National Funding CEO: Small Business Loan Market Is in ‘Hypergrowth’
About seven years ago, David Gilbert, president and CEO of small-business lender National Funding, was at the helm of a company struggling to stay afloat. The financial crisis sent some of its partner banks heading for the exits. Business had dried up, and the company was forced to cut staff.
Today, Gilbert faces a different situation. As the economy has strengthened, National Funding has joined other alternative small-business lenders in the scramble for innovative ways to meet robust demand for small-business loans.
National Funding began in 1999 offering equipment lease financing to companies in construction, manufacturing and the automotive industry. As demand for small business loans picked up over the last few years, the company expanded into new areas, including working capital loans, merchant cash advances and credit card processing.
In an interview with NerdWallet, Gilbert discussed the opportunities National Funding is exploring in a small-business loans market that he says is in a period of “hypergrowth.”
NerdWallet: How did National Funding get started?
We started in 1999, and I was inspired to start it because I really just like business, and to be on the finance side of it. We started primarily as an equipment leasing company focused on financing equipment that was pertinent to small businesses. We did that for nine years until 2008. When the markets started to turn, we went from primarily only doing equipment leasing to becoming an alternative lender and focusing on the working capital needs of small businesses in addition to equipment purchasing needs. We got into the alternative lender sector and started to really focus on the different niches within alternative lending. We started offering cash advances, then we migrated to the daily payment loan sector. Now our company is focused on four primary areas from a product perspective. We lease equipment. We purchase future credit card receivables. We do alternative daily payment loans, and we also do credit card processing.
We’re working now on new niches and new products. We just opened up a middle market division [for] loans of between $250,000 to a million, focused on bigger companies that have working capital needs, tailoring more of a weekly product from a collections standpoint.
All companies are basically undercapitalized and underserved right now in different ways. So you’re seeing a rush of alternative lenders filling this void.
What are the most popular loan products of National Funding?
We offer short-term working capital loans, merchant cash advances and equipment leasing.
Working capital has been the product most in demand right now, as businesses look to meet various shortfalls in cash flow. Working capital is based on a company’s cash flow as shown on their bank statements, and used for a short term cash need (payroll, taxes, advertising, salaries, etc.). It’s a daily payment loan debited from the company’s checking account, which provides predictability and makes it easier for the owner to forecast and manage payback.
A merchant cash advance is an advance against future credit card receipts, offering cash to the owner to meet short-term needs. We look at the credit card statements to determine how much credit card sales are done at the business, and then advance against a percentage of that. The owner then pays back a small percentage of each credit card sale for a several months until the advance is paid back.
Leasing is somewhat different in that it is longer term — typically 3 to 5 years — and is a loan for the specific purpose of acquiring a piece of equipment. “Equipment” is a broad definition. It could be a truck, computer, medical equipment, stove, or even office furniture, and is a monthly payment.
What kinds of businesses borrow from National Funding?
Our clients are typically quite small and relatively new to the marketplace. Often they cannot get money from their bank because the bank’s requirements are too strict or, what we have found lately, the loan is just not big enough for the bank to make money on it. Banks seem to be focused on deals bigger than $1 million, and our average deal is $30,000. Sometimes their credit is not as good as what a bank requires; we can do the transaction because we look at other factors, such as daily cash flow. We don’t ask for financials, and we don’t ask for business plans, as a bank might — most small businesses don’t have that type of paperwork, so they can’t even begin conversations with a bank. We see demand across hundreds of industries, but our core is in construction, specialty trades, trucking and restaurants.
Could you give an example of how a working capital loan works? Let’s say I’m an owner of a car wash needing $50,000 in financing. How do I go about it? What will the terms be like?
We base our decisions on the customer’s cash flow more than on credit. It is a short-term loan, typically about 9 months, sometimes shorter, sometimes longer. If bank statements show that they have steady income of a certain level, then we can base our decisions on that, knowing that they have the wherewithal to make payments. That’s why FICO [credit score] is less important in the process. In fact, using FICO can eliminate a lot of owners who might otherwise qualify. The way owners handle their personal credit can be far different from how they handle business credit. So in the case of the car wash, they would have to show cash flow in an amount that could pay back that type of expense. While most of our customers might say that the rates are slightly higher than what banks charge, they understand that their credit may not be up to a bank’s standards, and that the amount they are paying with us meets their budget.
[Gilbert offers this example of how a National Funding working capital loan works. Say you’re small business that takes out a $50,000 loan payable in six months. You will then make 132 daily payments of $446.97, which means the total amount you pay back is roughly $59,000.
