Archive for: Whitepapers

By Alex Branton and Marc J. Sharpe, M.A., M.Phil., MBA

Abstract

A family office whose private markets allocation has matured, whose distributions have slowed and whose capital calls have not, faces a liquidity problem of timing rather than solvency. Borrowing against the portfolio (NAV financing) is one of six or seven responses available to it, and the one least often explained properly. This paper compares a portfolio-level NAV facility against the alternatives. It distinguishes fund-level, portfolio-level and concentrated-position facilities, and shows why the governance question survives the choice to lever oneself. It explains why a lender almost never takes security over the underlying companies — because limited partnership agreements restrict transfers and pledges, often including indirect ones — and why that single constraint produces the three structures a family is likely to be offered, together with the covenants, cash traps and sweeps that accompany the most common of them. It then separates reported net asset value from eligible net asset value, the defined term to which an advance rate is actually applied and sets out what a position-level schedule must disclose before borrowing capacity can be assessed. It models what a cash sweep does to family liquidity when it operates from closing on a performing loan, compares a matched-cash partial secondary sale against a facility on the same date, and closes with four tests a requirement must pass before a facility might be considered the right solution.

Nothing in this white paper constitutes tax, legal, or accounting advice. The discussion of NAV credit facilities, security structures and secondary market pricing is a general educational summary only, and individual results depend on specific facts and circumstances. Readers should consult their own qualified counsel before acting on anything described herein and should not rely on this white paper as a substitute for such advice.

Introduction

Most families arrive at this issue the same way. The private markets allocation has matured, the distributions that were supposed to fund this year’s calls have not turned up, and the calls have. Nothing has gone wrong exactly. The cash is just in the wrong place at the wrong time.

At that point a family office has six or seven things it can do:

1. Hold more cash.
2. Sell liquid assets.
3. Draw on credit it already has.
4. Sell some LP interests in the secondary market.
5. Borrow against the private portfolio.
6. Slow down future commitments.

In practice most families do two or three of these at once. The fifth is the one nobody explains properly to families, so it is the one we will compare against the others here. What a lender is really securing. How much of a portfolio actually counts toward borrowing capacity. What a cash sweep does to your liquidity. And when the answer ought to be no.

Who is borrowing, and against what?

Several quite different things get called NAV lending, and the distinction that matters is who the borrower is.

A fund-level facility has the private equity fund borrowing against its own portfolio companies. Its limited partners end up carrying leverage the general partner chose.

A portfolio-level facility has the holder of a set of fund interests borrowing against them. That is typically the version available to a family office.

A facility against a handful of positions uses the same legal machinery on a concentrated pool. The credit changes. The law does not.

Choosing your own leverage does not dispose of the governance question, and this is where families sometimes get caught out. The borrower, the entity holding the interests, any guarantor, and the people who actually benefit from the proceeds, are often four different parties. Once trusts hold part of the portfolio it gets even more tangled still. Work out early which entity can borrow, which can pledge, and who would fund a cure. Then look at what leverage already sits inside the funds and their portfolio companies, because whatever you will sign sits on top of all of it.

How the security actually works, and why it drives everything else

Families often assume the lender takes security over the underlying companies. It almost never can, and the reason explains most of what you will see in a term sheet.

Most limited partnership agreements restrict transfers and pledges. Plenty go further and treat an indirect pledge, or an indirect change of control, as a restricted transfer too. That last part is what catches many people. Pledging the equity of a holding vehicle sitting above the interests can trip the restriction just as a direct pledge would.

The law firm, Mayer Brown, looked at this in March 2026 and put the consequence bluntly. A lender that took security without the consent it needed may find it cannot foreclose or sell the interest on a default. It may be left holding the economic proceeds and nothing else.

So, permission to grant a pledge is not permission to enforce one. Out of that gap come the three structures a family office is likely to be offered.

The first limits the collateral to cash. The lender takes a pledge of the right to receive distributions, a covenant that distributions go into a pledged account, and security over that account. Mayer Brown calls it security lite and notes it keeps gaining ground, because it sidesteps the transfer restriction problem altogether.

There is a price for that, and you should expect to pay it. The lender cannot reach the assets, so it leans instead on strict loan-to-value thresholds, cash trap triggers, diversification covenants, and the right to sweep all net proceeds.

The second structure pledges every equity interest except those carrying a restriction that would block a pledge, carving the restricted ones out automatically. It saves reviewing hundreds of documents on day one, and it has become common on larger deals. The third takes a full equity pledge and needs the consents.

Ask which of the three you are being offered before anybody talks about price. A family that knows it is looking at security lite will understand why the covenants and the sweep are as tight as they are and can negotiate on that footing rather than treating the terms as difficult or contentious.

One more thing sets the US timetable, and it is purely mechanical. A security interest in a deposit account can only be perfected by control. Unless your lender happens to be the depositary bank, it needs a control agreement with every bank holding a distribution account. Getting those agreed across several custodians, on top of any consents and notices, is usually why a deal takes longer than the credit work alone would suggest.

Eligible net asset value, not net asset value

Borrowing capacity is not an advance rate applied to the sum of your general partners’ marks. It is applied to eligible net asset value, which is a defined term buried in the facility, and the two numbers can sit a long way apart.

Generic advance rates are close to useless here. Ask instead for a position-level schedule, and read it for:

1. Reported value and the date it was struck
2. Which positions are excluded, and why
3. Concentration caps by fund, by manager, and by underlying asset
4. Valuation and currency adjustments
5. How unfunded commitments and existing debt are counted, and whether the marks already reflect them

Three further questions decide how much headroom a family office really has:

1. Does capitalized interest count as debt?
2. Can the lender challenge a valuation between reporting dates?
3. Is the initial advance limit the same as the maintenance threshold, and the same again as the level where cash starts being trapped? Often it is not, and nobody volunteers that.

Two portfolios with identical reported value can support very different facilities once those definitions bite. Diversification across fifteen funds can also hide the same managers, or the same companies, sitting underneath them.

What a cash sweep does to family office liquidity

Borrowers tend to read the sweep as a default remedy and move on. It is usually rather more than that. In many structures it runs from closing, on a perfectly performing loan, routing distributions to the lender before anything reaches the family office.

Accrued interest makes it worse. The balance climbs while the lender is taking the distributions. The calls still arrive. The cash you had earmarked for them has gone.

So, model the sweep on its own, before you model any breach.

1. How much of each distribution gets captured?
2. Are there carve-outs for capital calls, taxes and running costs?
3. At what point does it switch off?

Then push the case. Delay the realizations, mark the portfolio down, and look at what is left. If the answer is nothing, somebody has to find it, and the family office should know who that is well before it signs.

The arithmetic itself is easy. Hold the debt flat, drop the value 20%, and a facility drawn at 35% LTV sits at roughly 44%. Whether that is a problem depends on where the thresholds were set in the first place. It also depends on something less obvious. If the asset that fell is no longer eligible, an exclusion can push the effective ratio a good deal further than the markdown alone would.

Comparing cost, and comparing options

Headline margin is not a comparison. Nor is total cost divided by expected usage, because the offers will differ in fee base, draw timing, and repayment assumptions.

Put every proposal on the same dated schedule of drawings and repayments. Then look hard at what each fee is charged on. An origination fee on the full commitment is a different animal from one charged on amounts drawn, and on a partly used facility that gap gets wide.

