Tapping card sales: Boost for merchant cash advance in SA amid new deal

JOHANNESBURG — Amid South Africa’s sluggish economy, any kind of support for SMEs — especially those struggling to get financing — is much welcome. Futuregrowth Asset Management, on behalf of clients, has acquired a stake in the shareholding of Retail Capital, a merchant cash advance business that purchases SMEs’ future cash flows in order to provide these small businesses with the funding they need. It’s a concept that started in the US in the 1990s but which has started to catch on in South Africa. And with an estimated 200,000 POS (Point of Sale) machines in South Africa, the potential for this type of financing is promising. Conway Williams, an investment analyst at Futuregrowth, tells us more. – Gareth van Zyl

This special podcast is brought to you by Futuregrowth Asset Management and with me on the line from Cape Town, I’ve got Conway Williams who is an investment analyst at Futuregrowth. Conway, thanks for chatting to me today. Now, Futuregrowth Asset Management has acquired a stake in Retail Capital. Retail Capital specialises in something called ‘merchant cash advance’. Can you tell us a little bit more?

Thanks Gareth. What merchant cash allows the entrepreneur or merchant to do is have a daily deduction off their turnover. If you think of it in the most simplistic terms: every time one of the entrepreneurs or the merchant clients pay for goods or services, a small portion of that fund is taken off or reserved and gets paid back on the lend that they have, or on the borrowings that they have from Retail Capital.

In that way, you don’t have this massive, balloon payment right at the end. You can actually, manage your cash flows on a daily basis and you know that you can afford the payment because all of the repayments on any loan that you received from Retail Capital is actually a deduction of every single purchase. If your purchases aren’t at the level you expect it to be, the repayment to Retail Capital then is also adjusted accordingly. To get our minds around this type of product, we had to do an extensive due diligence on the track record of Retail Capital, on the application of the NCA, what their write-off policy is, and we had to do an in-depth review of their debtors’ analysis. This was just to see that was being sold to us is actually true.

Conway Williams, Futuregrowth
Conway Williams, Futuregrowth.

Again, when we do your usual lend, we’ll lend your company (for example) R50, your interest is serviced on a monthly basis and there’s some sort of bullet at the end. Then if it is a consumer lending business that we’re lending to, they will then on-lend on a similar basis. Because this is their (Retail Capital’s) disruptive type technology — where they’re offering a platform repayment mechanism that it’s a bit different to your usual ‘run of the mill’ operations — we needed to make sure that we are happy with that process and how you deal with stuff along the line, like issues such as fraud, when debtors do not pay, and how that impacts the repayment to us. In effect, that is what we were looking out for. We’re lending money or lent them money initially, and then that was used for a specific purpose, to grow the entrepreneur. So, this gives the entrepreneur another way of dealing with payment or payment issues, and it also caters for a market that is significantly hard for entrepreneurs or small businesses to get finance.

I’m guessing that this ideally works well in a very high turnover environment – like if you’re a restaurant, for example?

Yes and no. The bulk of Retail Capital business is in that space, yes, and you’d need that high turnover. But if you have a business, Retail Capital plays a partner role in your business. So, before you decided to put up a play area at your restaurant or expand your operations, Retail Capital goes out and does a business review so the lending that they do ranges from small amounts onwards. Retail Capital fundamentally looks at its ability to collect on that credit or debit card facility. Again, it matches your business and how short the term of the loan or how long it is, and it depends on your cashflows on a daily/monthly basis. So, it ranges anything from low to high turnover businesses.

For a high turnover business: Would that business then be charged lower interests on the loan? If you could just expand on the mechanics around how that works?

The starting point is that Retail Capital is actually purchasing future cash flows. So, they will do a credit assessment of the underlying business and then they will determine how long it will take to repay that facility and then how much needs to be deducted on a daily basis – that is the first part. What you have to understand is that it’s very different because this loan is the purchasing of future cash flows.

There’s a buying and a selling agreement that’s in place, between Retail Capital and the underlying entrepreneur and it’s repaid by daily instalments. And all of that is calculated based on card payments from the underlying consumer. In certain instances, it could be that you have a massive turnover spike because it’s the December holidays and then the loan gets paid very quickly, or it could be a slower month. The calculation tracks what your repayments from your underlying customer is or your swipes that your customer has paid the entrepreneur.

