What We Talk About When We Talk About Merchant Cash Advance

***Note from Editor: This article was written before the Covid-19 pandemic started to cripple the country. We may update the article after things return to a more normal state.

During my 20-year tenure in the MCA world, I have observed some amazing developments in the evolution of the product, including:

• The move from a credit-card based product to one that is principally retrieved via daily ACH;

• Turns extending from 4-6 months, which was the standard in 2000, to 24 months and beyond;

• The increasing popularity of weekly, bi-weekly and even monthly retrievals, as opposed to the daily pulls that were at the heart of the original product; and

• The emergence of Stacking behind other Funders not just as an emergency measure to assist a merchant at an unusual point of need, but rather as an entire business strategy for many in the long list of merchant cash advance companies.

I am frequently asked by MCA Funders and MCA Brokers what I think are the biggest developments happening right now in the alternative business finance arena.

Here are the 2 biggest evolutionary changes I am seeing:

1) Increasing polarization between the Legacy Funders and the ‘Fast Cash’ Funders. The Legacy Funders, who have been around for years, are rich in data, capital, expertise, systems, modeling and process. They fund deals based on tested and well-defined Sizing, Scoring and Underwriting protocols, they automate as much as possible, and they update their data daily, feeding these results back into their Scorecards to constantly improve their Models. The ‘Fast Cash’ funders, as I call them, look to tap the liquidity in a merchants’ bank account and get in and out fast, at high prices, winning deals on speed and covering off on risky deals by charging high rates (plus fees) on all Fundings.

The mid-market Funders, who are neither as powerful in data, capital, reputation and automation as the Legacy Funders nor as agile and lean as the Fast Cash Funders, are increasingly being squeezed. I believe the mid-tier funders will either need to move upmarket by investing heavily in infrastructure, talent and systems, or edge down-market (probably including a re-brand) to compete in the fast cash niche.

To compete and stand out in the current market, you need to have at least one significant competitive advantage – cost of capital, automation, reputation, speed, ease of use, etc – or you will find yourself priced too high, in too small a box, to compete with the Legacy funders, and yet too slow, with too many restrictions, to compete with the Fast Cash funders.

2) The belief that massive amounts of data can eventually eliminate the need for traditional Underwriting. The move towards Artificial Intelligence and Machine Learning is a boon for our industry, but the limitations must be understood. Since we only have performance data on Funded deals, there is built-in selection bias, and therefore not a ‘level playing field,’ within the available data. To put it another way, any deal that Funded was approved by someone at some time. Obviously, there is no performance data on the deals that didn’t fund. That’s why completely data-driven models often return results that are, to be polite, “counter-intuitive”…for instance, that 5 negative bank balance days in a month are no more risky than zero, or that Trucking Sole Props are as safe as incorporated restaurants. A Scoring Model must be constructed with the Underwriting and Funding protocols in mind in order to avoid fallacious assumptions based on the granular outputs.

A final point on Scoring: while all effective Risk Models are very predictive at the extremes, able to quickly determine very high-risk and very low-risk deals, they lose effectiveness in the ‘gray area’ in the middle ranges. That’s the spot in which old-school manual Underwriting has to take over.

There are no short-cuts in Merchant Cash Advance. Develop and follow best practices, hire great people, amass and analyze your data, and create a corporate culture of respect, integrity and transparency. Guard your reputation and put in the work, and the results will come…it just takes time.

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Steven Hunter is a FinTech pioneer with the most extensive Underwriting and Operations experience in Merchant Cash Advance. Steve was part of the original team at AdvanceMe (later CAN Capital), and in his 20-year career has consulted for many others. His personal website is www.HunterMCA.com.