Build in the benchmark convention and any floor, the split between cash and capitalized interest, the sweep, and anything payable on prepayment or extension. Produce a dollar total and an effective annual rate off the dated flows. Then run it again on lower utilization. Then once more on a delayed exit, because that is the case that typically happens.

Borrowing against the portfolio, or selling part of it

Both routes have to raise the same cash on the same date or the comparison is theatre.

Say a family office needs $20m. At a bid of 91% of reported value, raising it means selling ~$22m of reported value, so the discount is ~$2m before transaction costs and taxes. The alternative is a $20m drawing, which leaves $20m to repay plus interest, fees and covenant exposure.

Setting a discount on the whole portfolio against interest on a partial drawing is not a comparison at all. It flatters borrowing, and it is how decisions get made badly.

Three warnings belong with that arithmetic:

1. Buyers select. A strong bid on your two best funds does not price the rest, and a published average is market color rather than an offer for your interests.
2. Headline price is not cash. A good share of LP sales now carry deferrals or other structured terms, so what settles at closing can be well below the number quoted.
3. A sale takes the unfunded commitments with it, and borrowing does not. Where the real difficulty is the pace of future calls, borrowing to meet them finances commitments whose value dips through the early years, shrinking borrowing capacity at exactly the moment the balance is growing.

Some context, though not a forecast. In the first half of 2026, Jefferies, the investment bank, put average LP portfolio pricing near 87% of net asset value. Buyout was around 91%. Real estate was around 68%. Those are dated observations of dispersion. None of them is a bid for your interests, so family offices will need to go and get real ones when considering options.

When another route is better

A few situations argue against a facility:

1. A recurring shortfall is the clearest of them. Borrowing turns an allocation problem into a leveraged allocation problem, and the problem is still sitting there next year.
2. Concentration is the next. If one or two positions carry the portfolio, the terms on offer will tell you so.
3. Repayment is where families most often fool themselves. Portfolio distributions are the normal repayment source and there is nothing wrong with that at all. What does not work is a plan resting on values recovering, or on a refinancing nobody has committed to.
4. Then governance. If the committee has not settled who authorizes a cure, and whose assets fund it, have that conversation before signature rather than in the middle of a bad quarter.
5. And if the family would exit the assets anyway, a discount to a stale mark may simply be what they are worth.

A decision rule

Thin distributions do not automatically call for a facility. Four things have to line up:

1. The requirement should be temporary and defined.
2. The portfolio should be diversified, and one you actually mean to keep.
3. The sweep and covenants should still leave enough cash for known calls in a downside case.
4. And repayment should not rest on an assumption your committee would throw out in any other context.

Miss any of the four and other alternatives deserve the same arithmetic, done properly, before anyone signs anything.

About the Authors

Alex Branton is Chief Investment Officer of Nodem Capital, an investment firm working with family offices and private markets investors on NAV financing and GP financing. Nodem Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom, firm reference number 1017481. Authorization by the FCA concerns Nodem’s regulated activities in the United Kingdom and does not itself constitute authorization to lend in any other jurisdiction. Contact: abranton@nodem.com

Marc J. Sharpe is a global investment executive and board member with a career spanning family office management, private equity, venture capital, and investment banking. Known for his strategic insight, deep expertise in family office governance, and ability to foster innovation and value creation, Mr. Sharpe has built and led investment platforms that deliver sustainable growth while navigating complex financial and operational challenges. His leadership style emphasizes integrity, continuous improvement, and long-term partnerships that generate significant stakeholder value. Mr. Sharpe is the Founder and Chairman of The Family Office Association, a premier global peer network of single-family offices. Since 2007, he has cultivated a community of senior family office executives and principals representing some of the world’s wealthiest families, promoting education, shared-best practices, and co-investment opportunities. Under his leadership, TFOA has become a trusted forum for collaboration, market insight, and proprietary investment deal flow on a global scale. He also teaches an MBA class on “The Entrepreneurial Family Office” as an Adjunct Professor at Rice University and Southern Methodist University. Mr. Sharpe holds an M.A. from Cambridge University, an M.Phil. from Oxford University, and an MBA from Harvard Business School. Contact: marc@tfoa.me

About TFOA

The Family Office Association (“TFOA”) is a global peer network that serves as the world’s leading single family office community. Our group is for education, networking, selective co-investment, and a resource for single family offices to share ideas, deal flow and best practices. Members are not actively marketing products or services to other members, and no contact information or email lists will ever be shared. Since our founding in 2007, TFOA has led the global single family office community by delivering world-class educational content, unique networking opportunities, and exceptional thought leadership to our highly curated network of the world’s largest and wealthiest families: www.tfoa.info

Disclosures

Educational only. Not investment, legal, tax or accounting advice. Not a recommendation. Not an offer of financing.

What is described here are general market structures. Terms vary by transaction and turn on the relevant fund and facility documents. Readers should take their own professional advice and get their own proposals and bids.

Market data is a dated illustration drawn from the Jefferies Global Secondary Market Review, July 2026. It reflects aggregate transaction observations, not executable prices. Legal structuring points draw on Mayer Brown, Transfer Restrictions in NAV Credit Facilities, March 2026.

The figures in this paper are original illustrations prepared by The Family Office Association from the content of this paper. They reproduce no third-party artwork.

Authored by Marc J. Sharpe, M.A., M.Phil., MBA

Abstract

This whitepaper presents a conceptual framework for career and life success: Success = (Desire − Fear)^Luck, where Luck = (Relationships × Timing). While individual effort and talent provide the foundation, outcomes frequently amplify through net conviction and engineered serendipity. Academic studies, including Pluchino et al. (2018) simulations showing luck’s dominance in extreme success, Mauboussin (2012) on the skill-luck continuum, and Sinatra et al. (2020) quantifying randomness in creative careers, substantiate this perspective. Case studies of Bill Gates, Jeff Bezos, and Oprah Winfrey demonstrate the equation’s components in action. Implications for professionals emphasize managing controllable factors while positioning for fortunate alignments.

Success = (Desire − Fear) ^ (Relationships × Timing)

Introduction

Career trajectories and life fulfillment are often ascribed to talent or perseverance alone, yet substantial variance remains unexplained. Prominent figures frequently acknowledge circumstantial advantages—Bill Gates, for instance, credits access to early computers and supportive networks (Gladwell, 2008). This paper articulates Success = (Desire − Fear)^Luck, with Luck = Relationships × Timing.

Desire embodies sustained drive toward meaningful goals. Fear manifests as hesitation, risk aversion, or self-doubt. A positive base sustains pursuit amid setbacks. Luck compounds this: relationships foster opportunities and mentorship; timing aligns personal readiness with external shifts. This aligns with empirical models where moderately talented individuals with favorable events outperform pure talent (Pluchino et al., 2018).

Deconstructing the Base: Desire Minus Fear

Desire fuels persistent effort: fear erodes it through doubt or loss aversion. Sustaining desire over fear creates resilience essential for long-term achievement.

Jeff Bezos exemplified this during Amazon’s founding. In 1994, secure in a Wall Street vice presidency, Bezos identified internet growth potential (2300% annual web usage increase). Despite fears of abandoning stability, his desire for entrepreneurial impact prevailed. He drove cross-country to launch an online bookstore, maintaining conviction through early losses exceeding $1 billion cumulatively by 2000 (Brandt, 2011).

