By Chad Otar
Providers of merchant cash advance (MCA) services are involved in one of the riskiest types of alternative finance. This is due to the way in which repayments work. If the provider fails to correctly predict card sales for the borrower or the merchant goes out of business, the provider of the MCA will be left out of pocket.
Therefore, for businesses involved in the alternative finance industry, particularly merchant cash advances, it is important to understand the best practices for offering this type of borrowing.
Risk analysis is a fundamental practice in alternative finance. MCA borrowing is risky at the best of times. This is because there will be no set repayment cycle on the borrowing. Thus, an MCA provider needs to know how to analyze the risk of various companies. This means considering the borrower's:
With larger amounts of borrowing, an MCA provider may even want to carry out site visits before approving the lending.
A good MCA provider will have a rigorous set of lending standards in place. You can think of this as a checklist to help determine whether a business can receive a merchant cash advance.
New MCA providers may have to spend a little bit of time coming up with their own lending standards. This means thinking long and hard about what makes a good borrower. It's also essential to keep in mind that once they have standards that seem to be profitable and deliver returns, they need to stick to them.
By having set lending standards in place, it is much more likely that a provider will lend cash to a business that can reasonably pay it back.
Companies enter the MCA industry all the time. However, very few survive. This is because many new MCA providers lend to almost everybody. This is a bad practice and one that absolutely needs to be avoided.
MCA providers need to make it a practice to say no to risky borrowers. Contrary to popular belief, the profit margins in the MCA business are not all that high. This is because the cost per customer acquisition is huge.
This means providers should avoid handing cash to businesses that do not meet their risk analysis standards. In many cases, this means only lending to established businesses.
It is vital for MCA providers to keep in touch with their customers, particularly when the customer doesn't seem to be meeting the projections for repayments. By making it a standard practice to keep in touch with customers, the MCA will be able to stay on top of the reasons why the money is being returned a little bit slower than anticipated. An experienced MCA provider may even be able to provide assistance to get the repayments back on track.
Many MCA providers also report that by keeping in touch with their customers, the customers will be less likely to cause issues. They may even be more likely to use the services again.
Alternative finance is a risky business. It becomes even riskier when a provider doesn't take steps to mitigate their risk when lending. All it takes is employing a few of the best practices, and MCA providers can become profitable companies.
Note: I referred to the following while researching for this article: https://docplayer.net/10416697-Best-practices-for-merchant-cash-advance-providers-assessment-of-risk.html and https://fundbox.com/resources/guides/merchant-cash-advance.
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