Funding $350m+ but also prepared for a potential downturn – Interview with Expansion Capital Group
In these interviews with lending industry leaders, Monja covers their stories of success, challenges, and secrets of their competitive advantages in small business lending arena, as well as their perspectives on the online lending industry overall.
- Aggressive footprint: growing ECG 20 to 30% year over year
- What it took to fund over $350 mln to 12,000 businesses
- Why the vast majority of the hyper-growth of the small business lending MCA world is behind and what’s next
- Is automating small business lending achievable?
Hello, welcome back to the podcast. My name is James Wu, Founder and CEO of MonJa. Today, we have, Vincent Ney, President, and CEO of Expansion Capital Group (ECG) and we are excited to talk about the services that ECG provides.
James Wu: Vincent, welcome to the show!
Vincent Ney: Thank you, James, appreciate your hosting.
James: Great. Well, Vincent, to get us kicked off, would you mind telling our listeners a little bit about yourself and the company’s history.
Vincent: Sure, be happy to. So, I am from Texas, I was born and raised in a small town in South Texas, in a farm & ranch and agricultural environment. I attended school and high school there, ultimately received a degree from Texas A&M University and accounting was my emphasis and finance, was involved in the public accounting sector with Pitt Mark & Mitchell on the audit side and subsequently Ernst & Whinney on the tax side for about five or six years of my earliest career.
I then became a small business owner myself through a few different iterations and ultimately got involved in the non-bank lending in 2003.
That was originally/exclusively consumer-based and subsequently sold off those companies and intellectual property, the portfolios and had been an early investor in a B2B MCA company, that being Expansion Capital Group, and became it’s CEO about four years ago.
James: That’s terrific. So today, how many loans and financing have you funded through ECG?
Vincent: Great question. I always think of it in terms of dollars funded. We’ve funded $350 plus Million and let’s just take a quick gander here and come up with a more specific number there. It looks like about 12,000.
James: Well, that’s fairly impressive within this time frame.
Vincent: You know, we are not, by design, exclusively Internet because we do have an office footprint in our headquarters and our entire operation, with the exception of some staff extended across the country for easy biz dev or some specialty aspects, staff is in Sioux Falls, South Dakota and we have actually had a couple of groups we have funded in and around our office.
I actually think two of them have set foot in, but for the most part, it’s Internet-driven and that certainly give you, you know, some abilities to exponentially impact the marketplace as opposed to dealing with walk-in traffic and…..I know, James, you are in this sector to some degree so you understand the ability to scale and accomplish greater numbers to that scale of the Internet.
James: Actually, the scalability is pretty important and speaking of which….you know, from a scalability perspective, obviously, there’s the capital aspect too. So, do you fund the financing through your balance sheet, do you work with investors, how does that work, how does that capital stock work out?
Vincent: We are a balance sheet lender at this point. We began the company predominantly through equity from the founding shareholders, myself being one of them, and raised our initial credit facility to a large degree on what I would call a family office, friends and family type Rolodex request and then went from there to institutional capital which we have continued with a couple of different credit facilities.
At this point, we don’t sell any of our balance sheet debt to the third party, at this point have not done any syndications, I don’t know that I’d completely rule that out.
Although, as long as we’re able to find credit facilities that are cost-effective for us to be able to arbitrage ourselves, I suspect we’ll be on this path for a bit.
James: Yeah, absolutely, as long as you find quality companies to fund and you’re able to manage the capital stock pretty well, that sounds like a pretty good strategy. I know a lot of other participants in the MCA market have done similar things. So, maybe let’s talk a little bit about MCA because this is certainly a category that has grown quite a bit in the past few years compared to traditional business lending. How do you think about MCA and what gap do you think it bridges in the market for small business lending?
Vincent: Well, I think MCA, at its core and maybe at its earliest origins, was a method to quantify and to some degree mitigate some of the risks in underwriting that a more traditional contract negotiated loan might have required.