Oprah Winfrey similarly overcame fear. Early career instability and personal trauma could have deterred ambition, yet desire for authentic connection propelled her. Transitioning from local news to hosting, she persisted despite initial ratings struggles, building a media empire through relentless focus on empathy-driven content.

The Exponent: Luck as Relationships × Timing

Luck elevates the base exponentially. Relationships provide access and support; timing synchronizes effort with opportunity.

Bill Gates benefited profoundly. Born 1955, he accessed computers rare for teenagers—Lakeside School’s terminal in 1968 enabled thousands of programming hours (Gladwell, 2008). Relationship with Paul Allen led to co-founding Microsoft; timing aligned with 1975 Altair microcomputer release, prompting BASIC interpreter development. IBM’s 1980 PC deal—secured partly through familial connections—catapulted Microsoft (Isaacson, 2014).

Bezos timed the 1990s internet boom perfectly, launching Amazon amid deregulation and connectivity growth. Early investor relationships sustained operations during dot-com volatility.

Winfrey’s breakthrough involved timing and relationships. Hired in television post-1970s affirmative action shifts, she met Quincy Jones, who cast her in The Color Purple (1985), earning an Oscar nomination and elevating her profile (Academy of Achievement interviews).

Empirical Insights from Research

Simulations reveal luck’s outsized role. Pluchino et al. (2018) modeled normally distributed talent with random events; luckiest moderately talented agents dominated success distributions. Mauboussin (2012) positions creative professions nearer luck than skill-dominant fields. Sinatra et al. (2020) found consistent randomness influence across careers, with timing of peak impacts unpredictable.

These cases reflect transience: Gates post-Microsoft shifted to philanthropy; Bezos stepped down as CEO in 2021; Winfrey ended her daily show in 2011, pivoting successfully.

Implications for Professionals

Individuals control desire through goal clarity and fear via exposure and reflection. Engineering luck entails deliberate networking and adaptability to trends.

Conclusion

The framework Success = (Desire − Fear)^Luck illuminates why similar talents yield divergent outcomes. Skill and effort construct the base, yet luck—through relational networks and temporal alignments—often determines magnitude. Pluchino et al. (2018) demonstrate that without fortunate events, even high talent plateaus; conversely, moderate talent amplified by luck reaches extremes.

This underscores humility: acknowledging luck tempers overconfidence in meritocracy, fostering gratitude and resilience. Gates, Bezos, and Winfrey each credit preparation meeting opportunity, yet external factors—birth era, access, connections—proved pivotal.

For professionals, implications are profound. Prioritize desire by aligning pursuits with intrinsic motivations; mitigate fear through incremental risks and support systems. Cultivate relationships broadly, as serendipitous ties often unlock doors. Monitor timing by staying informed on industry shifts, positioning for emerging waves.

Ultimately, while luck remains partially uncontrollable, maximizing return on it—through readiness and action—distinguishes sustained success. This balanced view encourages persistent effort without disillusionment, recognizing life’s compound nature where conviction, amplified by engineered fortune, yields fulfillment beyond mere achievement.

About the Author

Marc J. Sharpe is a global investment executive and board member with a distinguished career spanning family office management, private equity, venture capital, and investment banking. Known for his strategic insight, deep expertise in family office governance, and ability to foster innovation and value creation, Mr. Sharpe has built and led investment platforms that deliver sustainable growth while navigating complex financial and operational challenges. His leadership style emphasizes integrity, continuous improvement, and long-term partnerships that generate significant stakeholder value. Mr. Sharpe is the Founder and Chairman of The Family Office Association, a premier global peer network of single-family offices. Since 2007, he has cultivated a community of senior family office executives and principals representing some of the world’s wealthiest families, promoting education, shared-best practices, and co-investment opportunities. Under his leadership, TFOA has become a trusted forum for collaboration, market insight, and proprietary investment deal flow on a global scale. He also teaches an MBA class on “The Entrepreneurial Family Office” as an Adjunct Professor at Rice University and Southern Methodist University. Mr. Sharpe holds an M.A. from Cambridge University, an M.Phil. from Oxford University, and an MBA from Harvard Business School. Contact: marc@tfoa.me

About TFOA

The Family Office Association (“TFOA”) is a global peer network that serves as the world’s leading single family office community. Our group is for education, networking, selective co-investment, and a resource for single family offices to share ideas, deal flow and best practices. Members are not actively marketing products or services to other members, and no contact information or email lists will ever be shared. Since our founding in 2007, TFOA has led the global single family office community by delivering world-class educational content, unique networking opportunities, and exceptional thought leadership to our highly curated network of the world’s largest and wealthiest families: www.tfoa.info

Disclosures

The Family Office Association (“TFOA”) is a peer network of single family offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

By Andrew Probasco, Sunny Zhang, & Sandip Bordoloi and edited by Marc J. Sharpe, M.A., M.Phil., MBA,

Executive Summary

Immigrant entrepreneurs outperform in founding U.S. unicorns and Fortune 500 companies, creating patents and jobs, and powering innovation in the U.S. economy. This white paper reviews findings from research to demonstrate the success of immigrant innovators and entrepreneurs and explore the reason(s) for their success, including the networking advantage they bring through the companies they lead that specialize in global markets at conception affording these firms a greater chance to succeed and scale.

Key Stats

• 55% of unicorns (billion-dollar startups) have at least one immigrant cofounder. National foundation for American Policy (2018).
• 43% of Fortune 500 firms in 2017 and 57% of the top 35 firms were founded by immigrants and their children. Center for American Entrepreneurship (2022).
• 35% of U.S innovation and entrepreneurship is created by immigrants accounting for 13.7% of the U.S. population. (Kerr & Kerr, 2020; Budiman, A. 2020).
• 20% of the world’s tech founders are immigrants, while they only make up about 4% of the world’s population. The Global Startup Ecosystem Report by Startup Genome (2022).

Unicorns and Outliers

What do SpaceX, Zoom, Wish, Robinhood, Stripe, Uber, DoorDash, InstaCart, and Pfizer have in common? Each one is a U.S. unicorn (i.e., a privately held company with a valuation of over 1 billion dollars) and each one was founded by immigrants. The overwhelming majority of unicorns are tech startups supported by venture capital funding which has generated tremendous returns for their investors.

The overwhelming majority of unicorns are tech startups supported by venture capital funding. Collectively, the VC industry in tech has generated tremendous returns for its investors. Broad research exists on the various factors that drive the success of unicorn companies. Among these are the number of founders, the time required to achieve unicorn status, the variety of industries, and the characteristics of founders.

Unexpectedly, 55% of U.S unicorns studied had at least one immigrant founder (Anderson, 2022). This finding echoes the disproportional success rate among Fortune 500 companies, of which 45% were founded by first- and second-generation immigrants.

Ilya Strebulaev, a tenured professor with the Stanford Graduate School of Business and head of the Venture Capital Initiative, a research group chartered to keep tabs on entrepreneurship, private equity investments, and the impact of venture capital on business, using recent data, has discovered a series of revealing correlations between venture funding, immigrants, and success.

Based on the research of 1,123 U.S based unicorns with some VC backing, start-ups with 3 or 4 immigrant co-founders were a whopping 74% more likely to reach unicorn status. Interestingly, Dr. Strebulaev’s highly representative sample indicates a series of significant correlations between immigrants, their education, their success in corporate leadership, and their success as founders.

