My last article about alternative investing, Taking Control of your Future Finances, got me thinking: if I was to participate in a new way to invest directly into small businesses via a technological platform, what would I want to know? First, I’d want to know how it works, and second, what are the risks? This article will answer those questions about the Family Business Fund.
I have now been in a doctoral program for one year and have learned a lot about research, which has helped me both personally and professionally. Studying the risk around Merchant Cash Advances (MCA) for small businesses has been interesting. Technology has changed our lives forever, even in the investing space. We now can invest in start-up companies by way of Crowd Funding (which is a fundraising method for people and organizations utilizing social media to raise money from people and businesses you may or may not know). We can even save money and invest in the stock market by using an app that rounds off each of your purchases to the next dollar. Why not be able to help existing cash flowing small businesses to small microloans? This had to be better than watching the stock mark tank with one tweet.
HOW IT WORKS:
The Family Business Fund (FBF) is a platform that connects people who are interested in microfinancing between $5,000 and $50,000 cash advances to companies that have been in business for at least two years. The financing is on future sales, account receivables, or purchase orders and is never longer than six months. The rate of return to the micro-financer is between 20% and 33% on a yearly ROI calculation. In short, the FBF platform gives you future receipts at a discounted rate. Typically, businesses wanting faster access to their cash (as opposed to waiting extended periods of time for their invoices to be paid) will participate in this kind of transaction.
Per Deal Basis – The Family Business Fund works with four brokers only and knows exactly what types of deals are wanted on the platform, which includes “A” paper clients only. FBF’s platform does the following:
- Underwrites the deal and does all the due diligence
- Displays approved deals on the FBF platform for all micro-financer participants to review
- Once one of the micro-financer participants takes the deal, the money is transferred into the FBF trust account
- FBF closes the round of financing and collects all associated fees and payment
- The participants will receive their agreed-upon finance fee first (typically within the first two weeks)
- Weekly principle payment will be collected by FBF and placed into the participant’s fund until the completion of payments
- The participant will receive monthly updates on their microfinancing clients, principal received, and outstanding capital
WHAT ARE THE RISKS:
Since I sold my private equity firm in 2018, I was sitting on cash and wanted to use it at the lowest possible risk but with the highest return. I decided to research different options other than giving my money to a money manager and hoping for a 6% Return on Investment. The merchant cash advance industry interested me. I was able to help small business owners with a critical need: cash flow. The MCA industry operated in an abyss between 1998 and 2008 and suddenly awoke like a sleeping dragon during the Great Recession. In what is now a $20 billion/year industry, the concept of MCA is now widely accepted as an alternative to traditional financing, even if at times criticized.
Foundation Capital’s Charles Moldow believes that “marketplace lending” will be a trillion-dollar industry by 2025. “Consumers are fed up,” writes Moldow in his white paper, “Banks are no longer part of their communities.” Small businesses cannot get loans without perfect credit and a 2-year history and need to jump through hoops for 45 days. During the Great Recession of 2008-2009, when consumers and small businesses needed access to credit more than ever, many banks stopped offering loans and lines of credit.”
One of the reasons that alternative loans like merchant cash advances became so popular was because banks dramatically reduced their small business lending after the great recession. Merchant Cash Advance companies seem to have more of demand during a recession, and the default ratio (which is the percentage of payment that a lender will write off if the borrower is unable to pay their debt) also seems to double or triple during these times. Most of these companies are giving loans anywhere from $50,000-$250,000, which is almost a guaranteed default ratio between 5-7% in our current economic climate, while during a recession, it may be 12-14%. An economic recession for the Family Business Fund could project around a 3-4% default ratio (keeping consistent with a multiplier effect—spending money to make money—with another MCA).
So, the question I needed to answer was, “How do I reduce my risk?” I needed to start building financial models. By using my own money, I was able to research the best way to help small businesses succeed and reduce their risk of default or being unable to pay off their debt in full. The following are my findings about how the FBF reduces risk in the Merchant Cash Advance industry.
- Underwriting, underwriting, underwriting – This is the key to success. The owner and CEO of the Family Business Fund was a credit risk analyst for one of the top five banks in New York City. She has invented a process using technology that gets smarter with each financial transaction and in turn has reduced the default ratios significantly in comparison to national averages.
- Educating the business owner – I learned that educating the small business owners on the amount of cash they want compared to the amount of cash they need, was much appreciated. This is not done by any of the other Merchant Cash Advance companies, as per our customers feedback.
- Amount of financing – I have learned that most of the other Merchant Cash Advance companies will not finance any client under $50,000. That is FBF’s sweet spot. By only financing $5,000 to $50,000 (the average is $15,000 currently), the payments are affordable and easy for the client.
- Time Frame – I studied three of the biggest Merchant Cash Advance companies in the country and found out that when they extended their payment plans to over 1.5 years, their default ratio increased significantly. Therefore, the Family Business Fund will never extend financing for over six months.
These are very interesting times for me. Supposedly, I’m in semi-retirement, yet I started another company. I love sharing my knowledge and helping others, which is exactly why I write these articles. The Family Business Fund has been helping my family and friends to very good returns on their money, that are normally only enjoyed by accredited investors. As we know, in life there is risk in everything we do, and nothing great comes without some risk.
If you are interested in learning more about our platform www.familybusinessfund.com, please feel free to email or call me directly at (904) 583-3123 or douglas@familybusinessfund.com