Also, you know, in the United States where we have state-based governance covering a number of the financial regulatory aspects, you have a tremendous patchwork of rules and regulations that the MCA product tends to find more consistent at this point across those states.
James: Yeah, that makes sense and I think, certainly there’s the regulatory angle, but as far as angle, with MCA you are able to get the funding in place, structurally view it more quickly without some of the same regulatory hurdles.
Vincent: Correct, because, you know, you’re essentially not loaning money at that point. You are taking a vested interest in the receipts of the enterprise and to some degree hedging that they will perform looking forward as they have historically.
You take a risk along with the operations and, therefore, you become a bit of shared risk with the operator in hopes that you run out possibly, I mean, sort of a little bit of an equity play if you really boil it down.
I mean, because if the business does not do well and doesn’t meet your numbers against your forward flow…I mean, you go at risk much as an equity party does.
James: Yeah, absolutely, and with that said, I think there’s a lot of you to fund businesses that probably don’t fit as well in the traditional loan model, so I think everybody wins.
Vincent: Exactly, and in the small business sector, obviously they come in every shape, size, you know, creed, color across a lot of SEC codes and a lot of different marketplaces and, you know, candidly, they’re not all created equal from a bookkeeping standpoint, they’re not all created equal from a reporting standpoint. And, you know, one of the things that the MCA product does is it mitigates some of that risk documentation because you’re focusing almost entirely on a revenue stream that generally has at least some aspect of also being kept by a third party.
James: Got it. So with that said, I’d like to ask this, what’s the most exciting or interesting or surprising business that you funded? Give me an example, something that you wouldn’t think is in your target market, but you ended up funding.
Vincent: Well, one that we talked about for a number of months, really maybe over the years is…..
so, we had a guy call us from the beach in California that was running a food truck selling lobster rolls that he was flying in twice a week from Boston which is where he was born and raised.
He was having challenges meeting his cash needs getting the lobsters in time because he was on the COD program and we kind of became a poster child for him and him for us.
It was interesting, you know, he invited us out, we actually even had one of our guys that was out on a biz dev at the West Coast go by truck and enjoy a lobster roll. So, that one, I think, was novel, number one, he is selling a product that’s kind of out of the market, starved for enough cash to sustain and has a going concern that’s working well.
Probably, a second one that, I don’t know, we thought was kind of intriguing, maybe the driving point was we funded a business that had been in existence for 50 years. Most of the time, these businesses are……you know, earlier in their life cycle.
This happened to be a wedding catering and special events company that a husband and wife had bought. They’ve been on it for about three years, kind of had been in existence for 50 years and they managed to land a serious contract and needed, essentially, capital to get a number of the elements that would be deliverables and they didn’t the ability to accomplish it through banking, both timing and supporting documentation.
We were able to accomplish it for them and, you know, they made a big presentation to us about the success of the event so that was kind of interesting.
James: Yeah, and I think both of these examples kind of speak to the business model in a way that’s unique about MCA. Both of these borrowers, both of these businesses don’t have much collateral and don’t have a lot of the characteristics that worked really well for a traditional loan, but, obviously, at the same time, they do need working capital so it seems like there’s a good fit.
So, I guess maybe to put it in a nutshell or to summarize it, how would you compare or just say the advantages of getting business funding through you, guys, specifically, in MCA in general, compared to other avenues of getting funding?
Vincent: I mean, I think I look to the feedback that we get from the parties that we’re funding and overwhelmingly, the factors that they talk about are what’s the realistic chance of being funded and what’s the timing to being funded and collateralization. I mean, those are generally the three big things and the regulatory world seems to always want to focus on the cost factor. The small business owner plays his cost considerably further down their list of concerns.
Now, I believe that you could define that as “relative cost,” i.e. if you’re running short on gas, is the prices a bigger concern to you if you don’t know if there is another station for 50 miles than if you have half a tank and you know that there is an abundance of stations over the next hour’s worth of drive time. I think, oftentimes, a small business is confronted with the fact that the next gas might be 50 miles.