Immigrants Outperform in Entrepreneurship and Innovation

Immigrants’ success in entrepreneurship extends beyond unicorn companies. Between the years 2008 and 2012, immigrants founded 25% of all new businesses (Krol 2021; Kerr and Kerr 2020). When compared to their native-born counterparts, immigrants are 80% more likely to register a business (Dizikes, 2022). Based on 2017 data from Fortune 500 companies, as well as the U.S. Census Bureau’s Longitudinal Business Database, which included information on every new business founded between 2005 and 2010 that lasted at least five years, for a total of 1.02 million firms, immigrants are more likely to found firms (of all sizes) than native-born entrepreneurs.

Immigrants’ rate of innovation is also much high than their native-born counterparts. Immigrants account for nearly 1 in 4 U.S. patents, despite constituting only about 14% of the population overall (Azoulay, 2020). From 1975 to 2015, immigrants as a group attained 40% more patents on average compared to all other groups in proportion to their steadily growing percentage of the U.S. population.

Data collected from the U.S. Patent and Trademark Office by Stanford researchers note that the higher number of patents secured by immigrants are in greater use in industry and research. Researchers found that immigrant-originated patents were 40% more likely to be publicly recognized or currently in use. The total speculated economic value of these innovations occurring chiefly through the utilization of patents by public companies is estimated to constitute 25% of economic value, or 50% higher than the overall average (Tam, 2020). Research from the CATO Institute indicates that immigrants are largely the originators of innovation and economic dynamism, rather than the supporters. Data collected from 1975 to 2010 notes that immigrants flowing into the U.S can be tied to a 27% increase in patent acquisition and an increase in regional wages (Burchardi et al., 2020).

Tech Leadership

Data on immigrant founders shows that they have taken on a disproportionately large role in management, product development, and have led several sectors in overall patent attainment. Exclusive use rights have provided their firms with access to new methods integral to emerging product designs. Anderson notes that as of 2016, over 70% of companies involved the contribution of one or more immigrants in a key role in management or product development. As of 2022, nearly 80% of U.S. unicorns have an immigrant founder or an immigrant in a key leadership position.

Notable examples include SpaceX, Uber, and over 30 others. Self-selection bias may be at play given the proportionally higher numbers of immigrant STEM holders. The discrepancy between lower absolute education in the immigrant population and increased numbers of those with STEM expertise is likely the result of a U-shaped skills curve within the immigrant population (Krol, 2021; Ganguli et al., 2020).

Jobs and Value Creation

Contrary to the usual narrative, immigrants create more jobs than native-born entrepreneurs, accordingly to Ben Jones, a professor of strategy at Kellogg. Immigrant-founded companies not only have more patents than native-born-founder-led firms, but they also pay higher wages than native-founded firms. Immigrants are found to be economically compliments in the multiple sectors in which they participate; these groups have been recognized as generators of roughly 25% of American jobs. NFAP finds that privately held U.S. billion-dollar startup companies with immigrant founders have created an average of 859 jobs per company. Thus, immigrants improve the economic outcomes for native-born workers. Immigrant-founded US unicorns are collectively worth $1.2 trillion and would be the 16th largest GDP as a country, more than the value of the companies listed on the major stock markets of most countries.

Self-Selection and Resilience

Many reasons can contribute to immigrant success as startup founders and corporate leaders. Peter Vandor (2021) notes in his Harvard Business Review article that the combination of a high appetite for risk, high achievement motivation, and follow-through are qualities supported by survey data as consistent with a business leader identified as an immigrant.

The ways in which the immigration process leads to a kind of self-selection bias may also be a key contributing factor. Cost, complications, and stringent requirements notwithstanding, the selection involved in F1 and H-1B visa attainment present an often-insurmountable challenge for many prospective immigrants. Given these limits, immigrants who successfully acquire visas and citizenship status exhibit a characteristically uncommon tolerance for risk and adaptability to unfamiliar circumstances.

Research performed by the Vienna University of Economics and Business found that nearly half of students who indicated an interest in starting a business and who also chose to move abroad and return later created a business (Gaskell, 2021). Additional obstructions like labor market discrimination compound these effects.

Nearly 25% of U.S. billion-dollar startup firms have a founder who was once an international student (Anderson, 2022). Standards for admission as an international student are considerably higher than average. Furthermore, international students typically seek out universities with high ranking and better outcomes. This historical data review records in years before 2020 indicating that successes were not influenced by recent or intentional changes.

Education

Successful firms in emerging industries like tech need technically astute talent. Although international students only account for 4% of the U.S. university population, they obtained 50% of the graduate degrees in STEM. Immigrants are 40% more likely to hold a doctorate, according to Tam (2020). And immigrants are the majority recipients of higher-level STEM degrees. NFAP found that in 2011, 65% of Ph.D. recipients and 60% of master’s degree students in electric engineering were foreign-born. Similar results appear in fields like computer science, mathematics, and statistics (Anderson, 2013).

The most current data confirm the value of education to financial outcomes led by immigrants vetted through the emigration process. Illya Stebulaeve (2022) found that 21% of these founders were educated, at least in part, in one U.S university. Universities such as the University of Waterloo and Tel Aviv University have developed immigrants who originated at least 26 unicorns. NFAP also found that 25% of billion-dollar startup companies in the U.S. have a founder who attended a U.S. university as an international student.

Among all the immigrant founders of U.S. unicorns, 174 international students became founders or cofounders. International students typically can only remain in the United States long-term after gaining H-1B status and (or) an employment-based green card. Those who have been granted a continuous stay lead these firms.

To be Born Global

Vendor (2021) from the Harvard Business Review quotes “immigrant founders have a competitive advantage when it comes to building impactful, global reaching ventures.” Such firms have a global market strategy at inception. These firms’ leadership is more often than not made up of immigrants with diverse backgrounds and competencies relevant to the tech industry.

Simply put, these global reaching ventures are birthed with international orientation by talent originating globally. Their founding teams come from within rather than expand into international markets. Strategic choices made typically mirror the capacities and interests of firm managers who leverage global connections for market access and innovation. These companies leverage local and global ecosystems for innovation and talent acquisition generating a truly unique, difficult to replicate business model. Research indicates that such firm’s success leans heavily on the networking abilities of its founder(s), the globally scalable product, and of course adequate funding (Gabrielsson et al., 2008).

This networking edge has been demonstrated to improve their firms’ chances of success during the take-off early stages of development while positioning them for potentially exponential growth at middle stage and late-stage development. This networking effect lends a competitive advantage due to knowledge generated about the global environment, access to market information, and access to the best products and developers.

Conclusion

The pace at which VC-backed firms achieve billion-dollar valuations is accelerating. In the past 10 years, the number of U.S unicorns has doubled. In the past 5 years, the number of U.S. unicorns went up 500%. For tech startups, global scale companies led by immigrant founders continue to demonstrate real competitive advantages in achieving higher success rates and bringing great returns for investors. This is especially true during times of uncertainty and disruption, given their resilience.

