For a company to be put on our Direct Funders List, they must meet some minimum criteria if we are not familiar with them or they claim to be a direct funder that transitioned from a broker. We ask for proof of being Direct, which mainly consists of a copy of their contract and ISO agreement. Recently we have received contracts from companies seeking to be added that included Power of Attorney sections in their agreement. This came as a huge surprise as I haven’t seen one in years although admittingly haven’t checked everyone’s Future Receivables agreement.
Power of Attorney(POA) had long gone by the wayside for many reasons but that led to the rise of Confessions of Judgements(COJ) being implemented into contracts.
Now COJs have now been almost entirely eliminated in most MCA(merchant cash advance) contracts. It would seem that one reason we could be seeing the POA is that since COJs have been outlawed in several states Funders are trying any other way to get more security in their agreements.
It also could be the attorney group putting these contracts together aren’t too familiar with the issues that arise once merchants recognize that a POA is required. Often deals are lost and brokers are certainly never happy with that. They will go elsewhere next time to get their deals funded.
While these are just a few contracts, just be aware of this possible resurgence of the POA inserted in agreements so that you can advise your clients appropriately.
(Are you using POAs? Have you seen them in many MCA contracts recently?
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Clawbacks
This recent contract we reviewed also included a personal guarantee as well as a 60 day Clawback period, which is for brokers to repay their commission earned on a deal that defaulted within that time period. Sixty days is an extreme length compared to the average of thirty days across the industry in my experience. Brokers aren't very eager to agree to this.
Some Funders have even eliminated clawbacks altogether, but don’t think those companies aren’t doing something to compensate for that additional risk.
Either they will ask for additional Stips, charge higher fees, increase the buy rate, or reduce the maximum commission on deals just to name a few things.
This happens with other aspects of underwriting also, but holding brokers accountable for defaulted deals soon after the deal is funded has always been a practice that helps funders track which ISOs and brokers they will continue doing business with.
Of course, if they can’t prove the ISO affected the deal going bad then there isn’t further legal action. However, a high Loss Ratio from the same ISO is not a coincidence and thus those ISOs are typically cut off from that funding company sooner or later.
There are always exceptions to this, with some super high-risk funders almost more concerned with how much money they can get the merchant on the hook for because they don’t care if the merchant defaults. As long as they can collect a certain amount before a default happens they can pursue the rest in court or sell it to an outside collections agency.
PSF
Brokers who charge Professional Service Fees aren’t inherently doing anything wrong unless it's prohibited in the ISO agreement for the Funder with whom they are funding deals.
The problem beyond that is how much is the PSF and whether it's excessive enough that it could impact the merchant's ability to pay back the merchant cash advance. This doesn't include the fees that a Funder might charge when closing, including underwriting fees, monthly maintenance fees, or other fees which sometimes are excessive as well.
One ISO agreement we reviewed recently had a 5% maximum PSF allowed for the ISO to charge. Anything above that, if caught, would have their partnership terminated and risk their commission being clawed back or never paid in the first place.
Many ISOs admittingly will charge up to a 10% PSF if they can get away with it regardless of the impact on the merchant. That’s on top of the average 10% commission they would get per deal!
If you are doing the math that is in fact a possible 20% of the total funded amount on one deal. Meaning on a $100k deal, the ISO would get $20K!
ISOs feel it's their right to charge for their service so if they must hide it from the funder somehow, they will do so, even though it jeopardizes the funder's capital deployed and certainly the relationship.
ISOs admit that if they think the merchant is going to default anyway, (they can’t predict this any more than any funder can), then why not get as much money as possible. If they can double up on what they are already getting on commission, it's worth it for them.
This is a very short-sighted approach that can lead to more defaults and doesn’t validate any person's assumption that inevitably a specific merchant will default. There are only odds of default, not exact predictions of future default. If there were then the funder wouldn’t fund the deal.
In the long term, this leaves money on the table from renewals and keeping the client in their ecosystem for other financial products.
Again, this doesn't excuse any excessive fees Funders are out there charging. We have seen underwriting fees as high as 8%, with another point or two for some other fees.
So if you combined that with a 10% PSF for example, then the merchant will net 20% less than the total contracted advance amount. Using this example, $100K at a 1.35 Factor Rate, a merchant would net $80k, paying back a total of $135K. Paying back $55k in fees when receiving $80k is a large amount that is not sustainable long term. With most profits coming from renewals for funders, this is not an ideal path to prolonged success.
All of this leads to ultimately a poor merchant experience across the board. Merchants experience higher fees and factor rates, untrustworthy salespersons, fewer good funding options, and risk losing their business even if in good faith they executed an agreement. It is also why there are funders reducing their reliance on deals from ISOs or totally eliminating broker referral partners.
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