James: Yeah, absolutely, and I think that gap there and opportunity that you’re helping fulfill is probably what’s driving a lot of interest in the space, particularly with some of the newer players coming on the scene. Some of them are purely Internet-based, I guess a lot of them like to use the label fintech. What do you think about the new funders or lenders, what they’ve done with the industry, how has that changed the industry?
Vincent: I mean, I guess, I don’t know when we begin to define, you know, the new funders or the new lenders. Probably we fit somewhere in that category. I don’t know if we’re one of the oldest of the new, or we’re, you know, mid-level in the new.
The MCA product has been around for various timelines, but, 20 to 30 years, it’s been around for a bit.
The proliferation, if that’s accurate, of kind of the non-banks, small business lenders, MCA funders…..you know, seems like it gained a lot of traction in the last maybe five to seven years, maybe eight to ten, but somewhere in that window.
What have you seen? I mean, I think you’ve seen the speed and decisioning for the party seeking funds has been reduced tremendously and I say that inside, you know, of the….if we’re going to label this fintech. Inside of the fintech world, it has actually gained tremendous speed and reduced time frames, maybe equal to what it accomplished against traditional banks, for example. You’ve seen an exponential effect, speed picked up by kind of the fintech genre against traditional banks and then I think you had competition driving speed inside of the fintech world.
What else? Collateralization, I think, you know, maybe in some cases the regulatory environment, maybe they’re accurate, maybe the pendulum swung or beginning to swing too far and collateralization, you know, might need to be revisited. But, nonetheless, the collateralization aspect that has historically been required has been reduced tremendously.
I think the chance of any given small business seeking funds actually being funded has increased fairly dramatically.
I don’t know that anybody has those stats, I know that the Federal Reserve attempts to gather those stats. I don’t know if they have a clearing house, obviously, they know what’s going on in the banking sector, they know what’s going on in the SBA sector and certainly, there are data points out there that you can extrapolate from. What do we know?
We know that there are a lot more businesses being funded today than there were 15 or 20 years ago.
James: Yeah, absolutely. I was speaking at a conference with regulators and there’s a lot of emphasis and a lot of interest on just how much credit access has been improved and the improvement in speed as well. So, that’s obviously a big factor that everyone cares about. Now, you can’t talk about speed without talking about technology so tell me about how you guys use the technology behind the scenes to fund, to underwrite and work in your process.
Vincent: So, having been in the consumer side since 2003, along with a group of, I don’t know, half a dozen consumer lenders that were kind of first to market on kind of a full online deployment where, you know, application funding was all accomplished online, obviously, we’ve seen most of that transcend traditional banks and everything at this point.
A lot of what was accomplished or attempted to be accomplished from an algorithmic learning and parceling of data, gathering of data, we’ve attempted to transfer over or to make very prevalent in our small business lending and MCA funding as well.
I think one of the common denominators, you know, data gathering, third party data acquisition, monetization of existing and historical loan files for decisioning…. certainly it allows for the ability to pass through massive amounts of data that you wouldn’t have been able to do efficiently in any kind of manual form.
It probably drives the ability to make decisions that you might not otherwise be able to make. I don’t think that the small business sector at large has…even a, gosh, 30/40% penetration of aggregated data that you see on the consumer side. It doesn’t land itself to be as efficient from data modeling, in my opinion, as a consumer.
James: Certainly, yes.
Vincent: I think there are some gains being made, but they’re pretty slow and there are certain aspects of the small business sector that I wonder if they’ll ever be automated.
Maybe we’ll find some surrogate data to, you know, use as a proxy, but I’m not sure.
I mean, without the ability to have a small business give you their revenue receipts through some kind of bank or bank verification and tax returns since the US Treasury won’t allow you to gather that information easily or timely, even with the approval of the rightful owners, it makes that very challenging. So, I think the answer is, you know, how much fintech is in fintech in small business? Probably half, maybe three quarters, depending on funding size.
James: Yeah, I think that’s right. I certainly agree with your point that there are aspects in small business funding that’s just fundamentally different compared to consumer funding and lending. Some of it probably won’t be able to automate in the foreseeable future, I mean, look at the lobster roll truck. How do you quantify the market of lobster rolls and have AI actually understand that?