About the Author

Marc J. Sharpe is the founder and Chairman of TFOA, an organization formed in 2007 to provide a forum for education and networking and to serve as a resource for single family office principals and professionals to share ideas and best practices, pool buying power, leverage talent and conduct due diligence. Mr. Sharpe is active in the community and has served on the Board of the Holocaust Museum Houston, the HBS Houston Angels, and on the Investment Committee for two Texas based foundations. Contact: marc@tfoa.me

About TFOA

The Family Office Association (“TFOA”) is a global peer network that serves as the world’s leading single family office community. Our group is for education, networking, selective co-investment, and a resource for single family offices to share ideas, deal flow and best practices. Members are not actively marketing products or services to other members, and no contact information or email lists will ever be shared. Since our founding in 2007, TFOA has led the global single family office community by delivering world-class educational content, unique networking opportunities, and exceptional thought leadership to our highly curated network of the world’s largest and wealthiest families: www.tfoa.info

Disclosures

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Texas Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

Authored by Sean Maher and edited by Marc J. Sharpe, M.A., M.Phil., MBA for TFOA

Over the past fifteen years, the energy industry has experienced significant challenges, which yield compelling opportunities today…

The Global Financial Crisis triggered a flood of capital into the market, ultimately hurting the returns on capital for energy investments due to their long-lived, capital-intensive nature. Over time, the shortcomings of spending on high-decline shale were seen and Returns on Invested Capital (ROIC) fell by nearly 2000 bps (20%) over the 2006-2019 period. As ROIC dwindled, mainstream investors retreated, further deepening the challenges by 2020.

Source: Third Gear Investments, Factset

As ROIC fell, generalist investors shunned energy companies, and these capital-intensive businesses could not secure development capital.¹ Over time, the fiscal situation worsened, investor apathy increased, and in 2020, capital disappeared; this forced additional bankruptcies, dividend cuts, and significant layoffs to self-fund ongoing operations.

However, the industry shifted its focus, prioritizing returns over asset growth, leading to a “Renaissance of Energy.” Despite these positive changes, many outside the sector remained oblivious. But the numbers speak for themselves. The industry is now making steady progress, and the increasing Free Cash Flow (FCF) to energy is undeniable evidence of this evolution.

Source: Third Gear Investments, Bloomberg

Efficiency, Optimization, and Technology

Contrary to popular belief, OPEC’s decision to increase production in 2014 was not targeted at U.S. shale but at large investment programs that required high commodity prices ($100/bbl+) to justify their significant capital investment and long gestation periods (5-7+ years to first production). OPEC’s strategy led to financial strains across all energy sub-sectors as investment was slashed in every vertical. However, this gave rise to a new era focused on capital discipline and resource optimization (i.e., inventory management and cost efficiency).

In 2020, there was a further reallocation of capital towards renewable electrification as many investors left traditional energy for more compelling narratives around renewables; clearly, a material change in behavior was underway.

However, what hasn’t changed is the notion that investors should embrace (and prioritize) companies generating tangible free cash flows, especially with rising capital costs and inflationary pressures, to earn a positive return on their investment. Investors should also recognize that traditional hydrocarbon producers contribute significantly to developing emerging technologies due to their financial strength, engineering expertise, and asset mix, allowing for commerciality and scalability assessments.

These alternative energy investments are in addition to traditional energy companies enabling global economic growth as they maintain investment in the fuels that power 93% of electricity demand today while working to improve (reduce) their carbon emissions. Hydrocarbon companies have traditionally focused on asset growth, but now they are increasingly prioritizing improved returns; efficiency and technology are potential ways to improve the company’s margins and environmental footprint simultaneously.

For example, heat loss accounts for approximately 25% of the lost energy supply, making resource optimization a top priority for industry (and the global economy). New technologies are promising, but old technologies are still the easiest path to improved energy supply and a lower carbon footprint. The hydrocarbon industry is investing more in resource optimization, which will help to maintain and enhance hydrocarbon supply. That said, demand continues to rise, with OPEC forecasting 105.2 MMBD in Q4 2024 (up 3% from the current 102 MMBD) and 110 MMBD in 2030; and supply growth will be challenged to meet this demand over the next 5-7 years due to insufficient investment. As such, we also need new sources of incremental electricity supply to support future demand needs. Therefore, the energy renaissance is an exciting time for industry, and we all hope for a cleaner, more efficient energy future.

The world will unlikely abandon any source of hydrocarbons for electric power generation for decades; this is an evolution of energy, not a transition from hydrocarbons. It is essential to appreciate this narrative because as energy consumption per person grows, it is not being met with improved efficiency elsewhere. Therefore, while the percentage growth rate of a specific energy source may slow, it is still growing on an absolute basis. Javon’s Paradox supports the narrative: efficiency enables one to use more of what they have, not to use less due to efficiency gains.

Hydrocarbons are the building blocks of consumer society, and nearly 60% of global end-use products have no alternative to hydrocarbons. Natural gas, propane, ethane, and butane demand is expected to grow approximately 5% annually over the next decade. With ~1.2 billion people entering the middle class by 2030 and nearly 3 billion in energy poverty, demand for all energy sources will continue to grow.

Source: Enterprise Products

Renewables will not ‘democratize’ energy overnight, as the power sector has struggled with integrating intermittent forms of electricity. Therefore, the global market will continue to rely on natural gas, coal, and nuclear to accommodate imbalances from weather seasonality.

Source: IEA, World Bank, Third Gear Investments

Energy security, reliability, and affordability are fundamental rights for the global population; they drive points 1-3 of the UN Sustainable Development Goals. In the IEA (International Energy Agency) Outlook of December 2022, 775 million people globally lack access to electricity, equivalent to the populations of the US and EU. This number is expected to increase through 2025, primarily in Africa and Oceania, where population growth is highest.²

Source: IEA, World Bank, Enterprise Products

By 2050, Asia and Africa will comprise 80% of the global population, while North America and Europe will only represent 11.7%. Incremental energy demand will come from these regions rather than the US and Europe.

Source: All data per World Bank, 2012, Data illustration per Grace Newton, Department of Geography, University of Illinois, 2016

Global energy consumption has nearly tripled since 1971, from 230 EJ to 608 EJ in 2019. Coal demand saw its market share go from 26.1% to 26.8%; in absolute terms, coal generated 60 EJ of power in 1971 and nearly 162 EJ in 2019 – more than triple.

When one contemplates the future of crude oil, natural gas, and natural gas liquids, to paraphrase Mark Twain: “It seems as though the tale of [their] demise is greatly exaggerated.” Unfortunately, energy investment in these hydrocarbons has fallen significantly, with current global upstream capex at less than half the levels of 2012-2014 (while crude oil prices are at the same levels), and with no signs of increases ahead, capital discipline is the new mantra in the oil patch and returns on invested capital are rising.

Source: Third Gear Investments, Bloomberg, RBC

Fortunately, global markets have become increasingly comfortable with natural gas as a transition fuel. Still, propane, butane, ethane, and crude oil will also play an essential part in improving the energy security, affordability, and reliability of global electricity demand and HDI (human development index) improvement. For example, the IEA forecasts that propane, butane, and ethane will see demand growth of nearly 5% annually through 2030. Without significant new sources of supply, prices will rise, which benefits margins and delivers more free cash flow.

The growth in natural gas liquids demand is supported by the massive growth emerging from the Midland and Delaware Basins in the Permian. The US is well endowed with natural resources, and these molecules are evacuated through the US Gulf Coast midstream and export facilities. The US is now the largest exporter of NGLs globally.

