How Long Can MCAs Avoid The ‘Loan’ Label?

For small businesses, especially with the rise of alternative lending platforms, there are a myriad of options for financing, each type of loan product incorporating its own underwriting and risk management process for lenders.

The merchant cash advance (MCA) is just one category of SME financing but one which, according to investment bank Bryant Park Capital, includes some crucial differences than its other SME financing cousins.

MCAs are not considered to be loans among regulators and, therefore, are not subject to the same legislation that governs other kinds of small business financing products.

But the market for this short-term financing tool is shifting, according to a new report on the MCA market published by Bryant Park Capital this month. As regulation evolves to adapt to an influx of SME lending products and technologies, the bank said authorities could change the way the merchant cash advance is overseen.

And as the volume of MCAs increases, players in this industry are diversifying their offerings for small businesses in need of capital. The typical merchant cash advance — which can land quick cash in a small business bank account, usually for immediate purchases, like equipment or operational costs — may soon be seeing some changes in the U.S. market, Bryant Park Capital said.

A Burgeoning Market 

The bank released its first-ever “Merchant Cash Advance/Small Business Financing Industry Report” earlier this month in an effort to gauge the growth of MCAs.

According to the research, the volume of merchant cash advances provided to U.S. SMEs has steadily increased over the last couple years, projected to reach $15.3 billion in 2017, up from an estimated $8.6 billion in 2014.

[bctt tweet=”The volume of merchant cash advances has steadily increased.”]

This growth, like many alternative financing products, can largely be attributed to economic changes in the country, according to BPC CEO and Managing Partner Joel Magerman.

“Given the tectonic structural shifts in the space, with the traditional large banks retreating from small business lending, merchant cash advance companies and other small business lenders have stepped into this void making capital to small businesses available at great speed and efficiency, albeit at a higher cost of capital, enabling them to do so profitably,” he explained in a statement.

The MCA’s appeal to SMEs can be attributed to several factors. According to BPC, the approval rate for this financing option stands at nearly 50 percent. Funding can land in a business’ bank account within just a few days.

The industry has also developed unique credit underwriting and collections technologies, the report noted. Small businesses can typically repay their MCA via ACH transfers from their bank accounts or repay via a portion of their credit card sales on a periodic basis.

Implications Of A Shifting Market

According to BPC, the MCA is largely believed to have emerged in the market soon after the rise in credit card use; CAN Capital, formerly AdvanceMe, is often considered to be the first merchant cash advance provider, having launched in 1998.

Over nearly two decades, MCAs, which initially resembled small business loans and included loan-like documentation that required borrowers to provide personal guarantees, have shifted away from characteristics of other loan products, the report said.

But according to some analysts, the MCA industry cannot escape the threat of regulation that hits other loan products.

BPC pointed to legislation, like Dodd-Frank and Basel III, that actually led to a decline in traditional bank lending to SMEs and helped the MCA industry rise up. However, the report found, the merchant cash advance market remains relatively young, and legislation may force the industry to take new directions in the coming years.

An influx of market competition has also begun to mold the MCA sector. Players like Square and PayPal, which are now offering their own financing services, mean squeezed margins.

Plus, while MCA players are largely in favor of allowing SMEs to stack their financing products — that is, to take out another merchant cash advance when they are already financed by one — more than half of small businesses surveyed by BPC and deBanked in a recent report do not support stacking.

Today, Bryant Park Capital said, these market changes have largely steered MCA companies to diversify their offerings. This means offering loans, revolving lines of credit and other services, as well as shifting their strategies — offering cheaper interest rates and stricter underwriting tactics.

Still, even with these shifts, the bank found that most MCA players are expecting more than 25 percent annual growth rates. With such rapid expansion, the report concluded, 2016 will be a particularly eventful year for the merchant cash advance as competition, regulatory threats, diversification and demand all heat up.