A small business can also take out a merchant cash advance. In this case, a company that takes out a loan of $20,000, for example, pays back $24,000 in seven months. “There is no fixed payment on these advances,” he says. “Rather, 10% of each daily batch of credit card sales is used to pay back this amount until reaching the total. Based on sales in the business, they may be able to pay back faster than seven months, or slower. But in either case there is neither a prepayment penalty nor a late penalty.”]
Can you elaborate on National Funding’s business model and the way you make money?
Over the past four years, we have evolved from a business model of being a broker to that of a lender. Thus, we look first to underwrite credits, and then if we are unable to undertake the credit based on our criteria, we offer it to lenders that we think can do so. At this point, we generate business through direct marketing and through referral from brokers.
Equipment leasing is a big part of the company. Can you explain how leasing equipment from National Funding is a good option for a small business?
Leasing is advantageous for businesses in some cases where the asset they want to purchase has a longer life. It is best to match any borrowing against the life of the asset, so inventory and payroll are good examples of a reason to borrow using working capital. Thus, when a piece of equipment needed for the business is expected to have a life of several years duration, it makes more sense for a business to repay the loan over that time — in which case leasing makes more sense.
You’ve been quoted as saying that many small-business owners have become risk averse. Why is that happening, in your view?
In 2008, the market fell apart. A lot of people look back at that time and are still concerned about the future. I think pre ’08 a lot of people did five-year business plans, and now people are really focused on a yearly basis what their needs are, what their strategies are. When you’re dealing with the small and mid-sized businesses, taking long-term obligations [is something] you are seeing people less comfortable with because they don’t want to be straddled with long-term debt. We offer products anywhere from a six-month loan to a five-year equipment lease, and there are people that would rather pay a premium to borrow for the short-term just to not have a long-term obligation. That just comes from the downturn and the market and the past and the severity of that and the mentality that has moved forward.
Is that the case even with the rising optimism in the economy?
A lot of the indexes are at an all-time high, but when you’re looking at the business growth initiatives and the forecasting, you’re [seeing small businesses] still more limited in their business plans and focusing more on the short-term needs versus the three-to-five-year horizon. With optimism you mentioned, you’re seeing people move on quicker, but they’re balancing their debt obligations. The banks never came back in to fill this niche, and so a lot of small businesses struggled to rebound from the recession and so they don’t want to be caught off guard again where they can’t refinance their debt or they can’t borrow to get themselves through the next patch of need and don’t want to have that extra risk hanging over them.
But the optimism is huge. We’re seeing tremendous demand for purchasing, tremendous demand for capital. I still feel that increase, but the duration of the obligations that these customers want are shorter in nature than they were pre-’08.
The bigger banks have been more reluctant to address the needs of small- and medium-size businesses. Why is this happening, and what’s the opportunity for companies like National Funding?
There’s huge opportunity for companies like us. For banks, it costs as much to process a small loan as a big loan. The risk of taking losses on these small loans have led banks to move away from that sector to the middle market and bigger companies. That’s where they feel more comfortable. That’s where there’s more data. Thats where the financials are stronger. There’s more information on those companies. [In the past], banks would finance small businesses through a variety of different products. That could have been the bank credit cards or the business line of credit or even a home equity loan. A lot of those [banks] have shrunk their extension of credit. Companies like ours and various alternative lenders have sprung up, and the hypergrowth is extreme. That’s just to fill a need that’s been there since ’08. So you’re seven years into it. I don’t know of any bigger alternative lender that isn’t growing at a very high rate.
Are there things about this hypergrowth that worry you?
No. The people that are borrowing money from alternative lenders have a specific need. The average debt-to-revenue is very low right now. Because the banks pulled away, a lot of these small businesses and middle market companies are very underleveraged, and so they’re still operating way under the leverage they used to operate. So they can manage their debt. They can manage their obligations. And the economy is strong. So lending is really good when there’s a good economy. U.S. GDP is growing. You have low unemployment rate, high business confidence rate. At the end of the day, small businesses are at a very low debt level.
You started in 1999, so your company has gone through the downturn that hit in the early 2000s and then the bigger one in 2008-2009. What are the key lessons you’ve learned?
People go through cycles, and you should prepare your capital and structure and manage your debt levels appropriately because there will be good times and bad. [You need] to learn a lot of lessons about managing and training employees to go through these types of cycles, and to be a disciplined lender because when the market gets heated up, a lot of lenders act irrationally. You’re seeing since ’08 a lot more prudence and a lot more discipline in underwriting standards, and underwriting for the long haul versus what you saw in pre-’08.
– Article by Benjamin Pimentel for NerdWallet