Alternative financing products like merchant cash advances (MCA) fill a critical gap for small and medium-sized enterprises (SMEs) that can’t access conventional funding or need quick capital in the here and now.
However, alternative financing is still a relatively young and evolving industry, making fraud a serious concern. And when merchants defraud funders, the law does little to help as a merchant cash advance is not a loan and does not come with a guarantee to be paid back.
Most merchants who seek alternative funding are legitimate and well-intended, but as in any industry, there are always bad actors to look out for.
The challenge of sorting the wheat from the chaff requires vigilance and resourcefulness.
In this article, we’ll go over some common forms of merchant fraud, as well as offer strategies for early fraud detection and fraud prevention, with a special focus on how modern lending software can be a strong ally.
Big Money: How Merchants Exploit the System
Most MCA fraud cases involve relatively small dollar amounts or insufficient evidence for legal action.
In a recent Louisiana case, however, the defendants managed to extract $6.4 million in funding from Caymus Funding, Inc., before they tried to avoid repayment.
Six defendants appeared before District Judge Jane Triche-Milazzo and pleaded guilty to charges of conspiracy to commit wire fraud and money laundering. Led by Ryan P. Mullen, the team of six fraudsters included Duane Dufrene, Dillon Arceneaux, Lance Vallo, Grant Menard, and Zeb Sartin.
They created a network of shell corporations that held zero assets and produced fictitious documents to fool the MCA funder. Ryan Mullen even pretended to be a broker representing the corporations he had helped spin up.
After securing the wired funds from Caymus Funding, Mullen and his accomplices shuttered the shell companies and attempted to get away with the money.
Fake vendor accounts and fake bank records played a pivotal role in the scam, as did Mullen’s broker con to legitimize the transaction.
It isn’t clear how the fraud was unraveled or what it took to get the Department of Justice involved, but the criminals did get punished.
Compared to most MCA fraud cases, it was an elaborate and high-dollar crime. But no matter how little fraudsters are after, it’s in the best interest of all MCA funders to detect and prevent fraudulent activities.
The lesson for merchant cash advance funders is simple and painful: the process of verifying a business before funding needs to be rigorous and detailed. This is the first step towards fraud prevention.
Types of MCA Fraud
Fraud is a loaded term, but at its core, it’s simply a deception for financial or personal gain. That makes the fraud spectrum rather large.
However, here are some of the most common types of fraud that the merchant cash advance industry faces. Keep an eye for these and other deceptions.
1. False Information
This is the most common type, as it can involve a seemingly innocent mistake or omission.
The business, the bank account, and some of the revenue might all be real, but there can still be an attempt to deceive the MCA funder behind it all, to secure more funding than the applicant is likely to repay.
Example: a merchant could overstate their revenue or lie about debt obligations to appear more qualified and trustworthy.
2. Fake Bank Statements
Confirming a business’s financial history is a no-brainer for MCA providers.
But if a merchant can forge documents, they can easily “meet” the lending criteria and score the funding.
Perhaps the merchant intends to repay the full amount, and the fraud is just a harmless white lie. But more likely, if someone goes through the trouble of fake bank statements, the transaction is headed south from the get-go.
Example: fraudsters can purchase bank statement templates for as little as $10 and customize them to appear authentic. This allows them to present higher deposit balances and healthier transaction flows.
3. Commercial Identity Theft
Consumer identity theft is the stuff of national headlines and Hollywood films.
However, even though its commercial counterpart is just as insidious, not even the Federal Trade Commision (FTC) collects data for commercial identity theft. This type of fraud is severe, should not be overlooked, and can be very costly to the MCA providers that get taken in by it.
Example: fraudsters steal the identifying information for a business, including financial documents, and apply for a merchant cash advance using their own bank account to receive the funds.
4. Phantom Merchants
Rather than steal the identity of a legitimate business, some fraudsters (such as Ryan P. Mullen from the Louisiana court case above) create an entirely fictitious business or a shell business with no substance.
All the documents are fake, including bank statements, credit card statements, and vendor accounts. It’s very difficult to detect this type of fraud, especially if the fraudsters have been thorough in their deception.
Example: a criminal goes to the trouble of fabricating a business through multiple channels, including fake websites, renting office space, and forging documents.
5. Sell and Switch
The behavior of a merchant participating in this type of fraud amounts to deliberate deceit.
Essentially, a “sell and switch” is when a business owner who seeks a merchant cash advance with no intention of ever paying it.
Example: an enterprise owner provides all the necessary documents and verifications to qualify for an MCA, only they’ve timed the transaction to coincide with the sale of the business to another entity. Everything checks out, but when it’s time for repayment, the new owner has no idea what’s going on, and the previous owner is nowhere to be found.