James: Probably a pretty challenging problem, yeah. At the same time, I think in the backend once you know what you are looking for, what data points you’re looking for, there’s only a lot that automation and AI is able to help you gather the data and streamline the process. So, it sounds like some of that has been done.
Vincent: I don’t think there’s any question that’s being done, I would theorize that there is probably the third party….you know, even though I’m not sure it’s the appropriate moniker, we’ll call them credit bureaus, data bureaus. I am of the opinion that there are both consumer and non-consumer credit bureaus, data sources that are looking to attempt assimilation of small business data.
James: Sure, yeah, that makes sense. So, let’s switch gears and kind of look ahead. In the last couple of weeks, there have been some headlines about the risk of a recession. Of course, you know, economists have forecast, what is it, 13 out of 10 recessions so nobody really knows when recession is coming, but how do you think about that, how do you think about a risk of recession, how it will impact small business lending, in general, and for your business?
Vincent: You know, in general, the only thing I know with any certainty is we will have another recession. I have no idea when, so I guess the answer is you plan for a rainy day, but you make sure your umbrella’s got along
life of material on it because I don’t know.
I feel like the talking heads have tried their best to put a recession and they didn’t get it done.
Are we going to have a bonafide recession, or are we going to see a trough? Once again, I think there are a lot of pendants that just can’t get over the fact that we’re not having one. I think some of it’s politically motivated, I think that when you look at the underlying factors, consumer strength, for example, spending strength, you know, it’s still there.
But, you know, I think it would be foolish not to expect that we’re going to see some softness, or likely going to have another recession. Trying to predict when is probably only less challenging than trying to predict how long it will last so what do we do? Now, we try to do meaningful and thoughtful underwriting expecting that if we moved into a full-fledged recession that we’ll see some softness in our book.
We’ve done some stress testing that shows that softness increasing our default rate anywhere from 15 to 40%.
There’s a very limited operational data from folks that were in the small business MCA or lending or funding world in 08/09 trough. What limited aspects are there seemed to fall in the kind of in that range, an increase of default anywhere from 10 to 30%. There are some outliers that, you know don’t make sense so we don’t give them as much credence, but that’s kind of the way we approach it.
What happens to us if we have to weather an increase in our default of 25%, I mean, it’s not pretty, we’re sustainable. If you told me that we’re going to be in a 10-year recession, I think that outcome is much more catastrophic than if it’s a year, 18 months or two years so that’s the way we generally view it.
Our products are kind of a….. maybe in the marketplace a little bit of a winner product, you know, we’re in the 8 to 11-month range, on average, and so in a recession that may be ….aligns with the timing of a recession so there’s that proverbial, you know, egg through the snake timely and you see the recoveries.
I think the answer is you really won’t know until you live it, we take the most prudent approach that we can try to anticipate it and to be thoughtful in our underwriting process.
But, small business lending, you know, it’s got risk, I mean, I think that’s largely why the genre has come to be because you have historic financial institutions that aren’t willing to take that level of risk.
James: Yeah, I think that’s always the challenge, there’s no free lunch. So with that said, if you were anticipating a recession, like how would you underwrite differently? Would you be increasing confrontations on types of businesses, would you stay away from others, how do you think about that tradeoff?
Vincent: Well, I think you might, you know, you’re obviously going to get greater concentration in your underwriting from a historic standpoint. How long has the business probably been around, you’re going to get maybe a greater focus on what’s their revenue stream been like, what’s their free cash flow looks like, what could they actually sustain.
There are tables out there under SEC Code that would suggest how businesses, from an SEC Code, fared in the 08/09 recession, you also got SBA statistics on that type of thing.
We’ll probably get more involved in overlaying that, you know, as an aspect of our underwriting and you probably have to give greater merit to what percentage of revenue are you willing to contemplate as a payback model. Those are all over the map, but if let’s say today you’re funding and you’re contemplating, you know, nothing greater than say 15% of their revenue source as monies that would be utilized to pay back a funding or a loan, you know, maybe that becomes 10, 12 and you try to mitigate some of it there.
