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Merchant Cash Advances   prEsEntEd by thE     risk & fraudmanagEmEnt committEE  of thE ElEctronic    transactions     asso...
ElEctronic transactions association                                        2007-2008 risk & Fraud                         ...
Merchant Cash Advancesan Eta White Paper/Best Practices guide                                                taBlE oF cont...
introduction / ExEcutiVE suMMary        The rapid growth of the merchant cash advance (MCA) marketplace has provided many ...
sEction 1 — tHE Basics                                       Merchants Best suited for this Product                       ...
lEgal considErations cont.                                   transactions, it is impossible to determine at the time      ...
unfair trade Practices                                       There are companies that are selling the advance for         ...
QuEstionaBlE PracticEs in                                    sEction 4 — card coMPanytHE MarkEtPlacE cont.                ...
card coMPany rulEs                                             data compromise potential in the event that the cash       ...
risk ManagEMEnt                                                 5. Develop maximum standards of review and                ...
become a loss, but also the credit card processing           To the extent allowed, the funding company shouldaccount may ...
Eta BEst PracticE PrinciPals           suMMary           The Merchant Cash Advance (MCA) is a           product currently ...
MErcHant casH adVancE BEst                                    avoid Merchants with High chargeback levelsPracticEs – Part ...
Merchant Education and customer                              MErcHant casH adVancE BEstservice Principles                 ...
ElEctronic transactions association         1101 16th street, n.W.               suite 402        Washington, dc 20036    ...
Merchant cash advance white paper
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Merchant cash advance white paper

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Merchant cash advance white paper

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Merchant cash advance white paper

  1. 1. Merchant Cash Advances prEsEntEd by thE risk & fraudmanagEmEnt committEE of thE ElEctronic transactions association ElEctronic transactions association • March 2008 1
  2. 2. ElEctronic transactions association 2007-2008 risk & Fraud ManagEMEnt coMMittEElaurie leBoeuf (Chair) Mimi Hart Victoria strayerVice president operations president & cEo Vp, business risk, operations &rapid advance magtek compliance7316 Wisconsin ave ste. 450 20725 south annalee avenue tsys acquiring solutionsbethesda md 20814 carson, ca 90746 8320 s. hardy drive(240) 482-4690 310-631-8602 tempe, aZ 85284-2007laurie@rapidadvance.com mimi.hart@magtek.com 480-333-7586 victoria.strayer@tsysacquiring.comJeffrey de Petro (Vice Chair) richard (rick) HerouxVice president president rob tourtEVo merchant services cost savings reduction specialists Vp, network services515 broadhollow road 2671 sW port st. lucie blvd. discover networkmelville, ny 11747-3709 port st. lucie, fl 34953 2500 lake cook rd.516-962-7849 772-344-7334 ext. 24 riverwoods, il 60015jdepetro@goevo.com rheroux@csrsi.com (224) 405-2961 robtourt@discoverfinancial.comrick allen kevin lavignedirector of compliancy Vice president, operations and anthony urquidezpayment processing, inc risk management director of operations8200 central avenue federated systems signature card servicesnewark, ca 94560 2 huntington Quadrangle 8360 melrose avenue 3rd floor(510)795-4977 (3rd floor north) los angeles, ca 90069rallen@paypros.com huntington, ny 11747 888-334-2284 ext. 225 631-270-7506 aurquidez@signaturecard.comcathy Billings k1@fpsemail.comaVp credit & fraud operations ginger Bergman /transfirst chad nielson Hector rodriguez371 centennial parkway senior compliance and risk manager Visa usalouisville, co 80027 authorize.net 800 metro center boulevard303-402-8115 915 south 500 East foster city, ca 94404-2775cbillings@transfirst.com american fork, ut 84003 gbergman@visa.com 801-492-6528 hrodrigu@visa.comstephanie cook cnielson@authorize.netVice president, risk and fraudmetavante corporation Mike Petitti For his contribution to the content of4900 West brown deer rd chief marketing officer this paper, we also thank:milwaukee, Wi 53223 ambirontrustWave414-815-7077 120 n. lasalle street suite 1250 Joseph looneystephanie.cook@metavante.com chicago, il 60602 general counsel (312) 873-7291 rapid advancelinda grimm mpetitti@atwcorp.com 7316 Wisconsin ave ste. 450senior Vice president, bethesda md 20814director of operations deana rich (240) 482-4690humboldt merchant services Western regional director of macpo box 1479 rich consultingEureka, ca 95502 16622 gilmore street(707)269-3249 Van nuys, ca 91406lgrimm@hbms.com 818-613-7627 deanar@bizla.rr.com 2 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  3. 3. Merchant Cash Advancesan Eta White Paper/Best Practices guide taBlE oF contEnts introduction / Executive summary 4 1. the Basics 5 a. understanding What a merchant cash advance is b. typical product features and the mechanics of repayment c. benefits to the merchant d. merchants best suited for this product 2. legal considerations 5-7 a. product definition — loan vs. sale b. usury laws c. collection issues d. unfair trade practices e. other issues 3. Questionable Practices in the Marketplace 7-8 a. Excessive retrieval rates b. additional funding obligations (“stacking”) c. acquirer notification — funding d. disclosure of fees and terms e. additional considerations 4. card company operating regulation considerations 8-9 a. Visa, usa i. background ii. payment system risk b. card company rules i. Visa, usa ii. discover network 5. risk Management considerations 9-11 a. due diligence standards for merchant Evaluation (operational/subjective risk) b. assessing a merchant’s ability to repay (financial risk) c. creating a Workable retrieval percentage d. dealing with merchants unable to satisfy payment agreements e. ongoing risk management monitoring Eta Best Practice Principles 12-13 ElEctronic transactions association • March 2008 3