Source: Grand View Research

The value of traditional energy, as viewed from the lens of public equities, is likely understated. This is especially true when considering the immense economic costs of ramping up production to satisfy current demand. Over the past decade, the global economy has been flooded with inexpensive energy — a consequence of over $500 billion in lost investor capital. However, management teams are increasingly zeroing in on enhancing their Return on Capital Employed (ROCE). This is a crucial determinant of valuation in the capital markets. Current forward estimates suggest that energy may be undervalued by approximately 35-40% compared to its peers, especially considering the ROCE. And this assessment may be conservative due to three main reasons:

1. Supply growth is decelerating, whereas demand continues to climb.
2. Energy companies have significantly improved their leverage ratios, leading to superior earnings quality and reduced volatility.
3. Increasing capital discipline and industry consolidation will compel companies to maximize their existing resources.

Source: Bloomberg

The near-term future suggests a rise in hydrocarbon prices, given that supply is expected to lag demand. Inventories, when adjusted for demand, are at historic lows. Until a short while ago, OPEC was producing at its peak capacity. Many OPEC+ nations are yet to fulfill their designated quotas. Throughout 2022, Russian crude oil and other products flowed continuously into China and India. The US Strategic Petroleum Reserve introduced an additional 750 MBD into the market during the same period. This was concurrent with a withdrawal of nearly two million barrels a day of demand from the market, attributed to China’s zero-COVID policy; both factors have since reversed.

The recent cut by OPEC, spearheaded by Saudi Arabia, reflects strategic foresight. They recognize the peril of halting hydrocarbon investments in the US. If prices stagnate between $60-$70 for a prolonged period, it’s likely to deter producers from investing. Given the ever-increasing global demand, this would hasten the natural decline of fields and pose a more significant challenge in just a few years. With Saudi Arabia at the helm, OPEC+ isn’t merely playing the game; they’re strategizing several steps in advance.

Of critical note is India’s looming surge in demand. Although lagging behind China by approximately 15 years, India has a population of 440 million below 18. This promises a sharp spike in demand over the next decade. Yet, there are no ready resources to counterbalance this anticipated near 10% hike in global demand.

Valuation & Market Leadership: Both Are Improving

The S&P Energy composite will represent nearly 10-13% of S&P EPS in 2023-2025 but is a mere 4.8% of the S&P 500. Ten (technology) companies in the S&P 500 currently represent 34% of the total market capitalization and trade at an average 50x P/E multiple. Energy multiples have contracted over the past decade, while technology multiples have expanded significantly. A notable change of leadership is emerging.

Source: Bloomberg, Wolfe Research

Public energy equities are expected to deliver industry-leading returns on capital, which should drive multiple expansion and improve valuation. As the market adapts to the new paradigm, the outlook for all hydrocarbon prices is higher. Importantly, for the energy investor, this demand has been increasingly met by US Shale – the Permian Basin – and the US Gulf Coast. If management discipline continues, it should drive improved valuation in the equity markets, and the Renaissance of Energy will be at hand.

Source: Bloomberg, Third Gear Investments

Electrification is a cornerstone in our transition to a low-carbon economy, with every energy source holding a pivotal role in this transformation. Renewable electricity is on an impressive growth trajectory. Yet renewables account for a mere 7% of global energy consumption. The projected surge in electricity demand will dwarf the forecasted growth of renewables. Princeton University predicts a 43% increase in electricity demand in the US by 2035 – electricity demand has been flat for 20 years, but AI, Cloud Computing, and EVs are dramatically changing that.

Source: Princeton University, REPEAT Study

A modest 2% uptick in global energy demand would necessitate renewable power generation equal to roughly 30% of the existing infrastructure. Therefore, the Energy Renaissance needs to be holistic and encompassing – an “All-of-the-Above” stance. However, staying financially grounded, operationally pragmatic, and commercially realistic.

An “All-of-the-Above” Approach Should Provide Energy Stability, Reliability, and Affordability.

In conclusion, the exponential growth in global energy demand will compel the world economy to incorporate more nuclear and renewable sources while acknowledging the indispensable role of hydrocarbons. As a stable and consistent energy foundation, hydrocarbons fuel both emerging economies and the progress of developing nations. Their significance in our future energy landscape remains undeniable.

Source: EIA

Strategic investments in energy companies and new technologies, primed for scaling and commercialization, are essential to satiate this burgeoning demand. Traditional energy companies have often been in the crosshairs of environmental concerns and greenhouse gas emissions. Yet, the undervaluation they face in the market currently offers an attractive prospect for investing in these vital hydrocarbon companies as they work to improve their environmental footprint.

About the Authors

Sean M. Maher is a Partner and Co-Founder of Third Gear Investments (TGI). TGI was founded in 2023 to redefine energy investment. Before founding Third Gear, Mr. Maher managed public equity portfolios for an energy boutique for fifteen years and served as a publicly traded energy company director. He began his career in energy finance at Morgan Stanley’s energy investment banking program in 1999 before covering Integrated Oils, Independent Refining, Midstream, and Integrated Natural Gas in the firm’s Equity Research division. Mr. Maher serves as Chair of the Investment Committee for the Houston Museum of Natural Science and as a Trustee for Covenant House Texas.

Marc J. Sharpe is the founder and Chairman of TFOA, an organization formed in 2007 to provide a forum for education and networking and to serve as a resource for single family office principals and professionals to share ideas and best practices, pool buying power, leverage talent and conduct due diligence. Mr. Sharpe also teaches an MBA class on “The Entrepreneurial Family Office” as an Adjunct Professor at Rice University and SMU Cox School of Business. Contact: marc@tfoa.me

About TFOA

The Family Office Association (“TFOA”) is a global peer network that serves as the world’s leading single family office community. Our group is for education, networking, selective co-investment, and a resource for single family offices to share ideas, deal flow and best practices. Members are not actively marketing products or services to other members and no contact information or email lists will ever be shared. Since our founding in 2007, TFOA has led the global single family office community by delivering world-class educational content, unique networking opportunities, and exceptional thought leadership to our highly curated network of the world’s largest and wealthiest families.

Important Notes

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. Responses to any inquiry that may involve the rendering of personalized investment advice or effecting or attempting to effect transactions in securities will not be made absent compliance with applicable laws or regulations (including broker dealer, investment adviser or applicable agent or representative registration requirements), or applicable exemptions or exclusions therefrom.

This document, including the information contained herein may not be copied, reproduced, republished, posted, transmitted, distributed, disseminated, or disclosed, in whole or in part, to any other person in any way without the prior written consent of Third Gear Investments, LP (“Third Gear”). By accepting this document, you agree that you will comply with these restrictions and acknowledge that your compliance is a material inducement to Third Gear providing this document to you.

This document contains information and views as of the date indicated and such information and views are subject to change without notice. Third Gear has no duty or obligation to update the information contained herein. Further, Third Gear makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.

Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Third Gear believes that such information is accurate and that the sources from which it has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Moreover, independent third-party sources cited in these materials are not making any representations or warranties regarding any information attributed to them and shall have no liability in connection with the use of such information in these materials. Statements made herein that are not attributed to a third-party source reflect the views and opinions of Third Gear.

