While MCA may have started out as a method to finance a predictable cash flow stream from small business' credit card receivables, it has evolved into a flexible financing tool not dependent on credit card receivables but based on projected cash flow from the business. This slide deck presents valuable insights on how merchant cash advance has evolved and the future of Fintech & MCA. It was created by Pearl Capital, a leading provider of short-term capital advance solutions for businesses.

1. The Future of
Fintech & MCA
How Merchant Cash Advance Has Evolved

2. Isn’t Merchant Cash Advance Old? And
Isn’t Fintech the Shiny Future?
• Disruptive innovation comes from the bottom of the market,
when a product or service with a minimum viable feature set
gets better and better until it improves its way up the value
chain.
• MCA began as a method to finance a predictable cash flow
stream from small businesses’ credit card receivables. Although
inferior in pricing to bank financing, it is superior in speed and
flexibility.
• MCA has evolved into a flexible financing tool not dependent
on credit card receivables but based on projected cash flows
from the business.
• Manually underwritten transactions’ key inputs are bank
statements, tax returns, and business credit of owners.
Automated credit models can be built on machine learning and
the same inputs for a company that can efficiently extract the
relevant features from those raw sources.

3. The Rise of the Fintech Lender
• Fintech lenders use alternative data sources to enrich or
replace FICO scores. They also offer a better customer
experience without the legacy systems that constrain banks.
• Most Fintech lenders focused on small businesses don’t
entirely replace FICO scores but enrich it with data such as
social media, accounting and bank activity, and tax returns.
• The charts beloved of Fintech lenders illustrate the “lift”
created by their proprietary scores. They claim an
improvement over FICO, allowing for lower default rates for
high FICO borrowers, and/or a product that can be offered to
lower FICO borrowers as well.
• Fintech lenders also provide a better user experience through
speed, well designed mobile applications, and “low-friction”
underwriting--with less documentation requirements.

4. Evolution of Small Business Finance

5. Is Small Business Fintech Prime
or Subprime?
• OnDeck, Kabbage, Square Capital, and Amazon’s growing lending arm all
use proprietary scores as an alternative to FICO.
• Will FICO alternatives allow Fintechs to finance traditionally “subprime”
borrowers at more economical, bank-loan type rates? Will they improve
credit performance to “prime” customers enough to offer pricing
competitive with banks with low doc and without collateral?
• OnDeck and Kabbage borrowers have Prime FICO scores, implying that
Fintech lenders create more value by delivering scores that enhance,
rather than replace, FICO.
• Fintech lenders are focused on the prime market and will remain so for
brand and regulatory reasons. While improved scoring has enhanced
customer experience for prime borrowers, it has not enabled lending at
low default and interest rates to subprime ones.
• Brand equity requires limiting interest rates and the population served
until true non FICO scores can be created. But if FICO truly measures
propensity to pay will it ever be entirely replaced?

6. Alternative SMB Finance: Risk
Management for Subprime
• MCA using the traditional manual underwriting
processes are capable of origination to subprime
businesses at less than 10% default rates
• Machine learning when applied to refine manual
processes have classes of MCA with sub 5% default rates
similar to those produced by Kabbage and OnDeck for
prime borrowers.
• Risk based pricing enables a broad spectrum of the
subprime population to be served.
• MCA scoring and underwriting mechanisms can be used
in loan and line of credit products as readily as in MCA.
• MCA has served as the lab for subprime experimentation.

7. Distribution by FICO Score
of Pearls MCA Transactions

8. Auto Loan Originations by Credit Score
Libertystreeteconomicsnewyorkfed.org

9. Auto Loans as the Potential Future
for Subprime Business Funding

10. How Banks Fit In
• Banks own the most important customer data and the tech budget to create the best customer
experience. They alsoenjoy the lowest cost of capital and the lowest cost of customer acquisition.
• Machine learning techniques are not rocket science and alternative credit scoring FICO enhancement
can be accomplished by any large bank.
• Most importantly, banks have a persistent relationship with their customers unlike Fintech lenders, which
have largely been unsuccessful in broadening their relationship with borrowers.
• Kabbageand OnDeck currentlylend at 35%+ APR’s totheir primeborrowers.
• Current alternative scores are enhancements to FICO that create value that can be passed along to the
prime small business borrower, but they can’t provide enough credit enhancement to FICO within the
subprime population to enable “prime-ish” rates.
• Banks will own the prime market.
• Subprime small business financing will remain outside the banking system and will be serviced by
Fintech companies.

11. Do Tech Companies with Access
to Proprietary Data Have a
Lasting Competitive Edge?
• Amazon, PayPal, and Square are modern variations of the MCA split
dollar financing, which primarily relies on transactional data.
• The proprietary data used in their credit models is company specific
e.g. Amazon or Paypal will have different focus than Quickbooks
Capital.
• The utilization of technology and general machine learning
techniques may be similar, but the major difference that will persist
is a bias away from the valuable bank account analysis that the
Fintech companies have mastered.
• Understanding more “universal” sources of input data, like those
extracted from bank statement analysis, unlocks a base of new
customers and enriches underwriting models.
• PayPal recognized this with its acquisition of Swift Capital.
• A lasting competitive edge requires understanding all important
sources of credit data -- not just the ones to which you have easy
and proprietary access.

12. What Do the Next Ten Years Look Like?
Banks own the customer and have technology to monitor and
interpret customer data. When combined with accounting data
and other sources they proactively push out offers to SMB
customers.
Lending becomes tied to insights into small businesses and
operates similarly to smartphones and cars.
Small businesses can check their business score, automate credit
applications, eliminate overdraft fees. Or access and
management of cash flow can be set to autopilot.
Alternative small business credit scores evolve but don’t
eliminate the bank/non-bank divide for subprime which remains
outside the banking system.
Technology companies enter banking and buy existing non-bank
lenders for their broader lending expertise.

13. If you’d liketo learn moreabout Pearl
Capital’ssmall businesscredit scoreor
bankanalysistechnology
Please contact
sol@pearlcash.com