  4. 4. introduction / ExEcutiVE suMMary The rapid growth of the merchant cash advance (MCA) marketplace has provided many merchants with an alternative source of funds for business development and provided Independent Sales Organizations (ISOs) with a profitable new revenue stream that can help offset pricing pressures in the hyper-competitive card processing business. While there have been no major reports of any increased risk to acquirers that have partnered to offer MCA programs, this growth has led to reports that some organizations may be engaging in questionable sales practices that threaten to create a reputational risk for the merchant acquiring industry and attract the unwanted attention of federal/state lawmakers and regulators. As such, the ETA Fraud and Risk Committee have developed this paper to explain the MCA industry as well as outline risks that are associated with this product. The MCA process is currently unregulated. To aide in the continued prosperity of this product, the committee has put together a list of best practices that can be found at the end of this White Paper.4 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  5. 5. sEction 1 — tHE Basics Merchants Best suited for this Product This mode of financing works best for small to mid-understanding What a Merchant cash advance is sized companies that don’t have collateral or start-upsA cash advance is a product currently being offered to that haven’t developed an established relationshipthe small businesses that accept credit card payments. with a bank. This product also fills a need for rapidly-The advance is based off the purchase of future expanding companies who are outgrowing theirreceivables of the credit card sales volume that the operating capital.merchant is going to process. The uniqueness of theadvance is that there are no “set” payments and no set Not all merchants are good candidates for this typetime limits. The repayment is based on the merchants’ of product. A merchant with very narrow marginsbusiness volume. This is why it is so important to and desperate financial needs is not suited for thisunderstand the seasonality and business stability of the product. If they do not identify the financial stressmerchant along with the current economics. they could experience down the road, the MCA will become a financial burden. This is especially true for merchants that process a majority of their sales volumetypical Product Features and the Mechanics of through credit card sales. A seasonal merchant alsorepayment has a difficult time during his off season meeting theMost companies will fund up to four times the obligations set forth in his contract. The perfect MCAmerchant’s average monthly card volume, with the candidate processes the majority of his face-to-faceaverage payback amount ranging from 15-25% of the sales, has a healthy ratio of other sales methods todaily merchant processing. The usual time allowed for credit cards and has consistent monthly sales.the repayment is six to eight months. This time frameis dependent upon the seasonality of the merchant’sbusiness. sEction 2 — lEgal considErationsBenefits the to Merchant Before offering a cash advance product to a merchant, there are several legal issues that should be considered.The two biggest advantages that the MCA offers the Set forth below is a brief discussion of the relevant legalmerchant are no personal liability and ease of funding. issues.Most retail store fronts and small businesses acceptcredit cards as a form of payment. Rather than using Product definition — loan vs. saletheir personal credit, personal collateral or personalguarantee to obtain funding, the business owner can Some cash advance providers intentionally structuresell his future credit card receivables at a discounted the product as a loan while others structure it as a sale.price to the MCA companies. For companies that structure the product as a sale, the provider should be careful to treat the product, in allThe other main advantage is that the MCA requires respects, as a sale.minimal effort and there is a quick turn around onobtaining the cash. Most companies only require Financial assets are sold every day. Examples includea signed agreement, processing statements, current mortgages, automobile contracts, accounts receivable,lease and a site survey to prove that the business is in etc. The price at which these assets are sold is based onexistence. The typical time for a customer to receive what a buyer is willing to pay for the asset. The cashtheir funds is 10 business days. Most banks take much advance product is similar in that the merchant’s creditlonger for an uncollateralized loan. card transactions are converted into payments right through the credit card processing system, creatingAlthough the MCA is not a loan it “feels” very similar an obligation on acquiring banks and their agentsto a line of credit. Therefore, if the merchant finds to forward the funds associated with the credit cardthemselves in an emergency situation and they need to transactions to the merchant. This right to funds is areplace equipment or purchase more inventory they can financial asset that a merchant may sell. Therefore, ifrequest a “renewal.” Depending on the company they properly treated and documented, the cash advancecan usually do this before the advance is paid in full. product should be treated like other purchase and sale transactions. ElEctronic transactions association • March 2008 5