The main thing that you have to understand is that it’s us providing funding to Retail Capital. Retail Capital will then go out and provide funding in various forms to the entrepreneurs, and the repayment comes from the end-consumer. When we did our due diligence, we were not only looking at Retail Capital’s ability to repay and their financial assessment, but we also looked at the various sub-sectors of the economy that they provide funding to because, at the end of the day, it’s the consumer that we need to take a view on for us to get our money back and get repaid.

Is Retail Capital quite a unique lender, in that regard, in SA?

I wouldn’t say they’re necessarily unique. They’ve just got the longest and strongest track record in doing what they’re doing. They are a disruptive type of technology in that they are disrupting the normal flow of funds from the banking institutions to the consumer or to the entrepreneur, and that is their competitive edge. They’ve developed a product that goes over and above what is currently offered to entrepreneurs.

If you just think of the need for working capital and the lack of finance for entrepreneurs for various reasons, because they’ve offered this product where they’ve been able to reduce the risk of not being repaid to such an extent that they can provide funding to what would generally be considered a very high-risk segment.

As Futuregrowth you’ve got a non-controlling stake now in Retail Capital. Are you able to tell us how big that stake is and why you decided to invest in Retail Capital, what prompted it?

Two years ago we started a relationship with Retail Capital, in terms of providing them with funding. What that entailed was ensuring that we understand the business and the business model, understanding the full process environment, the credit environment, the credit granting criteria, and the legislative overlay. Once we were able to get our minds around that, we extended a small portion of funding to them. So, we provided debt funding. As the business grew and we grew alongside them, we were able to increase our funding. Then over a period of time we got to know management very well. We backed the jockey in our normal lending business and then an opportunity arose for us to purchase a stake in the business.

The specifics are that there was a management team that fully believed in this business. We believed in the management team, and they wanted to take this business to the next level and we supported that fully. Then with this opportunity that arose, post our lending type transaction, we were able to purchase a portion of the business. Then the next question was: how do we do both? What we have in place is a development equity fund. For us to make these types of purchases we have to believe that a business meets developmental needs and we did a full-on analysis on the end consumer, the access to finance, questions that address a gap in the market, and if the product that Retail Capital offers are developmental in nature? Once we were able to get our minds around that we were able to proceed with the purchase negotiations and then also concluding the transaction. So, our purchase is specifically out of our development equity fund, which is a R2.5bn private equity fund focusing solely on developmental typed assets.

Developmental type assets would include the likes of start-ups, smaller businesses etc?

Yes. So, it’s not an angel fund. It’s not a VC fund, per say, but we do look at businesses that have track records, that has some sort of moat around it, that meets the general private equity requirements. But also, because of our lending agreement, we’re able to take a higher risk – we have a bit of a high-risk providency. When we considered this transaction as a whole, we supported management in what they had wanted to achieve through this transaction. Then that allowed us to purchase a specific percentage and because of our relationship, which started on the lending side, we were then able to take a larger stake in the business than we would normally do. Generally, our stakes are minority type interests that allow us board representation. In this instance, because of the relationship and the track record that we have along with them, and our view on the business and management we were able to take a larger stake, it is a non-controlling stake but it is quite a sizeable non-controlling stake that we purchased of this transaction.

Are you able to disclose what the exact percentage of that stake is or is that something that’s under wraps?

Unfortunately, I’m not allowed to but it is a significant amount. It does allow us to appoint more than the one director. We have the ability to appoint two or three directors in this regard and it does mean that it will take a bit more operational time. But in essence, we backed a jockey in Karl Westvig, who we believe has done amazingly well in this space. Not only in the Retail Capital space but also align our interests with theirs and grow this business and take it to the next level. Unfortunately, the percentage – I’m not allowed to share.

Just in terms of talking about aligning interests. What does Futuregrowth Asset Management get out of this deal or what is it seeking to get out of this deal, ultimately?

