Give up on traditional funding sources, for now !?
The present credit crisis has crippled our banking system: many say the major banks are insolvent. The loan process is much more strict and cumbersome. Bankers seem to be frozen with indecision. Even the most qualified borrowers are being delayed and time is of the essence for many small companies. How can a good company wait for a loan to work its way through committee, when there is a sudden (interim) need for positive cash-flow? I would not advise depending on your bank!
What's wrong with a loan from a bank ?!
A loan goes on your balance sheet and it takes awhile to procure. Often, the loan is for an amount that is "just a little more than we need," and so when it comes due sometime in the future, the company wonders why it borrowed so much money (have you ever asked yourself: where did it all go)? Sort of the cafeterial buffet equivalent of the line that says, "take all you want, but please eat what you take!" Debt is a necessary evil sometimes, but don't make it a deal with the devil. Presently, bankers are not loaning much money even to very qualified businesses, so this point, in many circumstances, is moot. Cash shortages are serious events to a business, sometimes enough to starve a growing concern.
Why not use the assets you already have !?
Many businesses have an Inbox piled with invoices already sent to customers. Leveraging the credit of those customers is one way to access to cash, now! These invoices are often called Accounts Receivable (AR) and they represent money owed to the business, but not yet paid. Factoring firms purchase these assets (AR) for cash (at a discount). This is not a loan and it does not go on the company's balance sheet. This is $$$ outstanding and has not been paid, but can represent cash-flow at the right time for a struggling small business. AR factors take a small (discount %) percentage upfront for fees and administration (usually 3% to 5% according to risk management issues) then pay an amount in cash in exchange for the good invoices. Factors count on the good credit payment of your customers to recoup their investment and help you make it through the night.
What are the necessities of making such a factoring agreement ?
Work with a reputable factor. That is job #1.
Make an application, do not sign a contract with a long-term committment!
Never fudge or misrepresent an invoice to the factor; make sure the best clients you have are factored.
Try to make sure your customers know that some of their invoices will be factored.
Look out for firms that charge monthly minimum fees and have volume penalties.
Be able to provide the factor with the AR/AP aging, invoice examples, and any documentation they require re: the AR of your company. Please provide them with historical financial documents and tax information. Be wary of leins that factors can place on other client-related assets.
Work with factors who want to bridge the gap to your eventual bank financing. In the short-term, factoring is a little more expensive than a bank loan, but the convenience of the cash now is vitally important when other avenues are shut-off.
Should the contract be in writing and do I need an attorney ?
A factoring contract should be simple and fair. Any contract that states a required term commitment or provides for a minimum volume requirement should be avoided. Read the contract carefully and make sure the business understands the terms of the factor and whether there are hidden fees included such as credit reporting, invoice verification, service charges, or application fees. Some factors will attempt to include "lein" language on other assets, or ask for a personal guarantee. Many factors offer a "hybrid" risk sharing agreement which is a combination of recourse and non-recourse factoring. Having a qualified business attorney or financial advisor look at the deal would be prudent if they actually have worked in the financial industry and are familiar with market terms in the factoring business. Find a factor with a loyal customer base and personal service because this is a "relationship" based on mutual respect and trust as much as any in the business world.
Additional resources provided by the author
International Factoring Institute (IFI), Prestige Capital Corporation (PCC), Forbes Magazine (Entrepreneur section), Small Business Administration (SBA)