  6. 6. lEgal considErations cont. transactions, it is impossible to determine at the time of consummation whether a cash advance contract with no set repayment term is usurious. The onlyWhether a cash advance is a loan or a sale depends on way in which to make such a determination is to waitthe intentions of the parties. The mere fact that the until the transaction is complete and see how long itsigned agreement states that the transaction is a sale, took for the cash advance provider to collect the fundsis irrelevant in most states. In order to be a purchase it purchased. Only then can you divide the dollarand sale transaction, the cash advance provider must amount associated with the discount by the repaymentassume some risk other than the typical risk in a loan term to calculate an “effective rate of interest.”transaction (risk of non-payment) and must treat thetransaction as a sale. Two risks that cash advance For cash advances intentionally structured as loans (orproviders should assume are the risks that the business ones re-characterized as loans), usury is the paramountwill slow down or possibly close. These are risks not issue to consider. While many states do not set apresent in a loan transaction, which generally includes maximum interest rate for unsecured commercial loans,a set repayment schedule. Because a cash advance is a some states do set a maximum rate. If a transactionsale of certain financial assets, the transactions should exceeds the maximum rate, the penalties associatednot include a payback period, have no minimum with a usury violation vary from state to state. Inpayments, and charge no fees. These are all facts many states, the law requires any interest chargesthat support the conclusion that the transaction is above the maximum rate be returned to the borrower.a sale and not a loan. However, whether or not a In other states, the law requires all interest charges in acash advance is a loan is an issue determined by the usurious loan to be returned to the borrower and someintent and actions of the parties. Therefore, even states make the entire transaction unenforceable. Aif the agreement with the merchant states that the handful of states also include a criminal usury cap (e.g.transaction is a sale, has no repayment period, and has New York). Any person charging interest greater thanno minimum payment, how the cash advance provider the criminal usury cap is subject to penalties under theactually treats the transaction will be the deciding criminal law.factor for most courts. collection issuesFor the cash advance products intentionally structured Another significant legal issue associated with the cashas loans, the provider should be licensed as a lender advance product is the collection practices of the cashin those states that require unsecured commercial advance providers. The collection practices can belenders to be licensed. While most states do not very intense and in some cases may violate state laws.require a license for unsecured commercial loans, a Examples of collection practices that may violate statenumber of states do require a license. Additionally, for laws include making collection calls repeatedly in antransactions that are structured as loans, the provider attempt to harass the merchant, calling merchants atmust be aware of state usury laws as they will impact unreasonable hours, making false allegations whenthe fees that the provider may charge. collecting (telling the owner of the business merchant he/she will go to jail for failure to pay). While almostusury laws all states regulate consumer collection activities, manySome argue that the discount paid for the credit card also regulate commercial collection activities. Thetransactions amounts to a usurious effective interest collection practices of cash advance providers are alsorate. However, applying the law of usury to a true relevant to the loan versus sale issue. If a cash advancesale is difficult for two reasons. First, usury is a legal provider collects on an account as if it were a loanterm referring to a rate of interest that exceeds the (requires catch-up payments when the merchant’smaximum rate permitted under applicable state law. If business slows down or requires repayment in fullthere is no maximum legal rate, there can be no usury. after a set period of time regardless of the merchant’sMany states do not impose a maximum interest rate credit card processing volume), the transaction looksfor business to business transactions. In these states, more like a loan than a sale. Thus, collection practiceseven if cash advance transactions are re-characterized become relevant in determining the intent of theas loans, there is no risk of a usury violation. Second, parties and may result in a transaction being re-in the states with a usury limit on business-to-business characterized as a loan. 6 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  7. 