The merchant cash advance (MCA) industry does not always come with a solid reputation. Much like the payday lending industry for consumers, MCAs can provide businesses with much-needed cash to keep their heads above water. However, it comes at a price (often in the form of sky-high interest loans), and sometimes, that price can be too high to handle.
MCA firms recollect loans by taking a percentage of a business’ daily earnings, plus interest. Unless a company can be sure that it will have enough income every day to support this repayment plan, this type of financing can be incredibly risky for SMEs.
Considering the industry’s notoriety, launching a new merchant cash advance company is a leap. But one of the newest market entrants, SOS Capital, is rewriting some of the rules of the MCA by placing the borrower at the top of the priority list.
In an interview with PYMNTS, SOS Capital Founder and CEO David Obstfeld offered an honest assessment of where other merchant cash advance firms go wrong and how to reshape an industry around the business borrower.
One common critique of the MCA business is the high cost of borrowing. According to the Federal Reserve in its 2015 analysis of small business lending, micro-businesses are more likely than larger companies to use a merchant cash advance service to access financing. But with smaller operations, finances can be tight, making loan repayments a burden on cash flow.
According to Obstfeld, using brokers to find and sign deals with borrowers can significantly increase the ultimate cost of a loan for a business.
It’s an issue the industry as a whole faces, he added. “Many other companies like myself are in the same position,” Obstfeld said, adding that high brokerage fees have led a shift in the MCA sector that sees players launching their own sales teams to reach borrowers directly.
With that in mind, SOS Capital is taking a new direction.
“Right now, we get all of our deals from brokers,” Obstfeld said. “But we’re trying to obtain customers through direct marketing; if they come to us directly, we’ll be able to provide cheaper capital.”
Roping in business borrowers directly will not only decrease the cost of a loan, but it will also mean SOS Capital gets more face time with its clients. Obstfeld explained that, in anticipation of this, SOS Capital is working on rolling out a slew of new features and services aimed at boosting the customer experience.
The first of these, rolled out earlier this month, is Free Money Mondays — a promotion that sees Obstfeld himself choosing one small business loan applicant every Monday to receive interest-free funding from the company.
The initiative is all about getting customers into the door. Looking at the rest of the year, the CEO said that SOS Capital will be focusing on customer retention.
“We’re working on improving our website to be more friendly and more simple,” he said. “We’re going to add more features to it.”
One of those features is access to resources like free accounting services for business borrowers, which would provide customers with an accountant for tax and money management advice.
Obstfeld admitted that, considering SOS Capital is still a startup, the company is juggling multiple concepts at once and has not yet organized a set timeline for the rollout of these features, though he hopes they’ll emerge sometime in 2016. Still, keeping these goals in mind is key to steering the MCA industry back in the right direction.
“As the industry becomes more competitive, everyone is going to lower their rates,” he said. “But eventually, it’s not going to be profitable, because this is a high-risk industry. I honestly believe that the way to differentiate from your competitors at that point is to offer different kinds of resources.”
But SOS Capital will be taking another approach to improving relations with small business borrowers, too.
While brokers can spike the cost of capital for business borrowers greatly, Obstfeld said that the MCA industry doesn’t have to do away with brokers altogether.
SOS Capital is working on another venture that collaborates with brokers. “When a broker sends us a deal now, we send him the offer, and he has the right to upsell that deal by 12 points commission,” the CEO explained. But a new initiative would see that commission limited to 8 percent, because SOS Capital closes the deal itself. “This way, we provide cheaper capital,” he added.
Building relationships with brokers and moving closer to small business borrowers will be key not only to SOS Capital’s success but to improving the reputation of the MCA sector overall.
That’s a smart move as regulators begin to eye the alternative lending market and as the industry moves to stay one step ahead of those regulators by initiating its own customer protection ventures.
One such project is the Small Business Borrowers’ Bill of Rights, a set of guidelines for lenders, created by lenders. Released last year, the Bill of Rights is largely directed towards the MCA community.
But the industry has a long way to go before SMEs are fully protected. As regulators continue their inquiries into the alternative lending market, the Fed’s 2015 small business lending report found that just 15 percent of small business borrowers are satisfied with their experience seeking funding from an alternative lender, compared to a 90 percent satisfaction rate with traditional banks.
That doesn’t deter Obstfeld, however, who said that, so far, small businesses are pleased with their experience at SOS Capital and that merchant cash advances can prove a more adequate financing option for SMEs.
“At this time, we’re much quicker than banks,” he explained. “Banks don’t see it profitable to fund deals under $1 million.”
And with about 5,000 different data points used to assess a potential borrower and mitigate risk, Obstfeld also pointed to efforts that safeguard and reduce the cost of the MCA process for everyone involved, especially the small business customer.