Thursday, October 23, 2008

Merchant Cash Advances And FICO Scores

It is interesting to see during this recent business credit crunch that the average credit profile for a merchant cash advance applicant is on the rise. We have seen a plethora of FICO scores in the 700s and even 800s which typically first seek traditional bank loans and credit lines before seeking alternative funding products such as a merchant cash advance. As I mentioned in my previous post, Merchant Cash Advance And The Business Credit Crunch, that the current conditions of the credit environment is an opportunity to introduce businesses to the merchant cash advance product that historically may have sought other options.

As I also pointed out previously, these better credit applicants will be less receptive to "cheap marketing" techniques such as voice broadcasting but require a more consultative approach about this product. There is an opportunity here that once the better credit score applicants are exposed to this product that they can use it in conjunction with traditional bank loan products once the credit markets eventually open up should the traditional product not be able to meet 100% of their needs. For example, a bank may only be willing to eventually give a business a $100,000 line of credit when they need $150,000 and this is where they can mix it with an additional $50,000 through a merchant cash advance. Time will tell, but I believe the average FICO score of the merchant cash advance customer will increase and remain higher once the credit markets / banks open up again to small businesses.

Monday, October 6, 2008

Merchant Cash Advance And The Business Credit Crunch

I've gotten several emails about how I think the recent business credit crunch will affect the merchant cash advance industry. The way I see it, there are pros and cons that are going to evolve as a result of the recent credit crunch and what appears to be a potential meltdown of certain aspects of our financial system. There isn't a newspaper, magazine, radio or television program that hasn't spoken about how hard it has become for small businesses to obtain a business loan, line of credit, etc. from their local bank. When it comes to business loans, banks have traditionally been a challenge for small to medium size businesses, especially retailers and restaurants without a strong personal guarantee (even then it can be challenging). Now, it's next to an impossibility. With the mergers of Washington Mutual / Chase and the scenario with Wachovia and Wells Fargo / Citibank there will be even fewer banks for small businesses to turn to.

All these factors above have resulted in a HUGE increase in demand for the merchant cash advance product. However, because of an increase in default rates (partially do to the economy, partially due to inexperienced merchant cash advance providers who first entered the market in 2007), you are seeing the underwriting criteria for ALL merchant cash advance providers tighten up (some have even been driven out of the marketplace because they funded the "wrong deals" in 2007 and their funding sources have cut them off).

However, there is a large opportunity now for MCA providers as well as Merchant Cash Advance resellers / agents to target a whole new clientele with stronger credit scores that typically would have gone to traditional sources such as bank, that no longer can. The good news is this will work well for MCA providers and small / independent sales organizations. The bad news is for the larger "merchant cash advance phone rooms" that we saw emerge from the subprime mortgage lending business, I can't see how they will be able to survive in the long run. These companies were setup and able to survive by finding "the new MCA provider in town" that would take their C,D and E paper because they didn't know any better. These places to "dump garbage paper" are all but gone and add to the fact that we are seeing a trend in a stabilization and/or a decrease in merchant cash advance broker commissions as I predicted would happen in 2008 (see 2008 Merchant Cash Advance Predictions) will make it next to impossible for these large cash advance broker shops to survive. The smaller independent shops that aren't using cheap / commodity type marketing techniques (eg. voice broadcasting, buying leads from telemarketing firms) and are actually taking the time to target higher end merchants will find a viable business model as they don't need to write a huge quantity of business like the larger merchant cash advance reseller brokers to survive.

Another aspect of the merchant cash advance business I predicted back in December 2007 was that Underwriting will tighten up / approval rates will go down. This is certainly not a bad thing as if MCA providers didn't change their underwriting models in 2007, they will not make it to the end of 2008 (In fact, a few merchant cash advance providers exited the business and/or lost their credit lines / were liquidated by their investors). We also have seen a complete slowdown of new players entering the merchant cash advance space most likely due to fear and the lack of their ability to raise capital in this environment.

With all the above said, I believe this is probably one of the best times for the merchant cash advance industry to come out even stronger. Those that aren't underwriting foolishly (or approved too many bad deals over the last 6 - 12 months) will be able to increase the credit criteria of their average merchant and be able to emerge from this current credit crunch / volatile economy with a strong portfolio and even a stronger company. The bad news is those MCA providers who didn't underwrite properly and haven't adjusted accordingly in this environment probably won't be around in six months from now. As a merchant cash advance agent / reseller, you want to make sure you are aligning yourself with a company that will be here in six months from now to be able to pay your monthly residuals.