6. Unlawful Debt Settlement
Although it’s not quite the same as an applicant who commits fraud intentionally, the rise of debt settlement as a strategy to side-step repayment is an alarming trend (and one that we have previously covered on our blog).
Example: a business owner contacts a debt settlement company that assures them that MCA funders are the problem. The debt settlement company suggests the business owner to stop repaying the MCA as a negotiation tactic, regardless of the extra costs and consequences.
3 Best Practices for Fraud Prevention
Despite high-profile cases like the one highlighted above, very little can be done once a merchant has committed fraud. Sure, taking the matter to court is always an option, but for many funders, it can be cost prohibitive.
Your best option?
Stop fraud before it happens with robust due diligence and the help of modern technology.
Here are three of the current industry best practices for fraud detection and prevention.
1. Thorough Know-Your-Customer (KYC) Procedures
You might be tempted to collect only the bare minimum details/documents needed to qualify a merchant, but that’s precisely what scammers count on.
The purpose of a robust KYC procedure is to cross-reference many details that would be difficult to fabricate as a whole.
You should verify the merchant’s business registration, check the owners against watchlists (such as Data Merch), and analyze their financials for inconsistencies or signs of tampering. Many MCA providers now require bank verification through DecisionLogic or a similar tool.
This positions the funder to better analyze/ensure the legitimacy of the applicants business (i.e., that they are not a fraudulent or non-operational entity).
2. Regular Audits
Examine your existing database for clients that failed to pay. Look for common threads and possible steps you could have taken to prevent fraud before you wired the money.
You should periodically run audits on your existing MCA clients, verifying the progress of their enterprise and how their financials compare against the originals that they provided.
Hire external auditors to observe your operation and look for areas where standards have slipped.
Even well-intended employees make mistakes and overlook details that could reveal fraud during the application phase. Yearly audits (scheduled and random) can help to catch these mistakes and keep everyone vigilant.
3. Training and Awareness
Teach your staff to recognize red flags and role-play conversations where they address those red flags and politely decline the applicant. When you catch a fraudster, document the process and debrief your team so that they are aware on a practical level, not just a theoretical one.
Time and money spent preventing fraud is always worth it, because the likelihood of recouping fraud losses is virtually zero. Even if you catch the person, you may not be able to locate their assets and mount an enforceable claim on them.
Talk with your peers in the alternative financing/MCA community. Learn about their experiences with fraud and what they do to detect and prevent it. Fraud always has an element of trial and error: bad actors test and shift their tactics to find vulnerabilities.
Technology Is Your Ally in Fraud Prevention
If you’re not using a modern SaaS lending platform to manage your MCA operation and evaluate applicants, you’re creating mountains of unnecessary work for yourself and your team.
Specifically, the right technology can help you detect and prevent fraud. This is the technology that you should be using.
1. SaaS Lending Platform
The importance of a centralized system to manage clients, transactions, applications, funding, and contracts cannot be overstated, especially when developing a fraud prevention protocol.
Platforms such as Onyx IQ allow you to automate much of the document/data collection needed to understand risk. When every application has to follow the same guidelines and checklist, it’s much easier to spot the outlying merchants.
Powerful platforms also enable API integrations (e.g., Decision Logic, TR CLEAR, MoneyThumb, etc.) so that you can easily verify financials, account information, identities, and much more.
2. Data Analytics and Real-Time Monitoring
You need to analyze data (a lot of data), identify patterns, and track performance if you’re going to spot fraudulent behavior and red flags.
The ability to set alert thresholds and automate reporting is an absolute must. Your team has enough to do already—let technology do what they do best, at all times, every second.
3. Fraud Detection Automation
Advanced technology can also help you automatically detect if digital documents have been tampered with or totally fabricated.
This kind of analysis is much easier if you’re already collecting documents in a central database alongside the rest of your clients’ data. Artificial intelligence and fraud detection algorithms can process your data, looking for patterns and highlighting trends to help you detect fraud early.
Be Your Own Watchdog
The world is imperfect, and as such, fraud exists.
There’s only one person who can keep criminals at bay: you.
Due to the nature of alternative financing, there will always be people hoping to score a payday and disappear.
Armed with the right tools and training, your team can identify problematic applications and prevent fraud. Using a SaaS lending platform like Onyx IQ is a great way to standardize your operation and develop robust anti-fraud controls.
If you’re ready to upgrade your MCA operation with purpose-built technology from Onyx IQ, feel free to schedule a demo today.
