Need a Financing Alternative for Your Business? Try Factoring

CREDIT: Dreamstime.com View full size image

No bank loan? No problem. More and more companies are turning to factoring — an alternative to asset-based lending that provides businesses with capital when needed. Factoring isn't lending — it's the purchase of accounts receivable from a business.

How factoring works

Factoring is a way for companies to raise cash to either help them through a tough time or help expand their business. Most factors are independent companies, although some are owned by banks. A factor buys invoices based on the credit of the customer. Brian Birnbaum, founder and director of Liquid Capital, said that factors generally advance somewhere between 75 to 80 percent of the receivable — meaning they will pay you 75 to 80 percent of the amount you are owed by your customer. Once the bill is paid to the factor by your customer, you receive the remainder of the amount owed.

"When the receivable is collected and the customer is notified to pay the factor directly, the customer receives the remainder of the reserve. If we deducted 20 percent, they would get that back, less fees," Birnbaum said.

Not only do factors advance against the receivable, but they also process the receivables. In essence, a small business owner is outsourcing their accounts receivable function.

Howard Hill, president of HRH Funding Solutions, thinks that factoring is as simple as it gets.

“It increases your credit score, there's no loan and no money to pay back.  It streamlines your receivables,” Hill said.

Robert Zadek, attorney with Buchalter Nemer, focuses his practice on factoring. “There’s no downside, per se. Like any other product or service you buy in the world, you try to get the best service and best product for the lowest cost," Zadek said.

Zadek said factoring offers small businesses an alternative to taking out a bank loan.

“If the bank would lend to you, you wouldn’t be in factoring. But there are many businesses that don’t go to a bank even if they can. Getting money from a factor is so easy, as long as you’re honest with a factor. You don’t live in fear of losing your money. There are plenty of factors that can work with you. You’re not locked in like you are with a bank,” Zadek said.

'Factors' to consider

Of course, factoring isn't for every type of business.

"Generally, it's used by a company that's doing business to business. A great deal of factoring volume is done by those companies selling to retail trade," Birnbaum said.

Staffing, construction, transportation and medical companies are also increasingly using factoring.

Factoring also works best for businesses selling products or services and offering terms of 30 days or longer. Factoring eases their capital crunch and provides immediate financing instead of having money tied up in accounts receivable.

However, companies with a very low gross profit would not benefit from factoring.

“The only time that we tell clients that factoring doesn’t fit is if their profit margin is too low. Ideally, we like to see a client have 30 percent or more profit margin. If they’re down to 10 or 15 percent, we don’t want to impose anything that might hurt them more for profit,” Hill said.

One of the most important things to consider from the factor's perspective is whether the client is being honest about their income statement and receivables. “The client can give the factor invoices that aren’t real or invoices where the goods shipped don’t conform to the invoices. That’s 95 percent of what goes wrong in factoring,” Zadek said.

Stepping stone to solvency

But, for companies who can work as a team with their factors, the process can be a lifesaver. It can also be a stepping stone toward getting a small business loan from a bank.

Liquid Capital, for example, had a client that did rust-proofing and painting for large oil rigs and related products.

"They came to us because they were losing money. The bank had called its loan and they were close to insolvency," Birnbaum said.

When the client began to factor, it removed the burden of collecting receivables. The client grew from $1.5 million to $10 million in sales in a three-year period.

"You have to wait for success and build up equity. Our client built up some reserve and then they had the ratios that were required to graduate to a bank," Birnbaum said.

• Business Owners Reaching Into the Cookie Jar for Financing
• Where to Go When the Bank Says No
• 5 Franchises That Don't Need Employees