The first thing is to deliver on our developmental mandate that we have in this fund. The reason that this fund was set up was to look at alternative assets with a developmental angle. If you think of the shortage of developmental funders within this space, we are able to deliver on our mandate. Secondly, we are able to support their management team that fully believes in this business. So, we are able to grow this business. There are various opportunities that this business could branch out into and we believe in the management team and because of that, we are able to support them and support their growth aspirations. Thirdly, it allows us to take a stake and get a risk-adjusted return so, it meets all the requirements that we had in terms of the developmental mandate, the return requirements, talking to supporting a management team that we believe in and we believe that this is a market that is underserved. That is what we achieved through this transaction and what we’ve achieved to date.

Talking about the market that is underserved: do you think that we’ll start to see more solutions, such as merchant cash emerging, especially in the depressed South African economy that we’re experiencing right now?

The philosophical answer to that is that we do need more entrepreneurs and counterparties or businesses that can provide an offering to a market that needs funding or finance. What Retail Capital has done successfully is they’ve been able to develop a product that mitigates the repayment risk by doing the daily, weekly, or the monthly deduction from payments and because they were able to develop this product they were able to reduce risk, mitigate risk, and then also provide funding to entrepreneurs that would generally be excluded from the normal banking environment. Secondly, the amounts that Retail Capital and its immediate competitors do provide to this market is very small. So, it doesn’t necessarily touch sides to the banks. It’s not only for entrepreneurs that wouldn’t meet normal banking requirements or minimum standards – it’s also in terms of the quantum that it can provide to this market. There’s been certain instances where we’ve seen sometimes it’s a R50 000 loan that they need and they only need it for three or four weeks, or they will need a larger amount for a longer period of time, but they need it quickly, they need it now, and if they don’t get that working capital their business can dissolve.

If you think of the needs of the entrepreneur are, Retail Capital has thought of their needs type analysis as opposed to forcing a product in a specific manner. I do think that there’s a massive need for this disruptive type technology in the market but it needs to be done correctly. What we had seen in the Retail Capital environment is that their corporate governance is up to scratch. They have a fully functioning board with independents. They have the appropriate auditors on-base. Their control environment is up to scratch. They met all of our tick-boxes in terms of not only our developmental needs but also in terms of the corporate governance. Especially where there’s a market with such a lot of spotlighting shone on it because this is, in effect, unsecured lending. You need to ensure that this is done correctly — that there’s no issues around excessive rates being charged. That all of the legislative and regulatory requirements are met and Retail Capital has provided us, at this stage, with something that we are very happy with and meets all of our needs.

Just out of interest, how widespread is the merchant cash advance market in SA, have you got any numbers or figures around that?

The information is quite scant in terms of the size and the offerings that are available. What we do know is that there are probably three or four big players. For you to grow your business you do need capital. What attracted us to Retail Capital is that they had capital, they had their funding base in place already, they had actually got the trust of the market so, not only is there this capital that they could deploy but they were doing it in the correct manner. Other players would not necessarily meet our requirements and I’m not saying that our requirements are a gold standard. It’s just that we needed to make sure that everything was in place. The other players that we saw didn’t meet all of our requirements, at this stage. Again, Retail Capital has just been around a bit longer. They’ve been able to institutionalise their business a bit faster and that is because of the management team that have done this before, in various forms.

Conway, just as a last question, could we see more deals like this coming out from Futuregrowth Asset Management in the future?

We definitely hope so. We are always on the lookout for good deals that meet our requirements, especially in the disruptive space. Even if you think of extending that a bit further so, not only in disruptive technologies taking on the banking sector, but then in types of technologies that allow the consumer needs to be met. We’ve looked at businesses that allow for delivery of parcels. We’ve looked at businesses that literally meet the client’s needs and that there is a developmental angle to it. That is what we want to achieve. We want to be as close to the consumer as possible in that regard. Then through our due diligence and our review of the counterparty and us backing a jockey that we are able to provide various offerings to the market obviously, through the underlying businesses and us deploying capital in a responsible manner for those underlying entrepreneurs or entrepreneur type businesses to do what they do best, and that serves the end consumer so, yes, the answer is yes.

Conway Williams, it’s been an absolute pleasure talking to you today. Thank you very much for telling us about your very interesting deal with Retail Capital.

It’s been a pleasure.