7. unfair trade Practices There are companies that are selling the advance for a steep price also known as a “finder’s fee.” TheseMany states as well as the federal government have fees can range from a flat rate to a percentage of thestatutes or regulations that prohibit unfair and dollars obtained. Although this seems innocuous, ifdeceptive acts or practices (commonly referred to as you are a customer and are trying to obtain funding,“UDAP” laws). The UDAP laws are usually written an additional 10-15% could be charged and reducedbroadly and permit the appropriate regulator or from the advance amount. This, as well as the cost ofattorney general to bring an action against a company money, could make the advance very unreasonable,regardless of whether consumers or businesses are thereby causing the merchant more financial hardship.harmed. This is evident by recent UDAP actionsbrought by various state regulators and the FederalTrade Commission against companies engaged in additional Funding obligations (stacking)leasing credit card terminals to small businesses. Cash Often if a customer is brought to an MCA by a Cashadvance providers should market the product in a Broker (a sales agent who receives a commission formanner that accurately describes the product and the the sale and nothing else) there is a possibility thatmerchant’s obligations. Practices such as marketing a the merchant is being shopped around, similar to theproduct with a discount rate for which no merchants mortgage brokers when they are trying to find the bestqualify (bait and switch), misleading the merchant as interest rates. The concern with this practice is thatto the true nature of the transaction, or harassing a if a merchant only receives a portion of the amountmerchant that breaches the cash advance agreement of cash that he needs he may be tempted to acceptare all practices that are clear UDAP violations. more than one offer. Or, he may accept one offer and then apply for additional advances. This is known asother issues “stacking” cash advances. As these advances are paidCash advance transactions are business to business off via a percentage of all the credit card transactions,activities. Therefore, many of the laws that apply a merchant with more than one advance being paidto business to consumer transactions do not apply. off at the same time could potentially deplete hisHowever, there are still many laws that do apply (e.g. cash flow. If there is a default on the agreement, theFair Credit Reporting Act, USA Patriot Act, Uniform advance company that has first rights or a UCC filed,Commercial Code, OFAC, etc.). All of these laws will probably be the only MCA able to collect. It isimpose responsibilities on cash advance providers. prudent for the underwriting departments of cash MCAs to research the merchant to avoid “stacking.” One such way would be very similar to the ACQ inquiries on the credit reports for merchant processing accounts. If an underwriter notices a cash advancesEction 3 — QuEstionaBlE company listed on the merchant’s credit bureau inquiry PracticEs in tHE (seen as an “MCA” suffix behind the company name MarkEtPlacE in the inquiry section), the merchant should be further investigated.Excessive retrieval rates Several of the cash advance companies will “pay off”The cash advance product has a growing presence in a merchant’s existing cash advance with anotherthe Acquiring industry. With that presence comes company in order to eliminate the possibility ofthe opportunity to provide a service to a section stacking. It should also be clearly defined in yourof our industry where the needs are currently not agreement that your customer may only have onebeing met. The banking sector has slowly reduced or advance at a time.eliminated the small business loan. They seldom arewilling to give the “customer down the street” funding acquirer notification — Fundingfor capital and now limit the loans they are willingto grant to established businesses with collateral for There are several ways that cash advance companiessecurity. It is imperative that we as an industry ensure can collect their “split” or percentage of the creditthat companies do not take advantage of the fact that card processing during the term of the agreement.these businesses have limited funding opportunities. The safest way is to establish a relationship with a ElEctronic transactions association • March 2008 7
  8. 8. QuEstionaBlE PracticEs in sEction 4 — card coMPanytHE MarkEtPlacE cont. oPErating rEgulation considErations“processing partner” and have the monies withheldfrom the daily funding of the merchant’s processing. Visa, usaAnother way is to receive a daily transaction file fromthe processor and send an ACH debit item to the Backgroundmerchant’s Demand Deposit Account. This way is In the basic framework of the four-party paymentsless desirable due to the potential of the funds not system, Visa has direct relationships with issuingbeing available when the debit is processed. The first and acquiring financial institutions, while issuingsolution not only protects the cash advance company banks have direct relationships with cardholdersby building a rapport in the case of diverted funds or and acquiring banks have direct relationships withquestionable activity, but it also alerts the acquirer to merchants. Visa is not a party to the relationshipspotential financial stress for the merchant. Although issuers have with cardholders and the relationshipsthis does not indicate a risk to the acquiring industry acquirers have with merchants. These financialit may assist in the monitoring of chargeback activity institutions are accountable to Visa