So, I think you probably should really look at your underwriting at every aspect and you probably don’t have to choice but to tighten some of it at each nugget, at each, you know, data point.
James: Yeah, well put and I think those kinds of adjustments are never easy and straightforward, but, certainly, those are tools you actually know that you can use if the time comes.
Vincent: It’s certainly not……maybe a little bit like, you know, getting your driver’s license at a young age and hoping you’re never in an accident, but knowing that there’s a strong likelihood that you will be.
James: That’s true.
Vincent: You really don’t know exactly how to prepare for it so you’re probably trying to be prudent about how you drive, but when it occurs, you’ll have more experience than before. We’d do our best to try to mitigate as much of that risk and find ourselves surviving with our small businesses on the other side.
James: Yeah, absolutely. So looking ahead, how do you think about the next couple of years? You guys have done pretty well in the last few years and have had pretty good growth, how do you think about what you should do to stay ahead of the competition?
Vincent: That might be the toughest question you’ve posed, so far, because I think that the marketplace ….inasmuch as I don’t think we’re seeing the tsunami of new funders and new money coming into the game, I still think there is a percolation of that.
Sometimes, you know, you either question, if they have any underwriting skills or maybe they’re just the smartest person in the room and you’re not sure which one it is, so I think, basically, my answer will be we’re going to stick to our knitting.
We’re going to continue to try and do what we do and leverage our reputation, leverage our relationships with both our brokers and associate lenders, affiliate companies that may lay traffic off to us that’s in our credit box or credit window that they’re not interested in and continue to do what we do.
I mean, I think we’re going to continue to try and mitigate aspects of underwriting and data crunching through our IT and our data analytics and hope to pick up some…both efficiencies and likely some small gains in return on our investment there.
But, I don’t think there’s a silver lining, I don’t think there’s a silver bullet product out there that all of a sudden is going to drive tremendous growth. Candidly, growing at a 20 to 30% year over year clip is, you know, that’s a fairly aggressive growth. I mean, early-stage companies, you know, you can have these big percentage swings and grow 30 to 400%, but growing exponentially year over year at those kinds of clips, I just don’t think is sustainable.
James: Yeah, that’s definitely true. That said, you had a pretty good track record in a very competitive space and you know what they say, ideas are cheap. There are certainly a lot of lenders and funders that can come into the market, but the winners are going to be companies and entrepreneurs that can really execute well. As you said, have a good reputation and have a good process and have good relationships with parties that are very important to your balance sheet, that’s what matters.
Vincent: It certainly is an industry, you know, we’ve seen a few folks take some black eyes, there have been some failures, there’s been some questionable antics inside some of those companies, at least per the coverage in the press and, you know, it’s good news, bad news. It brings a bit of a more aggressive spotlight for the regulatory world and maybe deservedly so.
But, it also brings maybe a little bit more rationalization from the credit and capital markets to maybe think through their propositions and maybe slow some of the funding that maybe sometimes looks a little bit like money without a conscience.
So, I think that the vast majority of kind of the hyper-growth of the small business lending MCA world is maybe behind us. Now, we’re maybe more in a mid-cycle of grinding outgrowth the old fashioned way but are running good businesses.
James: Well, at the same time, ultimately, the businesses that need capital, they win when there are more choices so, I think that’s the silver lining.
Vincent: That is a silver lining.
James: Yes. Well, Vincent, it’s been a great conversation and thank you for taking the time to talk with us today.
About Expansion Capital Group
Since its founding in 2012, Expansion Capital Group (ECG) has contributed to over $350 million into the American economy —and employs over 70 people.
ECG’s development of data aggregation and predictive modeling tools have enabled the company to provide superior, cost-effective service for the small business industry.
In August of 2018, Inc. Magazine named Expansion Capital Group in the top 20% of America’s Fastest-Growing Companies.