The New Generation of Alternative Lenders in the Merchant Acquiring Market
The alternative lending industry, which includes, but is not limited to, merchant cash advances (“MCAs”), continues to be dynamic, influenced by innovative new players. In December 2014, OnDeck, a major player in the alternative lending industry, raised over $200 million through an initial public offering (IPO) on the NYSE, valuing the company at $1.3 billion.1 More generally, new competitors are emerging and several have risen to some prominence over the past few years as the industry has grown to an estimated $4 billion in annual fundings.
Kabbage began operating in 2010, targeting e-commerce retailers with its business loan product. At the time, most MCA companies shied away from online retailers as they considered ecommerce merchants riskier than their brick-and-mortar counterparts. To generate sales leads, Kabbage initially relied primarily on partnerships with online marketplaces such as Amazon and Etsy. Since then, Kabbage has also extended its distribution network to include partnerships with small business service providers such as Intuit, Authorize.net, Xero and Stripe. Kabbage’s partnerships also allow the company to underwrite and make quick decisions on loan applications by looking at the merchant’s business / sales history and, in the case of Kabbage’s partnership with UPS, at the merchant’s shipping history.
The Kabbage business loan resembles a line of credit. Loans typically range from $2,000 to $50,000 and are generally paid back in 6 months. Fees can range between 6% and 18% of the loan amount.
Since its inception, Kabbage has funded over $500 million to 100,000 small businesses. In February 2014, the company also started targeting brick and mortar businesses such as restaurants, beauty salons, advertising agencies, IT consulting firms and other business verticals. As part of this effort, Kabbage raised its business loan lines from a maximum of $50,000 to $100,000. In September 2014, Kabbage announced that it is now funding more than $2 million per day to small businesses, making it one of the largest alternative lenders in the industry.
Kabbage’s business model, distribution, and underwriting practices have attracted the attention of multiple investors. In May 2014, the company announced that it had closed its latest Series D equity round of $50 million led by SoftBank Capital. Earlier, in April, the company also announced a new revolving 3-year, $270 million credit facility from institutional investors.
PayPal entered the alternative lending industry in September 2013. Although PayPal refers to its “Working Capital” product as a business loan, it resembles a MCA. There is no fixed term for repayment; PayPal charges a fixed fee (not an interest rate); there are no penalties for late payments; and payments are deducted daily from merchant sales processed by PayPal.
PayPal targets its own merchant base for the product, and it is offered only to businesses that already process payments through PayPal. Eligibility to receive PayPal’s business loan and the amount of the advance are determined based on the merchant’s PayPal cash flow history, with the maximum loan amount is approximately 8% of sales volume processed by PayPal over the last 12 months–although PayPal recently increased its maximum loan amount from $20,000 to $60,000 to attract larger merchants with repayment rates that can reach up to 12% of the advance amount.2
The latest notable entrant into the industry, Square, launched Square Capital in May 2014. Square offers cash advances to existing, pre-screened merchant customers. Merchants that are eligible for an advance will receive an invitation email from Square to apply for Square Capital. Merchants will also see a link in their Square dashboard saying “View your Options” for Square Capital. As in the case of PayPal, Square determines a merchant’s eligibility and advance amounts based on the merchant’s transaction history with Square. Advances typically range from $4,000 to 10,000, with repayment rates ranging from 4% to 10% of the advance amount.3 Advances are usually paid back within 10 months,4 with payments deducted daily from a merchant’s processed sales volume.
In August 2014, Square announced that it had received a multi-million dollar financing deal from Victory Park Capital that will be used solely to expand Square Capital. In February 2015, Square’s CFO stated that it had funded $100 million in advances to more than 20,000 small businesses. The company expects the average advance amount that it provides to rise in the future as larger businesses start using the services.5
Product distribution and underwriting have always been key issues for alternative lenders and MCA providers. Traditional players use a variety of distribution channels, including referral arrangements with merchant acquirers, ISOs and ISAs; in-house and out-sourced telemarketing / telesales operations; and multi-channel media advertisement and search engine optimization, etc., all of which focus primarily on targeting the general small business and merchant population. These new players’ distribution models are different in that they rely primarily on targeting a captive audience (i.e., their own customers or customers of a very tight partner) and, in some cases, pre-screened merchants. Their underwriting is based on internal historical data, which should give the newer players a better knowledge of their target market and greater confidence around risk – although their performance over time remains to be seen. As for pricing, the lower rates offered by these newer players compared to traditional MCA rates, which range between 35% and 45%, could prove to be disruptive to the traditional MCA industry as merchants become more aware of the options available in the market.
1 Ben Fischer, “On Deck raises $200 million in IPO, valued at $1.3B at Opening”, www.bizjournals.com, December 17, 2014.
2 PYMNTS, “PayPal Puts Holiday Cash in Merchant’s Wallets”, Pyments.com, November 18, 2014.
3 Mike Isaac, “Square Expands its Cash Advance Service”, NYTimes.com, August 19, 2014.
4 Gabriel Karol, “Square Now Offering Cash Advances to Small Businesses”, Fox Business, May 28, 2014.
5 Karol, Fox Business, May 28, 2014.
Other Sources: Companies websites.
For more information, please contact Janinne Dall’Orto, Senior Manager, specializing in Merchant Acquiring, firstname.lastname@example.org.
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