Over twenty-one years, Bret Zelisko's Canadian small business, Power Steam Carpet Cleaning, built a reputation for its specialized carpet and furniture cleaning. Then, during one slow period, the seasonality of the business threatened the brand's longevity, as Zelisko's working capital was insufficient to cover expenses as he waited for accounts receivable. With an immediate need, Zelisko turned to Merchant Growth, an alternative Canadian lender, for a loan.
"The financing helped greatly, and it was really easy dealing with Merchant Growth as opposed to dealing with a bank. The banks seem impossible to borrow from, they ask for collateral and too much," said Zelisko.
Like Zelisko, many Canadian small businesses operate on a revenue stream and have minimal collateral to leverage for a traditional Canadian banking loan. While commercial Canadian bankers have more flexibility with lines of credit, they typically only engage with businesses with at least CA$5,000,000 in revenue.
"This underserved market is large enough to build a sizable non-bank entity," explained David Gens, co-founder and CEO of Merchant Growth, during an interview. Gens launched Merchant Growth (then called Merchant Advance Capital) in 2009 to provide the most convenient and accessible financing experience to Canadian business owners. Since its inception, the company has invested over CA$500M across over 8,000 small businesses.
Merchant Growth recently announced a $300M in forward flow facility with Fortress funds. The capital will enable the Canadian alternative lender to finance small businesses paying back their Canadian Emergency Business Account (CEBA) loans.
This interview has been edited for clarity and flow.
Let's start with the founding of Merchant Growth and the company's mission.
I started the business 14 years ago, at the age of 22. Coming out of the great financial crisis, non-bank financing of small businesses was becoming a trend within the US. Part of our thesis was having the wind at our backs because we believed banks would only become more stringent with their lending amidst the recession and new Basel rules. Additionally, we reasoned that the Canadian sector would catch up to the US. While there were already some decent-sized players in the US—the typical rule that you divide by ten to get Canada's market size—it was clear there was an opportunity because Canada's market size was 50 times smaller.
Why do folks choose Merchant Growth as a lender over a traditional bank?
In Canada, we have an oligopoly banking system compared to the US. In the US, you have many community and regional banks, and therefore, there are more services a small business can receive from traditional banking institutions. Whereas in Canada, banking institutions are quite conservative and primarily assess a borrower's collateral.
Banks might offer you a credit card, but they won't provide you with a meaningful amount of working capital unless you have real estate that can be leveraged as collateral. Most small businesses have cash flow but no collateral.
This underserved market is large enough to build a sizable non-bank entity, which is what we're aiming to accomplish, but small enough to discourage banks from competing.
What are your intentions for the $300 million in forward flow facility provided by Fortress?
One of Canada's larger government loan programs during the pandemic, Canada Emergency Business Account (CEBA) loans, is coming up for repayment. During the pandemic, the government freely provided capital to encourage growth and meet a significant demand from small businesses. Now, with the government asking for repayment, it's serving as an incredible catalyst for creditors to help repay this CEBA loan—which we're able to support with the capital provided by Fortress.
I presume your goal is to establish new customer relationships and investment opportunities through these repayment transactions. Is that right?
Absolutely. We're finding borrowers who previously, maybe, wouldn't look at online platforms like us—and are now seeking capital to solve this repayment need. We anticipate that we're simply solving a singular problem for some businesses, so our renewal rates might drop slightly lower than we've experienced for our core business. However, we're also funding many businesses only for what they need to pay off that loan, even though they qualify for a fair bit more. Only time will tell, but by taking care of this immediate need for them, when we reapproach them for renewal and offer more capital to them on a net basis—we're optimistic that it can expand our business.
What was your experience navigating the economic recessions deriving from the pandemic?
The pandemic was bizarre in comparison to the general economic recession. We fund main street small businesses. Grocery stores, food services, and auto repair shops are small but stable businesses that chug along. A portion of our portfolio also funds discretionary consumer goods like travel, tourism, luxury goods, etc. Across our portfolio, only a minority of the portfolio was in the sensitive area heavily impacted by the pandemic.
It was actually quite interesting to see the resiliency of our model. What we witnessed was typical of a recession, with less deployment of capital due to a decrease in the volume of applications. It was a short period of quite an acute level of delinquency, followed by a gradual decline in that delinquency rate to the point that it hit an artificial low that was lower than anything we'd ever seen. It stayed there for a while. It's since normalized to some extent, but where we sit today, we still run at a lower loss rate than we did pre-pandemic. I think that's also because of our underwriting improvements.
What's unique or groundbreaking about your underwriting process? I assume it's largely automated and AI-driven by specific data inputs that you found particularly helpful.
Yes. There are basically four main pillars of data sources. One is the application itself. Two is their credit bureau data. That shows the health of the business owner's personal finances. Next is the business's bank transaction data, the third and most important pillar. Generally, our goal is to assess whether a business will be viable over the loan term and whether they have the cash flows to support the payments. The bank transactions support our risk analysis and our offer sizing. Lastly, our fourth is a catch-all bucket that includes government registries, online presence, and other indicators that we pull together without bothering the applicant to supply.
Our mission is to bring the most convenient and accessible financing experience, so convenience means as few clicks as possible. Let the business owner get back to work and save them time. That's really a big part of our value prop.
When you think about your customers, do you have a specific industry you view as your specialty?
It has always been a broad spectrum of industries. At the end of the day, we've always wanted to see cash flow profiles in bank transactions that exhibit consistent inflows that appear predictable. This is not limited to any specific industry. Typically, we skew towards business-to-consumer businesses because they're lower revenue-generating companies than business-to-business. Our biggest industry category is 15% of the book, which means our portfolio is diverse. We like it that way.