Factoring: An alternative source of financing during a crisis
By Chris Lehnes, Factoring Specialist
A primer for commercial finance brokers
- A challenge each commercial loan broker faces is understanding the options available to their clients.
- As the commercial lending markets enter unprecedented conditions, these options are changing and the onus is on the broker to stay informed.
- You have all see seen that the COVID-19 pandemic has caused many commercial lenders to tighten their lending standards or put an outright freeze on new loans as they assess its impact
- The initial funding allocated to Small Businesses under the CARES Act have been exhausted
- While some businesses may be able to wait for the next round of government funds, B2B businesses with strong customer bases have an alternative: Accounts Receivable Factoring
- Factoring Definition: Sale of a company’s accounts receivable in order to obtain working capital
- Types of factoring include recourse/non-recourse, full notification/non-notification
- With recourse, if a customer is unable to pay, the client is responsible. Under non-recourse, the factor takes on the customer’s credit risk
- Some will underwrite both the business and the quality of the accounts receivable (resource)
- Non-recourse factors are usually more focused on the receivables and put less (to no) weight on the performance of the business
- Your client must be a B2B business with a strong customer base to qualify
- Manufacturers, food producers, distributors, wholesalers, service business – staffing, trucking
- Most factors exclude construction & third-party medical accounts receivable (insurance company, Medicare, Medicaid) but there are specialists which are focused on these niches
- Focus of this piece will be on full-notification, non-recourse factoring which is best positioned for today’s credit environment.
- Typical terms:
- Usually consists of an initial advance of 75 – 90% against accounts receivable
- Factoring fees range from 1 – 3% of the invoice for each month the invoice is outstanding
- Lower rates are typically reserved for recourse factors with a greater focus on business performance
- Some factors charge both a factoring fee (aka discount) as well as an interest rate on funds advanced
- Be careful to “read the fine print” as there may be other charges from many factors
- Term: 6-24 months
- Size: $10k – $10 Million+ per month in factoring volume
- Different factors are focused on the low and high end of this range.
- Some factors set no cap on their facility and will allow fundings to grow as the client’s business grows as long as they keep selling to creditworthy companies
- 1St lien on AR will be required – Ask your client early in the process if they have any outstanding liens on their AR
- The approval process:
- For a non-recourse factor, little information over and above a recent Account Receivable Aging and Customer list should be necessary to obtain a proposal.
- Factors which perform more of a hybrid analysis may also require a standard commercial financing package including current and historic financials.
- The funding process:
- Can differ from factor-to-factor
- Your client does what they do…ship products, complete services, invoice customer
- Factoring is very different from PO financing.
- With Factoring the goods must be delivered or service completed.
- Factoring is very different from PO financing.
- Notification: Invoice will include payment instructions to factoring company
- Invoice is sent to factor
- They will verify the invoice by contacting the customer (also known as the account debtor)
- Upon verification, they advance your client 75 – 90% of the invoice – often the same day the invoice is issues
- When the factor receives payment from the customer, your client will be sent the “rebate” The remaining 10 – 25% less the factoring fee.
- Most factors will fund their clients as often as daily, or less frequently as needed by the client
- If an invoices goes over 90 days
- Client Profile:
- Small to mid-sized B2B companies with annual revenues from $100k to $100 Million
- Businesses which need liquidity and can’t afford to wait 30-90 days for their customers to make payment
- Declined by traditional lender for reasons such as:
- Start-up/Insufficient operating history
- Fast-growing – needs more credit than a lender is comfortable extending based upon the history of the company
- Seasonal businesses – erratic revenue
- Companies with historic, current or projected losses
- Client’s customers are large corporations, municipalities or other government agencies
- Use of factoring proceeds:
Most factors put no restrictions on how funds may be used, but can include:
- Project Financing
- Business Growth Financing
- Business Acquisition Financing
- Bridge Financing
- Financing Working Capital Needs
- Realization of Supplier Discounts
- Preparation for High Season
- Crisis Management
- Debtor-In-Possession (DIP) Financing
- Choosing your factor:
- Reputation matters
- Google the company
- Ask about their funding source
- Many rely on lenders or other factors for funding
- Will those funding sources continue to fund their business if markets continue to deteriorate?
- Many rely on lenders or other factors for funding
- Ask about industry expertise
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- The right factor for your manufacturer client may not be the best suited for your staffing client.
- Ask for references
- To learn if your client could benefit from factoring, contact Chris Lehnes at 203-664-1535 or clehnes@chrislehnes.com Connect on LinkedIn
- Request a Proposal
- Reputation matters
