Some people in their 20s try to think about how they can build enough savings to move out of their parents house. Others, like David Gens think bigger by thinking about how to disrupt traditional financial institutions with tech driven alternative lending. David, who comes from a family of entrepreneurs has always been ambitious but building Merchant Advance Capital, which is now one of the largest alternative lending solutions for SME businesses in Canada was likely one of the largest challenges he has taken on.
About eight years in and he has proven that with a measured approach and creative problem solving even the most unproven individual can do big things. He has also built an incredibly formidable and industry leading lending solution that suits the needs of small businesses across Canada.
Check out our discussion below and see how David and his team are reinventing small business lending and in turn small business building for the better through applied technology.
CL: David since you were right out of college, you have been working in PE and banking positions, and then started Merchant Advance Capital at a very young age. So what led to the decision to found this company?
DG: I grew up here in Vancouver in an entrepreneurial family that really provided an amazing set of role models and I always had the entrepreneurial gene in me. This gave me an opportunity to see firsthand all of the challenges that come with running your own business from having to work all the time to being incredibly stressed. But, I also saw it as the more rewarding path with lots of personal and monetary reward when you succeed.
I ended up studying finance at UBC and then started work for a PE firm in Vancouver called Canadian American Investors (CAI). It was a terrific experience and I learned a lot about how to analyze a business and model cashflows. It was during this experience in 2009 that I first heard about merchant cash advances, and started to hear about the initial rise of online lenders such as OnDeck that were just getting started.
I studied the space a bit and felt that from a return standpoint serving the small business merchant advance capital space was attractive and the tech component really drew me in. As I mentioned earlier, many of my family members were entrepreneurs and several of them happened to be in tech so it was something that always interested me.
CL: So in your early 20’s you decided to start building this business. What was your approach with such little experience and likely capital?
DG: Though my computer science classes really didn’t stick from college I figured I could hire the developer talent to build the tech. Being in my early 20’s I took a bit of a boot-strappy approach to building the business. For instance, I worked with my old man to build the platform, and we built a simple system at the beginning to get it off the ground at the lowest possible cost. We actually formed the business with an LP model similar to an asset management model, which makes us a bit different than other companies in terms of how our balance sheet is structured.
In March of 2010, we wrote our first loan, and since then we have always been profitable. We never ran losses, and we only spent the money we could afford. We didn’t really start adding more staff until we were 24 months into building the business. Today we are about 45 people in Vancouver and Toronto, and have funded about $120M since inception. The numbers continue to grow and performance continues to stay strong.
Today we offer a whole suite of products from fixed payment, to revolving line of credit, to equipment leasing loans. Now, we can really offer small business pretty much everything they need but we have only added products and built the business as it has allowed us over time.
Though the space has become more competitive in recent years we have a well sized business, especially in Canada, and we are now trying to reach more businesses that haven’t heard of us.
CL: For those that don’t know can you define Merchant Advance Capital as a business?
DG: We provide funding based on a business’s cashflow. That is core to what we do. In the banking sector, businesses can only borrow based on collateral assets that they have to back the loan. But most SMBs don’t have the necessary collateral to meet a banks standard. We instead focus on whether or not you have cashflows and customers paying for your services in order to determine your viability to pay back a loan.
We do this by reviewing bank statement, online reviews, geographic data and information about the business that we gather on the backend. We combine this data into a statistical scoring model with a keen eye for consistent revenues coming in the door. That to us signals a healthy business that is worthy of being provided capital.
CL: Merchant Advance Capital was started in 2010, which was really early days for innovative loan marketplaces like this. Did that timing present challenges for you early on and how is that helping you to be a market leader now?
DG: It was challenging to raise money in the early days no doubt about it. We also had the added challenge of me being in my early 20s with no track record of my own. I am super thankful to my early investors that at the time probably thought I was crazy to be entering such a largely unproven space.
I only had a couple examples to point to, so getting the money from investors was challenging and frankly providing loans to borrowers was also challenging. We faced skepticism from both investors and borrowers. There was lots of hesitation then around the online lender space especially in the SME markets.
I would say we got through that period with hard work, but we were small for the first few years and we grew measured for a while until the space started getting better coverage and people started to trust it more. But when it comes to building a lending business I’d say being first really helps. If you can build a book of clients before others can build a bigger business you give yourself a nice market position to grow from.
CL: How is Merchant Advance Capital structured in terms of offering its loans? Does the organization hold all the loans on the balance sheet or are you selling these loans to other investors?