for ensuringand or risk monitoring. Please note that all Association compliance with all rules promulgated to facilitate therules must be adhered to in the MCA process. smooth, efficient and safe operation of the payment system. These rules extend to the governance ofdisclosure of Fees and terms merchant settlement funding.It is very important that a customer understand theterms of the agreement that they are agreeing to. Payment system riskOftentimes, the merchant is only seeing that he is Visa has developed extensive risk models used to assessable to get funding and doesn’t actually understand the financial strength of each financial institution. Thethat a percentage of his credit card sales are going to acquiring models include but are not limited to, thebe withheld daily, or he hasn’t actually calculated the monitoring of each financial institution’s Tier 1 capital,complete amount he will be paying for the money. An loan losses and reserves, the amount of chargebacksefficient manner in which to educate the merchant is processed, settlement volumes and high risk volume.to complete a “pre-funding” call with the merchant. As Visa does not have visibility in merchant fundingThis gives the company the opportunity to go over advances, any diversion of settlement funds from thethe amount of funds being dispersed, the amount of merchant to another entity can significantly alter anmoney expected to be paid and the percentage of the acquirer’s risk ratings, resulting in under-valuing thedaily sales that are going to be required to meet the risk of the business. In the most extreme case, it couldobligations in the time specified. result in the failure of the financial institution and payment system losses.additional considerations Visa’s right to control merchant settlement does notWhen establishing an MCA relationship and mapping extend beyond the point at which the funds reachout the details of the process, ensure that all applicable the account of record for the merchant. Entities thatcompliance rules are considered. This may not be extend funds against a merchant’s future paymentlimited to just each individual card brand, but could system deposits may access the proceeds of thealso include NACHA, OCC, etc. Each program is merchant settlement funds after the point at whichunique; therefore those rules are not covered here. it has been deposited into the account on file for theHowever, as with any program, approaching the design merchant at the acquirer.and operational support in a comprehensive mannerwill help ensure your compliance risk is protected. 8 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  9. 9. card coMPany rulEs data compromise potential in the event that the cash advance company has access to merchant’s customer records.Visa, usaAcquiring financial institutions that participate in the Contractual Considerationspayment system are financially liable to Visa for all The Merchant Services Agreement and Operatingactivity that passes through the ICAs and BINs for which Regulations should consistently establish a requirementthey are the licensee. This includes but is not limited to, that Discover maintain its rights to all chargebacks,funds derived from merchant processing and settlement returns, adjustments and fees prior to depositingactivities. Visa rules require the acquirer to provide settlement funds into the established bank account.settlement directly to the merchant. This statement Establish a process in which the merchant is requiredhas been interpreted to mean that all settlement funds to obtain Discover’s explicit permission to depositthat are due and payable to the merchant, less any funds into a bank account that is not in the legalfees, chargebacks or other essential holdbacks, must be name that the Merchant Services Agreement is in.directly funded to the account on file for the merchant. Maintain the right, in the event that a bank accountThe splitting or diversion settlement funds to an entity rejects debits, that the merchant is obligated to provideother than the merchant are not permitted. This includes alternate banking within a defined period of timethe use of multiple deposit accounts for the merchant, (suggested 3 business days). Establish requirementsthe use of trustee accounts and/or other similar scenarios in the Merchant Services Agreement and Operatingthat do not result in the direct funding and available Regulations requiring a merchant to notify Discover inusage of these funds by the merchant. the event that settlement funds are being directed to a third party.discover networkConsiderations Mastercard WorldwideDiscover is generally unaware that its merchants are provided no comment for this paperparty to such agreements. Discover considers suchcash advances in exchange for payment through credit american Expresscard receivables as an indicator of incremental risk whichmay result in default, financial instability, formal or provided no comment for this paperinformal reorganization or liquidation. In that such cashadvances are not obtained from a recognized financialinstitution, it is likely that the merchant is unable toobtain the necessary credit to be eligible for a traditional sEction 5 — risk ManagEMEntcredit facility or loan. Discover is unable to be assured considErationsthat the settlement bank account would have availablefunds for debits associated with chargebacks, returns,adjustments or fees. Risk Management considerations encompass both due diligence standards of review and approval as well asHigh Level Requirements ongoing risk management and monitoring