The coronavirus outbreak is shutting down our service economy. Besides the usual suspects — restaurants, bars, gyms, etc. — we have a whole host of products and services where demand is collapsing:
|Media Content||Athletes, Artists, Musicians, Performers|
|Business||Temporary Staff, Translators, Testers, Developers, etc.|
|Content creative||Writers, Photographers, designers, etc.|
It’s tough sledding when demand is vastly reduced or just plain stops.
One area where we won’t see declines is around digital commerce. As widely reported, Amazon announced plans to hire 100,000 warehouse workers. Many of the sellers on these platforms will be in need of cash to survive or to meet demand, and thus keep workers paid, including employees and gig workers.
While merchant cash advances (MCAs) may not be the cheapest form of generating quick cash flow, they are fast and are not a loan, but a sale of future receivables.
Early days of MCA
Back in the Wild West days of MCAs, around 2006, when a laundromat or pizza shop needed a quick $20,000 to buy equipment or expand a patio deck, they used MCAs. And the MCA lender would typically take 10% of every credit card swipe on a daily basis to return principal plus profit.
At that time, almost all companies borrowing were brick and mortar. MCAs became very popular with restaurants, small retailers and others that rely on credit card sales. There were upward of 80 competitors in 2007, and only around five of those survived following the Great Recession — OnDeck and Rapidadvance to name two. When banks shut down their small business financing in 2008, it was hard for those businesses to get a loan. Merchant cash advance products evolved and helped fill the void.
How MCAs fit in the U.S. regulatory framework
Because MCAs aren't considered loans but future receivable purchases, states don’t regulate how much lenders can charge companies with usury laws. Merchant cash advance companies use something called a factor rate to determine payback, and factor rates usually range between 1.2 and 1.5 of the amount borrowed. APRs can be determined and can range from 70% to 200%, so yes not a cheap form of credit.
E-commerce and MCAs
Today, e-commerce is a big driver in MCAs for one simple reason. When you can market direct to merchants, such as Square or Shopify or PayPal, you have a serious competitive advantage. Marketing can include text messages, point of sale finance offers, emails, etc. Customer acquisition costs for MCAs skyrocketed, from $225 in the early days to where costs have grown to $3,500 to $4,000.
This put those companies that provide B2B payment services in a competitive advantage given they have a direct relationship with the merchant. Companies like Square, Shopify, Stripe and PayPal have rapidly expanded into this space. Square loaned $1.6 billion late year, and since its public launch in May 2014, Square Capital has facilitated nearly 1 million loans and advances, representing over $6.3 billion. Shopify Capital is on pace to do more than $2 billion this year, and PayPal is No. 1 at $4 billion. Shopify Capital offers cash advance amounts of $200 to $1 million.
Marketplaces will continue to prosper, especially as brick-and-mortar small business suffers greatly. Can MCAs potentially help some segment of the SMB economy during the coronavirus pandemic? For sure. When you look at other potential solutions out there, they fall short:
- Supply chain finance is not really impacting the small business customer base — and also faces serious threats of credit downgrades.
- Procure-to-pay (P2P) systems, with early pay finance, (including dynamic discounting) only finance invoices on their platform.
- Network-based factoring replacement models have not yet scaled.
- Receivable auctions have not taken off to any degree.
- Blockchains tokenized invoices and new forms of payable and receivable finance using blockchain have a ways to go.
My only hope is that lenders in this space find ways to make this funding technique more affordable given the lack of usury laws.
David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital. He can be reached at dgustin (at) globalbanking.com.