DG: We deploy a Limited Partner (LP) model, which is different than a corporation model. We essentially have a pool of capital and act as a management company that passively manages the fund. But that is essentially a balance sheet of its own. When we have loans that are too large for our fund, then we syndicate out portions of those transactions, otherwise we hold it.
The fund itself pays the operating expenses of the business. The LPs that invest in the fund care about how our loans perform and how we operate because that impacts the returns for them.
CL: In the US there are several different loan marketplaces for serving the small business loan space, each with unique offerings be it a line of credit, an advance, etc., yet Merchant Advance Capital has decided to be a marketplace for all of these offerings. Why have you undertaken this strategy and what benefit does this provide to the end user?
DG: We really ask our customers, what do you want and need. Though it sounds simple and cliché it really is at the core of everything we do. For instance, we recently started an equipment leasing division, which is our most different division from the rest of our business. But, we saw our merchant base already had some leasing going on and could likely use more of it. We thought why not play that role if that is something our customers need?
And to be clear we are measured in our approach. When we decided to pursue this line of business we brought on an individual who was a total expert in the space for a long time, which gave us the management power to take this on without distracting from the rest of the business.
Our thesis for entering this business line was that our customers would use this product and it would be better than what they are finding in the market. We also felt that it would work in the opposite direction in that they would find our leasing product and end up using other products of ours as well. The strategy is working for us in both directions.
One thing that differentiates us is that I take a very long term view to the business. When you think about building enterprise value quickly for a sale or raise you become more limited in the ability to build different lines of business that may detract from near term enterprise value. Having so many lending activities may actually be less saleable in the near term, but we aren’t looking to sell.
CL: What types of businesses do you define as your core user and what is the main reason that you find they come to Merchant Advance Capital instead of a bank or elsewhere?
DG: The core business as I mentioned is financing based on cashflow and what we find is we end up financing a lot of storefront businesses. Typically, our clients are in the B2C environment, and run storefront mom and pop businesses. Though they have cashflows, they don’t necessarily have a lot of assets.
All these restaurants and retail stores struggle to obtain a lot of unsecured financing from traditional institutions, which is why they end up coming to us. The way we differentiate against competitors directly, is we work to be incredibly transparent in the way we do business. It is an unregulated space and one where borrowers in the past and present find ways to take advantage of business owners because they have the latitude to do so.
From the very beginning we saw this happening and vowed never to do that. We always keep the business owners in control at all time. We also differentiate through our continuous investment into better, faster technology to create an experience that is as frictionless as possible.
CL: Why did you decide that focusing on retail businesses more specifically was the best place to focus, and what benefits are there to providing a loan offering to seasonal businesses?
DG: Our business started with one product being the merchant advance product. This product naturally led us to these retail businesses that are predicated on customer purchases through debit and credit. As we have increased our product offering we have also seen a growth into other types of customers such as B2B businesses, but the majority continues to be the storefront business environment.
The seasonal business is super relevant to Canada, especially for storefront business because they get killed in winter, shrink in the fall, see a Christmas bump, and then slow in the first quarter. These significant moves in revenue with constant fixed cost and rent creates an environment that needs cashflow management tools.
We find increased demand for services in the first quarter of each year based on that dynamic. One thing we provide to our customers is we allow them to pay us more during the busy seasons and less in slow seasons to help them manage their finances better.
CL: In taking on these higher levels of risk with a business consumer that doesn’t necessarily have high levels of collateral, how do you utilize technology to make smarter loan decisions?
DG: As I mentioned earlier we provided our first advance in March of 2010. At the time, it was a manual human process. In 2014, we started using statistical methods to make decisions. This required building up huge data sets that we could rely on to give us answers on underwriting decisions. Since 2014 we have been refining that model. What it allows us to do is be faster and do a better job of allocating capital to businesses and be more price competitive.
CL: Recently Merchant Advance Capital partnered with EVO Payments International to provide their customers with a more seamless way of obtaining a loan. Can you tell us about this partnership and how it will work for customers?
DG: EVO essentially offers our product to their merchants. We are a very partnership driven business, which takes a variety of forms from high to low integration. In some cases, our partners may makes some outbound sales efforts, and in other cases we may provide API integrations, or even cobrand an experience.
EVO is an example of a great partnership where we provide a simple integration and they pitch their merchants on the types of loan offerings they prequalify for with us.
In the future, we are working on partnerships that will enable us to provide a loan offering that looks and feels like Square Capital.
CL: In addition to utilizing partners to help grow the Merchant Advance Capital business, what other scaling techniques / customer acquisition strategies have you utilized to grow this business efficiently?