to manageIn the event that Discover is made aware that its liability.merchant is party to an agreement with a cashadvance arrangement, a risk analysis using the due diligence standards for Merchant Evaluationestablished proprietary methodology is completed. (operational/subjective risk)The fee frequency should be established to be taken The first step in the merchant evaluation process is toon a daily basis. All settlement, offsets, adjustments, ensure you have well developed and well implementedreturns, chargebacks, and fees should be netted prior due diligence standards (aka underwriting policies).to depositing into the settlement account. The fraud The due diligence standards should continually beteam should be alerted and regular monitoring should reviewed to ensure the standards evolve with thebe established. The financial risk team should be alerted industry, track trends and address liability.and regular monitoring should be established. The datasecurity team should be alerted with respect to possible ElEctronic transactions association • March 2008 9
  10. 10. risk ManagEMEnt 5. Develop maximum standards of review and above the standard set additional requirementsconsidErations cont. such as an onsite visit 6. Set minimum for eligibility for re-funding uponThe application of the due diligence standards should repayment of X% of repayment from previousbe applied to each merchant’s request for funding. advanceFunding companies should follow similar standardsand then apply further subjective review should a assessing a Merchant’s ability to repayrequest not fit within the standard guidelines. (Financial risk)When a merchant applies for a cash advance the During the underwriting phase, the assessment of thefunding company should follow strict guidelines for merchant’s ability to repay the advance funding is a keyunderwriting and approval. Underwriting guidelines factor in determining the decision if it will be fundedshould be based on a review of the business, principals and how much will be funded. Knowing the purposeand financials. of the funding helps in the final determination. Not only should the financial standing of the company andBusiness Review: principals be taken into consideration, but also the 1. A minimum number of years in business product or service provided by the merchant. 2. A minimum timeframe of existing processing If a product or service is provided that does not have of credit cards in which to assess the history of growth potential, that must be taken into advisement. the merchant’s processing Additionally, if the product is high risk or has the 3. Adequate legal business formation ability to have high chargebacks or returns, then 4. Set standards of minimums and maximums for the merchant may not be around long due to his advance amounts payback of his capital to refunds and chargebacks, 5. Set standards of minimums and maximums and ultimately go out of business due to the product for transactions types (i.e., swipe vs. MOTO vs. or service not having much of a successful future. E-Commerce) Knowing the margin and growth of the business will assist to effectively estimate the repayment percentage. Not going above the margin reduces the risk of puttingPrincipal Review: the merchant out of business. 1. A minimum number of years of the principal’s ownership of the business Verify that the merchant has no other funding 2. Clean criminal record obligations with other providers. Verify that they do not split their processing between multiple acquirers. 3. Majority ownership signing If there is an existing funding, work to manage the 4. Set minimum credit bureau FICO scores and repayment of the first prior to creating another derogatory reporting funding. If the existing funding is from another provider, then take into account this consolidationFinancial Review: of the funding. These same standards should apply 1. Review of financial statements for both the to any renewals of the cash advance by the merchant business and principals over time. Many times a merchant finds that the cash advance works well for his business model, so he will 2. Review a minimum of 3 to 6 months prior utilize this process for funding future business needs. processing statements to adequately assess processing volumes and activity creating a Workable retrieval Percentage 3. Good standing with other creditors and vendors (premise lease, etc) Ensuring that a merchant has adequate capital to continue to operate unimpeded is the most important 4. Development of maximum repayment consideration. If the merchant is unable to continue percentage and payback timeframe to ensure to operate their business with the reduced revenue due no adverse effect to the merchants cash flow to the funding split, then not only will the funding ability to continue business 10 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  11. 