By Patti Murphy
The Takoma Group
The merchant cash advance business has been attracting attention lately in the form of equity funding, new ISO sales opportunities and stories about unscrupulous lenders. What we're witnessing, I believe, may be the early signs of an industry shakeout.
I don't mean this in a bad way. The annals of business are filled with tales of hot new products (or as in the case of the Internet new venues) attracting hordes of prospectors until the market takes a hit.
Three years ago, only a few companies offered cash advances to merchants. Today, at least 50 companies offer them through the ISO/merchant level salesperson channel, said Paul Martaus, an Industry Consultant who recently completed syndicated research on the merchant cash advance phenomenon.
To the casual observer, merchant cash advances might seem like loans. But providers insist that's not the case.
Here's how it works: The cash advance company purchases a portion of a merchant's future credit card sales at a discount, typically 20% to 30%. For example, a merchant might get $7,500 on a $10,000 advance.
In exchange, the merchant authorizes the cash advance company to take a cut of its daily card receipts directly from the processor that clears and settles the merchant's card payments. Once the agreed-to obligation has been met (typically in a year or less) the automatic deductions stop. That is, unless the retailer agrees to another advance.
AdvanceMe Inc., for example, claims 78% of customers return for additional funding. Some industry experts warn that renewal rates of this magnitude suggest an economic fragility among merchants using cash advances, a fragility that could become more pronounced if the economy slides into recession.
Marc Abbey and his associates at First Annapolis Consulting discuss this possibility in "Recession may roil acquiring risk," which was published in The Green Sheet, June 11, 2007, issue 07:06:01. They suggest restaurants might be hardest hit.
"[C]ash advances likely divert on the order of 10% of the merchant's cash flow. For restaurants, this represents 60% of their gross margins," they wrote.
In a statement released earlier this month, AdvanceMe said it gets reports regularly from merchants about "unscrupulous funding companies" destroying small companies with unexpected rate hikes, "dog piling" cash advances on top of one another and outright fraud.
"These predatory companies taint the entire industry," the company complained.
AdvanceMe wants the industry to come together to work on standards and best practices for cash advance companies to follow to avoid tarnishing the industry and, hopefully, fend off government regulation.
The company, which has been making cash advances to merchants for about 10 years, also said it is willing to share some of the extensive data it has collected to assist in identifying and preventing abuses. To that end, AdvanceMe is willing to share a white paper that delves into best practices such as "Do not harm the merchant customer" and "Do not harm the industry."
According to the white paper, responsible funding means knowing your customer and using commercially reasonable efforts to ensure that your funding does not harm the merchant's business.
"Every business has a maximum percentage of its gross revenues that it can afford to pay each month against any financial obligation (the safe retrieval percentage)," the paper notes. "If the merchant has to pay more than that percentage, it risks going out of business."
Glenn Goldman is Chief Executive Officer of AdvanceMe's parent company, Capital Access Network. He said AdvanceMe believes responsible cash advance "providers care about their merchants, as well as their partners, and strive to protect them and ensure their success.
"We have taken a stand in the hope that the industry will come together to set a high level of expectation."
Today's discourse over merchant cash advances echoes discussions about pay-day loans and, before that, the chains of check-cashing storefronts that began popping up in middle class neighborhoods. It reflects the natural hesitation of traditionally conservative banking types to deal in what Martaus describes as "grade B paper."
Cash advance worked for my cousin's husband, Joe. For the past few years, Joe has been running a bar/restaurant in an upscale Washington, D.C., neighborhood. He once told me that he might not have made it through the first year had he not been able to get a cash advance based on credit card receipts.
But, as with any business with lucrative cash flows, the merchant cash advance space has attracted some folks who want to make a quick buck without regard to the consequences to them, their customers and the market overall.
Check cashers had a similar problem in the late 1980s. Some companies, for example, would take a 20% to 30% bite out of customer paychecks. The initial result was state laws and regulations restricting fees for check cashing, and talk of federal legislation.
So, some of the largest chains got together and set up a trade association, the National Check Cashers Association, which is now known as the Financial Service Centers of America.
FISCA spent time lobbying, but invested more efforts into educating the public and the check cashing community on how to use services responsibly. Today, check cashing houses are pretty much considered mainstream, with minimal state oversight.
Payday lending companies were not as successful in fending off government watchdogs. Several states have outlawed these cash advances; federal bank regulators are scrutinizing more closely banks that make these loans; and last year, Congress passed a law restricting payday loans to military personnel, capping rates at an annual percentage rate of 36%.
It's really all about education. An educated customer is a happy customer and is more likely to be a repeat customer. Any shakeout that occurs is less likely to impact companies that work to keep the industry free of unscrupulous participants.
And as with any customer-facing business, treat customers with respect.
Patti Murphy is Senior Editor of The Green Sheet and President of The Takoma Group. E-mail her at firstname.lastname@example.org.
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