Of all the loan options available to small businesses today, the merchant cash advance (MCA) may not be a borrower's first choice. Like the payday loan, the MCA has a reputation for high fees, and is sometimes the only option for borrowers with poor credit histories.
"The merchant cash industry first started as a product for unbankable clients," said Andrew Mallinger, COO of PIRS Capital, in a recent interview with PYMNTS. “It was for restaurants that didn't have collateral or the credit score to apply for a bank loan.”
The rise of alternative lending and familiarity of growing names like OnDeck is beginning to shift public perception of the merchant cash advance, however.
"The lending world has evolved," Mallinger explained, adding that today, MCAs don't necessarily mean sky-high interest rates and fees. There are scenarios, too, in which a merchant cash advance may actually be the best financial option for a business in need of working capital.
"We see a lot of clients who already have a long-term equipment loan, or an SBA loan, or a loan from a traditional bank or a factoring line, and they're looking to unlock short-term liquidity from their business," he said. "When you take out an SBA loan or equipment loan, you have to have some type of collateral to pledge, and that money can dry up quickly. We come in un-collateralized."
A study by deBanked and Bryant Park Capital in 2016 aimed to assess confidence in the merchant cash advance industry, and found that 91.7 percent of small businesses in Q1 2016 expressed optimism about accessing loans from this segment of the financial services industry. Of the lenders analyzed – which primarily offer merchant cash advances – researchers calculated a 56 percent compound annual growth rate and a combined loan origination volume of $1.9 billion.
Investors are coming in to support the changing face of the merchant cash advance industry, too. Earlier this week, PIRS Capital announced it has secured a revolving credit line from an unnamed institution to continue providing working capital to borrowers, while the alternative lending space overall has emerged as a huge target for venture capitalists in recent years.
One driver behind the shifting reputation of merchant cash advances is the industry's participation in technology adoption and innovation.
PIRS Capital recently launched its proprietary credit scoring technology via the PIRScore, a technology that uses machine learning to underwrite loans based on a slew of data points. Mallinger explained that this unique insight and analysis of potential borrowers offers the company a competitive edge, which is now key in such a crowded industry.
"It's a game-changer, because we can make decisions off past data through machine learning," he explained. "The model is re-teaching itself on a daily basis, finding new trends. For instance, in December in Louisiana, is there a downturn in the trucking industry? The model can find its way down that stem of trends and make decisions based off of that."
Moving forward, he said the company hopes its technology can also take into account broader economic data. And while proprietary credit scoring models offer each lender a competitive edge, the shift toward data sharing in the financial services industry could find its way into the alternative lending and credit underwriting space, noted Mallinger.
"There are certain data points that we have to keep to ourselves, and certain things that are unique to us," he explained. "But there are other data points we would love to share, and put into a national database with all other lenders."
There are already businesses that do this, but Mallinger noted that the merchant cash advance market could be a particularly large benefactor of this trend. Because MCAs are not technically loans, and are based on predictions of future revenues, risks can be significantly greater, and fraud is a significant risk to MCA companies.
A collective database of information among lenders and MCA companies could offer red flags and warn of "bad actors," the executive said.
Data sharing isn't quite at this level yet, but as the financial services industry opens up, and as the MCA market strengthens its reputation among borrowers, the opportunity for machine learning, artificial intelligence and sophisticated data analytics technologies is vast.
"It was a struggle for the first couple of years getting the stigma off," said Mallinger. "But there are now larger lenders in this space – Wells Fargo has money in this space, Capital One, too. It’s starting to trickle down to merchants and small businesses. They're starting to understand that if it's the right fit for them, then the merchant cash advance stigma doesn't exist anymore."