DG: Largely, we have been partner driven. We have done other things like advertise online and we have our own direct sales office as well but where we hit our stride is serving our partners really well. We are constantly talking to more potential partners. It has been fairly crowded in the online advertising space, as companies have started to stretch their budgets on customer acquisition so we have pulled some of that back.
At the end of the day we want to make money for our investors every year. If the economics don’t work we won’t chase it. But the right partner has been worth investing in for us because they have provided a powerful channel for growth once we invest in onboarding them.
CL: Are there any specific challenges to building a loan business like yours that you think differs from that of a US based business?
DG: Canada is about a 10th the size of the US market, but when it comes to alternative finance, the average Canadian borrower looks very different from a US borrower. In the US half of consumers are subprime. In Canada the majority are prime borrowers, so it is a different profile on average. This means that more of the market is captured by the traditional banking system because more people fit the profile of a banking customer.
Adding to that, the banking sector here is actually pretty strong and many of the big banks do a decent job of providing an intuitive online experience. As a result, in order to have a big enough business here to pursue you can’t just focus on one niche. In the US you have many lenders doing one specific thing in alternative finance, but you couldn’t survive here with that approach based on the limitations of our market size.
CL: In the past you have discussed the challenges of managing regulation in Canada. What are some improvements you would like see be made in the small business loan space to help businesses like Merchant Advance Capital to thrive?
DG: I think where Canada has really lagged the US but starting to play catch up is on the securitization side (The raising of money). It took a really long time for any true peer-to-peer model to work here. That has been very provincially regulated in Canada. Every province is different making it almost impossible to implement the P2P model here.
Now the Ontario Securities Commission and others are working to fix that issue. We have always focused our efforts on raising through our LP fund from friends and family and other accredited investors, but it would be extremely beneficial to be able to raise more broadly with ease. Right now the amount you would have to spend to do so legally and meet all compliance obligations is just too much. They can really streamline that process to make running a business like ours easier in Canada.
The Minute Rundown with David Gens
CL: If you could provide one tip to someone considering starting up what would it be and why?
DG: As a general note, I would say I have written about this in a blog post here or there, I am of the opinion that you really do need to prove you can make money. In my eyes, you don’t really have a business until you can be self-sustaining and make money every year.
You see in any space that gets hot and raising equity gets easy, you do what the equity markets wants at the time, and what they want to see then is growth over earnings, but inevitably those trends fade and equity funding becomes more difficult. We have been profitable from day one, and if you look around this space there hasn’t been a lot of that. I’ve seen a lot of people raise a lot for big vision and in process burn a lot of capital. We know in many cases, you will fail many times before you succeed.
In a small market like Canada there are few individuals to raise from and you will be hard pressed to find someone to raise your next venture round from so you need to be prudent and careful with spend. I think across the whole venture and entrepreneurship space the dialogue around building businesses needs to be more about self-sustainment.
CL: Since you are also an investor in several startups, what other startups or themes in Canada excite you?
DG: I think there is a lot of exciting stuff happening in Fintech. I have an investment in a company that is really streamlining the equity research process for asset managers, to help model cashflows and forecast to help investors make investment decisions based on that.
Also, AI is something talked about a lot. I invested in one that applies AI to how you interact with banks and investing, through text messages, and Facebook messenger utilizing AI bot. I think that if you look at banks and you look at all of the customer interactions that exist there is a lot of room for improvement. There are all sorts of ways that Fintech can be applied and we are just beginning to scratch the tip of the iceberg.
CL: If you could model yourself after one founder who would it be and why?
DG: I have always looked up to Warren Buffet. I think that is where I get my slow and steady approach. He has taught me that you don’t have to take too much risk if you take a long term approach. He has proven that you can have long-term success with this approach. That is where I get my mindset from. Though I’m applying technology to loans, I still take a lot of those lessons to heart.
It’s not often in this day and age that businesses can tout being profitable from day one. The fact that David has been able to pull this off while building meaningful share of the Canadian SME lending space is something that many other businesses can learn from.
I also think it is important to highlight a lesson I learned time and again in consulting that David has highlighted nicely here. Thinking that you can apply the same type of business model in Canada as you can in the US is foolish and should not be attempted. He and his team have not taken a niche focus for their business because the Canadian market is too prime to be able to support itself with just one unique loan product.
My takeaways from speaking with David; Be a first mover to keep customer acquisition cost low, know your market and find ways to save cost and be self-sustaining as early as possible. Awesome work David. I look forward to watching your truly Simple.Innovative.Change proliferate.