who really appreciate that if their volume, if they have a slow day, a slow week, the percentage that you're taking automatically comes down. The flip side of that is if they have a really big week, it's 4th of July and they blow it out, they're a bigger, the same percentage, but a bigger dollar amount is going to come back as a result of that.

Daniel Wolfe (23:13):

So I'm not out of questions yet, but I figured if anybody out here in the audience has some questions, this would be a good time to jump in. Oh, I see a hand way in the back. All right, Stephanie with a microphone. Oh, I see her with a microphone.

Keagan Russo (23:35):

It's a great hustle.

Audience 1 (23:38):

So this question is for Keagan. I get a lot of declines. I'm a lender for gas stations. I was wondering, do you take broker business?

Keagan Russo (23:50):

I could. I apologize. I could hear half of the words you were saying. So can you try it one more time for me?

Audience 1 (24:00):

Do you take broker business?

Keagan Russo (24:04):

For the MCA product? Or so today it's a relatively small part of our business. We do work with some brokers on our, we have a large number of SNB fleets, and we do work with folks to provide small business financing there. I would be happy to have that conversation after. I think we have a lot of, it's probably 40% of gas stations are part of this proprietary network, and if there was a better way to get distribution and reach out to them, I would love to explore that for sure.

Audience 1 (24:53):

Thank you.

Daniel Wolfe (24:55):

Anyone else? So I don't see any hands. If somebody did raise their hand and I'm just blinded by these lights, just start screaming and I'll know that I can stop. Okay. All right. So looking ahead into the future, what do you see as the next big thing that folks in the audience should be aware about? Small business financing and the impact of any kind of payments innovation?

Benjamin Johnston (25:23):

I guess I can go first. So we're very excited about the possibilities of embedded finance. We've had several of our partners reach out to us and say, Hey, we want to embed your ability to decision on our platform, run our customers through that decisioning engine. And the ones that your engine says are good, we're going to have you make an offer to them and then turn the file over to you to do some backend underwriting. What they seem to be most concerned with is getting to yes, very quickly with some acceptable level of fallout on the backend. I think that's tricky to do for small business underwriting because it is more complicated than most consumer underwrites. And so there are a number of, the way we underwrite is we run a series of knockout models that are AI driven, and then we have human underwriters that pick up the file and fill in the blanks beyond that and are checking things that we have not been able fully digitize yet and build models around.

(26:47)

In order to do embedded finance really well, you need to be, at least with this model, you need to be able to make a decision with a fairly high level of confidence, but know that there are certain things that you are not going to know at the point of sale and buy yourself a little bit of time to fill in those blanks on the back end. We are currently working on a model around that. I do think we are years and years away from having perfect technology that allows you to decision with near a hundred percent confidence instantly, upfront. It's just a more complicated underwrite than what you're going to find for your prime credit score of a customer who's had a stable job for the last 10 years making relatively same amount of money. It's just a different animal when it comes to small business, but it's something that we're actively working on because we know there's such demand both from the customer base and from our partners out there.

Keagan Russo (27:50):

And Keagan, what does your crystal ball tell you? Oh, man. So I think just a little bit more niche. One of the things that I, I'm working towards, we have a partner that's a digital fleet maintenance platform. And I think about that sort of transaction. And I'm very focused on companies with fleets, obviously. And if you have a fleet, you also have maintenance spend. And it's a category that I don't think any of fleet or competitors have really done a good job of going out and capturing. But when I think about this platform and what happens when a vehicle goes in, the mechanic opens up the hood, and there's five other things that also are wrong with your vehicle and drivers. They don't always have the ability to approve transactions. So we digit the workflows so that the back office can approve or decline additional services, but a lot of times the credit line isn't there. They don't have a way to pay for these what could be very critical repairs and get their vehicle back on the road. So it's costing them money. So one of the places where I think we'll be playing more is an underwriting at the you point of sale at the mechanic shop to get our customers vehicles back on the road a lot faster and kind of grow that category in terms of free spend.

Daniel Wolfe (29:23):

All right, cool. So we're out of time. I want to thank you both for this conversation. I learned a lot. I hope you all learned a lot as well.

Keagan Russo (29:32):

So, thank you.

Benjamin Johnston (29:32):

Thank you very much.