It’s common knowledge that you are likely to achieve a lower cost for a product or service, by cutting out as many “players” within the ecosystem as possible and eliminating all of the middlemen who markup said products and services for profit. Nevertheless, in some cases, a middleman might actually be your source for cost savings and higher levels of efficiency than if you were to go “direct.”
This is certainly the case many times in the alternative business financing space, which is centered on products that include the merchant cash advance and alternative small business loan. As a merchant, you might actually receive better levels of service, better product placement, and better pricing by working with the “middleman” compared to initially working directly with the lender.
For this article, I wanted to discuss the benefits of working with a broker versus going direct and working with a lender, when a business owner is seeking alternative business financing.
Alternative Financing Products
For this article, in comparing the choice to work with a broker or a direct funder/lender, I’m going to make the examination strictly on the basis of the Merchant Cash Advance product and the Alternative Small Business Loan products. In case you are unaware of these products, here’s a quick recap below:
The Merchant Cash Advance (MCA): The MCA is the purchase of future credit card receivables using a cost factor with no interest rates, fixed terms, or APRs, origination fees. A purchaser (funder) would take a look at a merchant’s (seller’s) previous processing statements and note that the business has been made over 85k a month in over the last year for processing. Based on how much, the funder offers to buy 102k of future processing receivables in exchange for advancing the merchant 85k tomorrow, but will keep 20% of the merchant’s daily processing volume until the full purchased amount is collected.
- Approval: $85,000
- Cost Factor: 1.20
- Total Payback: $102,000
- Holdback: 20%
Note: As long as the merchant continues to process like normal, the full purchase should be completed in 6 months.
The Alternative Small Business Loan: This product is offered by the same companies that would offer an MCA product and is a real business loan with interest rates, fixed terms, an origination fee, etc. These terms usually range from six to 60 months, with costs from 8% to 45%. These approvals are based on about 10% of annual gross revenues, so a company doing $1 million a year in sales with a decent credit profile, might receive options for a 12-month, 18-month, 24-month, and 36-month loan offer, with the 12-month option looking like the following:
- Approval: $85,000
- Origination Fee: 2.5%
- Disbursement Amount: $82,875
- Interest Cost: 22%
- Total Payback: $103,700
- Daily Payment of $411 every business day
- Number Of Payments: 252
- Term: 12 Months
The Different Players
In the alternative financing space (similar to other financing spaces) you have both brokers and direct funder/lenders that you could submit an application package to.
The Business loan Broker would manage all of the activity involved with the sales process and submit the package to one or more direct lenders to fund your application. The business loan broker would then chase down additional paperwork, signatures, and more. Commercial brokers are compensated through marking up a buy rate that’s provided by the direct lender on the individual deal. So if you are approved for $100,000 on a six-month payback with a 1.14 buy rate, the business loan broker might mark this up by three-to-10 points (to 1.17 – 1.24) to make their revenue.
The Direct Lender is usually a licensed commercial funder who has their own vetting system, underwriting team, and criteria that they utilize to directly fund working capital requests. Some will also house internal inside sales teams to manage inbound lead sources that originate outside of the broker channel.
Pros/Cons of Working With A Business loan Broker
In terms of the positives of working with a competent broker, they can save you a lot of wasted time and energy submitting your applicant package to direct lenders that aren’t the best suited for your current risk profile.
However, speaking of “competency,” the major drawback in working with brokers is that many of them are not competent. There really isn’t any regulatory body that oversees brokers in the alternative financing attributes, so as a result, most have little industry experience, do not have an efficient network of lenders, and many use unprincipled acts by marking up buy rates too high, charging side service fees, and stealing the identity of merchants.
Pros and Cons of Working With A Direct Lender
In terms of the positives of working with a direct lender, the main positive is that you can easily verify if the entity is real, credible, and regulated. You can look up their license, usually find that they are a part of professional associations and online reviews of the firm.
The main negative is that you are handcuffed to the underwriting and approval criteria of that one firm.
As a merchant, the honest truth is that it’s almost impossible for you to know your Paper Grade and know which funder/lender in the alternative financing marketplace is best suited for your current risk profile.