This document contains forward-looking statements, including observations about markets and industry and regulatory trends as of the original date of this document. Forward-looking statements may be identified by, among other things, the use of words such as “expects,” “anticipates,” “believes,” or “estimates,” or the negatives of these terms, and similar expressions. Forward-looking statements reflect Third Gear’s views as of such date with respect to possible future events. Actual results could differ materially from those in the forward-looking statements as a result of factors beyond Third Gear’s control. Readers are cautioned not to place undue reliance on such statements. Third Gear bears no responsibility or obligation to update any of the forward-looking statements in this document.

Charts, tables and graphs contained in this document are not intended to be used to assist the reader in determining which securities to buy or sell or when to buy or sell securities.

Disclosures

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

By Marc J. Sharpe, M.A., M.Phil., MBA

Abstract

This research report analyzes the history, performance, risk, and returns of the merchant cash advance (MCA) industry in the United States. The MCA industry has grown significantly in the past decade, providing small businesses with an alternative to traditional bank loans. However, the industry has faced some criticism due to its high-interest rates and lack of regulation. Through a review of literature and analysis of industry data, this report presents an overview of the MCA industry, including its history, market size, major stakeholders, risk factors, and financial performance. The report concludes with recommendations for policymakers and investors on how to address the risks associated with the MCA industry.

Introduction

Merchant cash advance (MCA) is a form of alternative financing that provides small businesses with a lump sum payment in exchange for a percentage of future sales. The MCA industry has grown significantly in recent years, with estimates of its market size ranging from $10 billion to $15 billion annually. While MCA has become an attractive financing option for small businesses, it has also faced criticism for its high-interest rates and lack of regulation. This research report aims to provide a comprehensive analysis of the history, performance, risk, and returns of the MCA industry in the United States.

MCA is a form of financing for small businesses that usually have no other means to borrow money. This is an under-the-radar industry, largely overlooked by academia, media, and government, and as a result has very little regulation. Most lenders in this space are privately-owned and there is little public data on this industry.

The typical firm taking an MCA is a small-to- medium sized business, often a subprime borrower, often paying a much higher interest rate than a typical business loan. It is estimated that in 2016 MCA borrowing summed to around $10 billion, with a default rate up to 600% higher than loans from the U.S. Small Business Administration. Many borrowers find MCA to be a last resort option, if they are unable to get a loan from a bank and because “cheaper loans backed by the Small Business Administration are tough to get and can take months to close.”

History of the MCA Industry

The MCA industry emerged in the early 2000s as a response to the difficulties small businesses faced in obtaining traditional bank loans. The MCA industry began by offering cash advances to small businesses in exchange for a fixed percentage of future credit and debit card sales. This model proved successful and expanded to include other forms of payment, such as ACH transfers. The MCA industry has continued to grow as a result of the continued difficulties small businesses face in obtaining traditional bank loans, particularly in the wake of the 2008 financial crisis.

The merchant cash advance industry is relatively new. MCAs are only possible with the advent of digital payments. In some ways they can be thought of as the technological successor to factoring. Credit cards became widespread in the 1990s, and the MCA industry closely followed. It is believed that AdvanceMe in Georgia became the first MCA provider in 1998. Originally, AdvanceMe had a patent on MCA technology, which meant it was the only provider at that time. In 2007, a Texas judge invalidated AdvanceMe’s patent on cash advances against future credit card transactions, allowing new MCA firms to compete.

Within the next year, the 2008 crisis and following recession greatly changed the financial system. Firstly, banks as a whole became more reluctant to underwrite loans. Loans were risky, and after the housing and financial system collapse, banks were risk averse. Secondly, the banking system saw consolidation. Large banks absorbed many smaller regional ones. Between 1998 and 2015, the number of small banks decreased by 38%. Small regional banks have traditionally been, and still are, more willing to lend to small and medium sized businesses, as compared to large, multinational banks. Historically, big banks approve roughly 22% of small business loans, compared to small banks approving 49%. The effect of the financial crisis was therefore twofold: banks reduced lending to small businesses overall due to uncertainty in the economy, and small banks which are more likely to lend to small businesses were replaced with large banks.

In addition, regulation and compliance costs disincentivize big banks from lending to small businesses because the regulatory costs are not worth these small dollar loans. For a small bank, the dollar amount of a small business loan is more meaningful to the bottom line of the firm. The aftermath of the financial crisis led to more regulations, exacerbating this issue. Legislation like Basel III and Dodd-Frank made the financial industry more cumbersome, which to some extent reduced small business lending.

Borrowers’ Reasons for Dissatisfaction by Lender Type

Percent of Employer Firms Dissatisfied with Lender

Overall, small business lending has declined throughout the United States over the past decade. As a result of these changes, many small businesses are unable to obtain a traditional loan from a bank. Their need for financing still exists, however, so small businesses are forced to look for alternative ways to borrow money. This has led to the merchant cash advance industry becoming increasingly popular.

Market Size and Major Stakeholders

The MCA industry has grown significantly in the past decade, with estimates of its market size ranging from $10 billion to $15 billion annually. Private companies dominate the industry, with the largest players including CAN Capital, OnDeck, and RapidAdvance. However, the MCA industry has also attracted the attention of ‘disruptive technology’ public companies, such as Square and PayPal, who have begun to offer their own MCA products. In addition to private and public companies, the major stakeholders in the MCA industry include small businesses, funders, and brokers.

The Small Business Credit Survey (SBCS) is a collaboration of all 12 Federal Reserve Banks and provides timely information about small business conditions to policymakers and lenders, including an annual survey of firms with fewer than 500 employees. These types of firms represent 99.7% of all employer establishments in the United States.

Financing & Credit Products Sought by Small Business

In 2021, the survey found that application rates for traditional financing were lower in 2021 than in recent years, and those that did apply were less likely to receive the financing they sought. The share of firms seeking traditional financing fell from 43% in 2019 to 34% in 2021. One beneficiary of this reduced demand for traditional credit is the MCA industry which, according to the SBCS survey, now comprises 8% of financing sought by small businesses.

Percent of Applicants

Source: The Small Business Credit Survey (SBCS) – 2022 Report on Employer Firms

Growth of the MCA Industry in the United States

While the MCA industry is still a small percentage of the overall lending in the United States, at an estimated $15.3 billion in 2017 it is clearly emerging as an important growth segment for small and medium sized businesses.

USD Billions

Source: “A Dive into the Merchant Cash Advance Industry” by Noah Britton

Origination

Merchant cash advance providers source their clients in one of two ways, each making up around half of the advances in the industry. The first is directly, meaning their internal marketing team will find merchants in need of an advance. The second is through an Independent Sales Organization (ISO). Both methods involve cold calling and paid outreach to small businesses. The ISOs will charge the MCA provider a one-time commission, usually around 5-10% of the advance amount.

As part of the underwriting process, MCA providers conduct a due diligence. This may involve analyzing bank statements, monthly credit card sales volume, the age of the company, and the rent-to-sales ratio, among other things. With an MCA ‘advance’ a business will receive a lump sum of capital and will pay back a multiple of that amount with automatic daily deductions until it is paid off. These ‘advances’ are typically short-term, with little paperwork involved, and the money is received in as fast as 24 hours.

