Are Merchant Cash Advances eating into Factors Market at Low End

When Cash Control is King

In speaking with many small factoring organizations, I am finding the biggest impact on their portfolios is coming from merchant cash lenders.

Merchant Cash Advances became popular back in the early 2000s as a way for small companies to access unsecured credit based on their credit card receivables. This was a great innovation, as a funder would underwrite future credit card receivables based on historical receivables and the funder was paid back from a percentage of days sales direct from the credit card processor. For example, a funder may lend $100K for the right to get $120K over the next 12 months by taking a small % of each days credit sales. This product became very popular with restaurants, small retailers, and others that rely on credit card sales.

Today, the product is very popular and in the last few years, has evolved into an ACH Product, which funds all revenue, not just credit card receivables. Here, the funder does not look at credit card cash flow but overall revenue. If a business has $1.2m in cash sales the funder will ACH debit for a certain percentage.

If I am a Merchant Cash Advance lender, the one big advantage I have over everyone else is first access to cash. I may be in a second or even third lien position, but that access to cash gives me an distinct advantage.

For marketplace lenders, factors, and other specialty finance companies, that first access to cash creates a disadvantage.  If a borrower takes a loan deal for an inventory line of credit or some asset based finance solution, even though they may be positioned as a first lien lender, the Merchant Cash lender has access to daily cash even though 2nd or 3rd position.  If the borrower takes on this debt and can’t afford, lenders could find themselves in trouble, particularly ones that focus on where the MCAs have their sweet spot, such as restaurants, small distributors and wholesalers, etc. Some businesses will do what is called stacking. Stacking is when the business has multiple short term cash advances. This can create cash problems.

If a borrower defaults on a specialty finance or marketplace loan and the MCA already has cleaned the account, what does the lender do? There is no easy or attractive solution –the lender may have acceleration rights with the borrower which does trigger in the event of default.  Or the lender may have the ability to enforce debt settlement.   Or they could sue the MCA for interference, but that is costly.

In the end, cash control is king.

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