March/April 2014 – Issue 2

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When Will The Bubble Burst?

By Jeremy Brown, RapidAdvance

As a long-time (9 years) participant in the MCA industry, I think we are either currently in, or are fast approaching a “market bubble” in MCA. Bubbles never end well. We all know what happened in 2008.

Wikipedia defines a market, economic or speculative bubble as “trade in high volumes at prices that are considerably at variance with intrinsic values” and “as a situation in which asset prices appear to be based on implausible or inconsistent views about the future.” What does this mean to those of us who fund small business owners every day? When I see some of the business practices, offers, terms and other aspects of our business today, I am worried. I am worried because I believe that 2008 has been too quickly forgotten, and very few, other than those of us that were on the front lines on the funding side at that time, appreciate what happened to outstanding portfolios at that time when average duration was 6 months and no deals were written over 8 months.

There is a huge amount of new money chasing MCA deals (like all of us, I use MCA as short hand for “alternative lending” which includes not just traditional MCA but daily ACH, revenue based ACH, weekly ACH repayment deals and so forth). New funding companies pop up every day. Established companies receive equity investments and get new or expanded debt facilities. And private capital is active in the marketplace. For example, we entered into a relationship last year with a hedge fund looking to invest in excess of $10mm into directly held MCA’s. We underwrite, service and assist on the originations for that asset pool. This servicing is outside of our regular funding business.

If the pool of merchants accepting MCA funding is growing at a faster rate than money coming in to buy those assets – the assets being loans and purchase and sale MCA’s – there is no imbalance and the assets will perform as expected (i.e. loss rates will be within a tolerance of forecast and so will actual repayments). An imbalance will bid up the price of the assets, for example through lower factor rates and longer terms than supported by the funding company’s risk analytics.

Throw on top of that equity investors expectation of growth and the stacking phenomenon, and things get ugly. To accomplish high growth rates, which may be driven by a desire or need for an IPO or to raise investment or to sell to private equity, assets are being overpaid for through higher than economically justified commissions (I’ve heard 12-15 points upfront from the more aggressive companies) and stretch the repayment term of the MCA or loan even further (On Deck24, I am talking about you). Stacking simply stresses out the merchants and depresses the “intrinsic” value of the assets by reducing the available cash the merchant has to repay the original advance. Assets don’t perform as originally underwritten, as the underlying cash flows have changed.

Does any of this sound like 2008 and subprime mortgages? My former CFO used to say “trees don’t grow to the skies.” The rationality that held things in check a few years ago is gone. There will be a rebalancing at some point. And it will not be pretty.

Jeremy Brown is the CEO of Bethesda, MD-based RapidAdvance.

Merchant Cash Advance Bubble

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