By way of example, in a typical MCA the borrower will receive a lump sum, say $100,000. The borrower will owe an amount larger than the amount received. This figure will be equal to the advance amount times the buy rate, also known as the factor rate. In this example, the borrower will repay $135,000. because the buy rate is 1.35x on $100,000. The terms of the MCA specify how the advance will be repaid. Unlike a traditional loan, the borrower does not pay the lender in fixed amounts. Instead, the borrower repays the MCA with automatic electronic payments. More specifically, a designated percentage of daily, weekly, or monthly credit card sales will be directly sent to the MCA provider until the borrower pays the entire payback amount.

Notice how words like “interest rate,” “debt,” or “loan” are not used to describe an MCA. This is because an MCA is classified as an “advance” rather than a “loan.” Even though a loan and an MCA both involve receiving a sum of money that must be paid off, regulators do not consider an MCA a loan. In effect, MCA’s “aren’t actually charging interest—they’re buying the money businesses will make in the future, at a discount.”

Although it seems like a pedantic distinction, by not being classified as a loan MCAs avoid the laws and regulations associated with lending. For example, banks that lend are subject to Dodd-Frank and Basel III, which include capital and disclosure requirements, whereas MCAs are not. In addition, MCA providers are not subject to usury laws, which limit the maximum percentage of interest that can legally be charged. Therefore, MCA providers can charge whatever APR equivalent they desire without disclosing it to the borrower. This has been proven in court as recently as 2018. Champion Auto Sales, LLC et al. v Pearl Beta Funding, LLC in the state of New York found (in a unanimous decision) that MCA lending above the usurious limit is permitted.

Risk Factors

MCA firms are buying the rights to the future receivables of their customers. As a result, if the customer finds that it cannot pay back the loan or that the repayment on each transaction becomes too high, it may cease operations so that there are no more future receivables. And since it is not debt, the “lender” has no claims to the assets during bankruptcy or liquidation. Therefore, MCAs are riskier than debt, which means lenders need to be compensated accordingly.

Rates and Time to Funding Vary Dramatically by Product

Small Business Loan Products by APR, Time to Fund, and Borrower Credit

Source: Fundera, Inc.

Some commentators have criticized the MCA industry due to its high-interest rates and lack of regulation. The effective interest rates on MCA loans, given their short duration, can be very high, which has led to concerns about predatory lending practices. In addition, the lack of regulation in the MCA industry means that borrowers may not have the same protections as those who obtain traditional bank loans. The lack of transparency in MCA loan agreements has also led to concerns about hidden fees and charges.

By the same token, concerns are also raised about the high cost of short-term lending products now being offered by online lending platforms. Providers of these loans explain that the APR is an annual cost and overstates the actual expense, or dollar cost, of a loan that is only in place for typically less than twelve months. Some industry observers have raised concerns that costs at this level are very hard for a small business to manage in a profitable way. They argue that a small business needs to generate a very high return in a very short period, or they risk the consequence of being unable to repay. On the other hand, these loans or advances are valuable for a small business that, for example, needs to buy inventory for the holiday season or bridge a seasonal cash shortage.

In all cases, to minimize defaults it is clearly important that small businesses understand in a clear fashion the product obligations they are committing to take on, including exactly how much they are paying.

Financial Performance

Despite the risks associated with the MCA industry, it has demonstrated strong financial performance in recent years. The average annual return on MCA investments is estimated to be between 15% and 40%. This high return has attracted a range of investors, including private equity firms and hedge funds. However, the high returns come with significant risks, and investors should be aware of the potential for losses due to default or fraud.

MCAs serve a purpose. If a business needs quick capital to cover liquidity needs and no bank approves their application, it often has no other option than an MCA. The industry exists because small businesses that cannot borrow through traditional finance need to borrow money.

Conclusion

The MCA industry has provided small businesses with an alternative to traditional bank loans but has also faced criticism for its high-interest rates and lack of regulation. This research report has presented a comprehensive analysis of the history, performance, risk, and returns of the MCA industry in the United States. Policymakers should consider regulating the industry to ensure that borrowers are protected from predatory lending practices and have the same rights as those who obtain traditional bank loans. Investors should be aware of the risks.

Arguably, MCAs have a niche in the economy because of government regulation. Usury laws prevent banks from charging their risk-adjusted required rate of return from small business loans, so they opt to not lend to these businesses. Banking regulations have made it difficult for small banks to compete with big banks, while simultaneously disincentivizing small business lending with onerous requirements. The Small Business Administration is unable to provide adequate loans to all the small businesses in need. If banks can charge higher interest rates or are otherwise incentivized to lend to small businesses, this might reduce the market for MCAs. Additionally, new disruptive technology like peer-to-peer and decentralized blockchain lending pose a potential alternative.

Banning the MCA industry outright would mean that many small businesses would lose their only source of financing. Regulators must legislate on the fine line between protecting borrowers, while at the same time ensuring that these borrowers do not lose their existing lenders of last resort.

Bibliography

• “It’s Settled, Merchant Cash Advance Not Usurious | DeBanked.” Accessed May 5, 2021. https://debanked.com/2018/03/its-settled-merchant-cash-advance-not-usurious/ .
• Stevens, Jordan. “The Merchant Cash Advance Industry May Have a Few Bad Apples, but That Does Not Mean It’s Time to Empty the Barrel Comments.” Texas Tech Law Review 49, no. 2 (2017 2016): 501–46.
• “What Is MCA ‘Stacking’ and Why We Discourage It?” Accessed May 5, 2021. https://www.elevatefunding.com/post/what-is-mca-stacking-and-why-we-discourage-it .
• “A Dive into the Merchant Cash Advance Industry” by Noah Britton (Leonard N. Stern School of Business)
• “BPC-MCA-SMB-Financing-Industry-Report.Pdf.” Accessed May 5, 2021. https://bryantparkcapital.com/wp-content/uploads/2018/06/BPC-MCA-SMB-Financing- Industry-Report.pdf.
• Dabertin 1, Troutman Pepper-Mark T., and Gregory J. Nowak. “Merchant Cash Advance Participations and the Federal Securities Laws | Lexology.” Accessed May 5, 2021.
• “FTC Alleges Merchant Cash Advance Provider Overcharged Small Businesses Millions | Federal Trade Commission.” Accessed May 5, 2021.
• The State of Small Business Lending: Innovation and Technology and the Implications for Regulation by Karen Gordon Mills & Brayden McCarthy (Harvard Business School)
• Small Business Credit Survey – 2022 Report on Employer Firms (Federal Reserve Banks)

About the Author

Marc J. Sharpe is the founder and Chairman of TFOA, an organization formed in 2007 to provide a forum for education and networking and to serve as a resource for single family office principals and professionals to share ideas and best practices, pool buying power, leverage talent and conduct due diligence. Mr. Sharpe also teaches an MBA class on “The Entrepreneurial Family Office” as an Adjunct Professor at Rice University and SMU Cox School of Business. Contact: marc@tfoa.me

About TFOA

The Family Office Association (“TFOA”) is a global peer network that serves as the world’s leading single family office community. Our group is for education, networking, selective co-investment, and a resource for single family offices to share ideas, deal flow and best practices. Members are not actively marketing products or services to other members and no contact information or email lists will ever be shared. Since our founding in 2007, TFOA has led the global single family office community by delivering world-class educational content, unique networking opportunities, and exceptional thought leadership to our highly curated network of the world’s largest and wealthiest families: www.tfoa.info

Disclosures

The Family Office Association (“TFOA”) is a peer network of single family offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.