11. become a loss, but also the credit card processing To the extent allowed, the funding company shouldaccount may also be subject to loss as the merchant report the loss to the credit bureaus so that any othermay not be able to fulfill their products or service due funding company or acquirer can see the loss andto the lack of adequate capital. Therefore, creating a take this into consideration when reviewing a newworkable repayment is key in the repayment of the application for funding or credit card processing.fund and longevity of the merchant. A negative reporting to the industry (MATCH-like)Know what the funds are to be used for to help should also be explored.determine the longevity of the fund as well asrepayment. For example, will it be used for remodeling Whether or not a principal’s personal guarantee isso the restaurant may be closed for some time, for allowed, dependant upon usury laws, there shoulda vacation, to pay down some debt to increase cash be considerations and warranties on a fraud level forflow, or to buy new equipment? Each reason for the misrepresentation of data if they go out of business andnecessity of funds may cause a different outcome. are unable to repay. Therefore, to the extent possible, there should be some liability personally if there isdealing with Merchants unable to satisfy misrepresentation of data, if the merchant sells thePayment agreements business prior to satisfying their repayment obligation, if the merchant blocks ACHs or changes theirThe risk associated with a merchant’s inability to direct deposit account, preventing their repaymentrepay the funding, and the cascading effects such obligations from occurring.as the credit card processing potential losses, etc. isparamount in the success of the funding company ongoing risk Management Monitoringas well as the success of the acquirer. Simply put,complete repayment must be the ultimate outcome. As stated earlier, ongoing risk management monitoringUnfortunately merchants go out of business, sell is key in the continued success of the fundingtheir business or are simply unscrupulous, which company, acquirer and merchant. Risk managementleads to losses. Hopefully, a loss can be avoided by departments at both companies should be in contactworking closely with the merchant and acquirer to with each other and should correspond regardingtrack performance. If a merchant begins to struggle events, issues, etc. for the merchants they share. Byto stay afloat due to the reduced daily capital, then applying standard risk monitoring tools, patterns andthe funding company and acquirer should be in signs can be spotted that will lend to the identificationcommunication so that they can work together to help that a merchant has either gone bad or is strugglingthe merchant to ultimately avoid losses for all. and about to go bad. This is the point at which both companies should step in to work with the merchant,If a merchant simply can’t afford to pay the repayment as it is in both of their best interests. In most cases,percentage, then a reanalysis is needed to reduce the when an acquirer must act to protect their liability,repayment amount. If a merchant begins to struggle they will divert funds to create a reserve to cover anyto fulfill product or service, then the cascading effect potential loss. This unfortunately impacts the fundingis inevitable. ISOs and acquirers carry this burden provider as now they are not obtaining their split of thetoday and with a funding, this liability is compounded. processing which in turn increases their liability. If theTherefore, monitoring merchants with funding by the two sides are not in communication, they risk causingfunding providers as well as the acquirers is needed losses to each other due to each side’s individualfor the ongoing management of liability. When dealings with the merchant.either group begins to see the signs and patterns, thencommunication is needed to restructure the funding to Tender Shifting is another risk. Tender shiftingensure neither side is left with a loss. Under standard occurs when the merchants ask the cardholders to useprocessing agreements, acquirers must ensure full and American Express instead of Visa and/or MasterCard sofirst rights to all funds processed by the merchant the deposit of funds is not affected by the repaymentshould there be a default on the merchant account. split. If the MCA and acquirer work together to monitor volumes they can help prevent tender shifting.If a merchant does go bad, standard collection practicesshould be followed, per state and federal regulations. ElEctronic transactions association • March 2008 11
  12. 12. Eta BEst PracticE PrinciPals suMMary The Merchant Cash Advance (MCA) is a product currently being offered to small businesses that accept credit card payments. The cash is advanced to purchase the future credit card receivables that the merchant is expected to process. The rapid growth of the MCA marketplace has provided many merchants with an alternative source of funds for business development and provided Independent Sales Organizations (ISOs) with a profitable new revenue stream that can help offset pricing pressures in the hyper-competitive card processing business. While there have been no major reports of increased losses to acquirers that have partnered to offer MCA programs, this growth has led to reports that some organizations may be engaging in questionable sales practices that threaten to create a reputational risk for the merchant acquiring industry and attract the unwanted attention of federal/state lawmakers and regulators. Consistent with the principles established in ETA’s Code of Conduct, the ETA has established a set of “best practices” that set forth a framework for acquirers/ISOs to assess the business practices of the MCA companies (“MCACs”) they select as vendors or with whom they otherwise have relationships. Following these practices will foster ethical behavior and lead to further industry success and continued growth.12 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  13. 13. MErcHant casH adVancE BEst avoid Merchants with High chargeback levelsPracticEs – Part I The majority of MCAs are given to face-to-face merchants where only a minimal number of chargebacks should be found on the processingWhen selecting an MCAC, acquirers/ISOs should statements reviewed. Chargebacks should NOTconfirm that the MCAC adheres to the following be the normal course of business of a merchantpractices/guidelines: receiving an MCA, as merchants with a high level of chargebacks represent a risk to the integrity of thecash advance repayment criteria Must Be Fair payments system.and sustainableDue to a variety of factors, merchants that apply for a Existing cash advancescash advance based on payment processing are often Most MCA contracts require merchants to disclosenot able to obtain funds from traditional methods outstanding obligations; however, some merchants(e.g., bank lending, corporate financing, etc.). As may knowingly misrepresent the existence ofsuch, it is important for the sake of the viability of obligations in order to obtain additional funding thatthe merchant that the retrieval percentage be fixed can create a risk to the system. This issue is furtherand set at a reasonable level to ensure the merchant is complicated by the fact that MCAC inquiries mayable to maintain an appropriate and predictable cash not be readily apparent on a credit report as they areflow to operate his/her business. Careful attention not a specifically identified business category to theshould be given in the underwriting process to the credit bureaus (pursuant to applicable law, MCACs domerchant’s processing history, business plan (including not generally report advances to the credit bureausproposed use of funds), cash flow position (including because most do not involve a personal guarantee).the cash flow once payments are being made), profit To the extent an MCA provider obtains consumermargins, and the overall health of the business prior to credit reports, procedures should be in place toestablishing the retrieval percentage. identify an inquiry as one from an MCAC where possible.disclosure of terms/conditions and MarketingMaterials Must accurately Present Product limit Multiple advances to a single MerchantAll marketing materials and contractual documents In order to effectively manage risk and prevent afor an MCA should represent the terms/conditions of merchant from becoming over-extended, merchantsthe product accurately and all the principles involved should not knowingly be allowed to “stack”in the product offering to the merchant. Contracts advances (obtaining an additional advance whenshould clearly and conspicuously disclose: an outstanding balance on a previous advance • The name of the funding source exists). In the event additional advances are sought, • The actual repayment/pay-back percentage the original advance should be paid off directly to • The purchase price paid the previous MCAC by the new MCAC (to ensure • The value of the receivables sold that the merchant does not retain funds due to the • Disclosure of all fees previous MCAC) with a portion of the proceeds given on the current advance.Additionally, when marketing the product, the criteriafor qualification should be clearly and conspicuously ongoing due diligence and review ofdisclosed. Any change in the terms/conditions of Merchant activityan existing MCA must be evidenced by the written MCACs should diligently monitor the processingconsent of the merchant. volumes of their merchants on an ongoing basis to identify any significant changes (increase or decrease) that could indicate an issue with a merchant and investigate any such changes. ElEctronic transactions association • March 2008 13
  14. 14. Merchant Education and customer MErcHant casH adVancE BEstservice Principles PracticEs – Part IIThe MCAC must have practices and procedures in placeto ensure the merchant understands the terms of the When performing services on behalf of MCACs,advance. Additionally, the MCAC should establish acquirers/ISOs should adhere to the followinga responsive service level requirement for customer practices/guidelines:service (e.g., inquiries responded to within 24 hours,live-customer support, etc.) to provide ongoing support Merchant Payment of cash advances Mustto the merchant and strengthen the processing system. adhere to applicable regulations In order to preserve the accounting integrity of theMerchant cash advance companies Must Be card payment system, any repayment processesPci compliant established by acquirers/ISOs to forward funds toFor MCACs that handle sensitive payment related MCACs must comply with all applicable operatinginformation subject to the Payment Card Industry Data regulations and guidelines issued by the paymentSecurity Standards, the MCAC must fully comply with networks (i.e. direct pay and other fundingthe Standards. issues). Acquirers/ISOs are expected to clearly and conspicuously disclose to merchants the procedures established for repayment, or verify that the MCAC is doing so. information sharing Acquirers/ISOs and MCACs should work together to create a process to identify merchants that have fraudulently obtained cash advances to avoid harming the processing system. Additionally, acquirers/ISOs should to the fullest extent practicable work together to coordinate ongoing risk monitoring of the merchant as well as ensure that an adequate level of customer support and awareness is provided to the merchant. 14 Eta WhitE papEr/bEst practicEs guidE • Merchant Cash Advances
  15. 15. ElEctronic transactions association 1101 16th street, n.W. suite 402 Washington, dc 20036 (202) 828-2635 (800) 695-5509 toll-free (202) 828-2639 fax www.electran.org

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