Like with most other financial services, you have choices when it comes to factoring your accounts receivable. It used to be that when you needed a home mortgage, you went to a mortgage banker. When you needed a line of credit, you went to your bank. When you needed factoring, you went to a factoring company.
Not true any more. You may now obtain your line of credit from your stock broker, your car loan from your insurance agent and your home mortgage from an Internet company that makes as many car loans as it does home mortgages.
One of the latest trends is for banks to offer accounts receivable factoring. Let’s examine the difference between banks offering factoring and a factoring company offering factoring. As you are about to see, they offer two entirely different experiences, often for the same price.
First, let’s examine why banks began offering factoring a few years ago. To understand, you must first realize that banks have never embraced the concept of financing accounts receivable. Banks tend to favor loans secured by assets they can touch, hold, or walk on—like machinery, inventory, equipment, and real estate. Obviously, you cannot “touch” an account. It is an “intangible” asset with real value. Typically, banks require a borrower to put up other “tangible” assets when lending against accounts receivable. Moreover, to qualify for a credit line or a loan, you must demonstrate to the bank your profitability, solvency, and a successful track record in business. You must also have good credit. Most new companies will not qualify for a loan of sufficient size to support receivable growth.
A few years ago, private factoring companies began proliferating, because they saw a niche. Banks lent too little against accounts receivable and tied up all their borrower’s assets in the process—if they could qualify at all. Besides, lending against accounts receivable was a side business for banks that were more interested in lending against hard assets. Factoring was an industry on the rise.
It’s not that factoring companies are a new idea. In fact, the contrary is true. To understand the history of factoring, you have to understand some basic U.S. history. Factoring companies began to first populate the colonies shortly after the British began colonizing New England. Back then, a factoring company was a company or individual that facilitated trade between sellers of goods in Europe and buyers of goods in the colonies. The factoring company (also known as Factors) would “vouch” for the buyer, essentially ensuring the seller in the old country that the buyer in the new country was good for the money.
A tea producer in England might seek out a factoring company in the colonies to vouch for a tea merchant in Plymouth, Massachusetts who wanted to buy tea from England. The factoring company, became an expert in knowing who was good for the money and earned a fee for its expert credit advice. At some point, factoring companies cornered the market in credit underwriting and saw another business opportunity. In addition to charging a fee for its credit advice, factoring companies became trade merchants themselves and facilitated the sale by acting as the buyer and reseller of goods.
Now, the factoring company could also earn a small spread between what the bought goods in England and what it sold the goods for to the merchant in the U.S. The factoring company was now also assuming some risk by laying out cash. If the factoring company was unable to collect from the buyer, the factoring company took the hit. The seller of the goods (the client of the factoring company) received the benefit of increased cash turnover and avoidance of a potentially uncollectible or risky debt. The only real considerations in the transaction for the factoring company were 1) would the factoring company get paid by its client’s customer; and 2) could the factoring company make a spread between the selling price and the purchase price of the goods.A lot has changed since the pre-Revolutionary War factoring company that acted as a trade merchant, but the basic services offered by modern-day, full-service factoring companies have remained largely unchanged: Offer credit advice to help the client minimize bad debt, offer cash advances against the client’s accounts receivable; and offer collection expertise. Many modern factoring companies also specialize in industries where factoring is most prevalent: apparel, furnishings, textiles, trucking, IT staffing, temporary staffing, Nurse Staffing, and manufacturing.
This is where it is important to distinguish between the modern-day factoring company and banks that offer “factoring” as a side line. Indeed, factoring has become a side business for banks that view factoring as an opportunity to obtain higher fees from a company seeking to obtain funds against its accounts receivable rather than charging ordinary interest on a credit line or loan.
Remember what you learned earlier, banks are fee driven. The fees to “factor” with a bank are likely four or five times higher than the cost of borrowing the money from the bank—and likely you have received none of the services typically offered by modern full-service factoring companies. You received nothing of value over and above what you would have received from the bank if the bank were to have lent you the money in the form of a credit line or loan.
So the real question is, “What do you get from a modern-day full-service factoring company that you don’t get at a bank?”
1. A receivable specialist. With a factoring company, you are getting a specialist. If you needed a heart transplant, would you go to doctor that specializes in skin disease? Probably not. You would seek out a cardiovascular surgeon. Why, because the cardiovascular surgeon is specially trained in heart transplants and has lots of experience. Same goes for a factoring company. Factoring companies are accounts receivable specialists. They are comfortable advancing you funds against your accounts receivable.
2. Speed, Simplicity, and Efficiency. The first thing you will notice when applying for factoring with a factoring company is how quickly you are set up and funded. You will not be asked for piles and piles of paperwork. Remember, a true factoring company is only really concerned only with the credit strength of your customer(s). Therefore, you will likely not be asked for your own financial statements, tax returns, profit and loss statements, or bank statements. In fact, you don’t even have to have good credit. Your customers must have good credit. Your factoring company will check out your customer’s credit for you and advise you what credit limits are appropriate given their financial strength. Your factoring company should be able to get you set up and funded within three to five business days.
A good factoring company will limit your exposure to poor credit risks and allow you virtually unlimited credit for the strongest accounts. Most factoring companies have no overall limit for you as a client. You are eligible for as much money as your eligible accounts warrant.
Banks like to make their decisions based on your credit and therefore applying is slow, tedious and unpredictable. If your credit is not perfect, you may not qualify. If your balance sheet is not strong, you may not qualify. If you are not profitable, you may not qualify. If you are in an industry the bank finds too risky, you may not qualify. It takes time for banks to dig around and identify all the risks. In other words, be patient and don’t wait for the last minute to apply.
Banks tend to set arbitrarily low or high credit limits for your accounts based not on the credit strength of your customer(s), but on your own credit strength or on the strength of additional collateral the bank may require you to pledge. Credit limits set too low restrict how much business you may do with your customer(s). Credit limits set too high expose you to unwarranted risk.
3. Collection Expertise. A full-service factoring company will supply you with your own collection specialist. This individual will act very much like an extension to your company. Your collection specialist will obtain and maintain a status of your customers’ payments once they become past due. You may call your collection specialist and ask him or her to make collection calls for you and report back to you of their progress. Banks typically offer no collection assistance much less your own personalized collection specialist.
4. Flexibility. Banks have loan committees, executive loan committees, in-house limits, regulatory limits, auditors, and bank regulators. Everyone wants to have a say. They must all be satisfied that your factoring transaction fits within the bank’s and regulator’s definition of “acceptable risk”. Your factoring company is not subject to regulatory oversight. A factoring company makes decisions it deems appropriate. A factoring company is motivated to buy your invoices. As a result, increases are automatic. No approval authority is needed by a loan committee. Decisions are made same day in most cases and some factoring companies will allow you to factor as many or few accounts, as many or few invoices as you desire.
Most banks will require a senior secured position in all your assets as security. Likely, they will limit your outstanding balance equal to only a fraction of the collateral value. If you need additional funds and wish to refinance or sell some of your equipment to raise cash, you are at the bank’s mercy to release its security interest in the equipment. Likely, the bank will require you to pay them some of the proceeds of any such refinance or sale. Most factoring companies will require only a pledge of your receivables, leaving you the flexibility to finance your other assets elsewhere. Most banks will require you to maintain your operating (checking) account at the bank. This gives the bank additional leverage over your company’s finances. Factoring companies will allow you to maintain your checking account where ever you wish. Your factoring company will wire your advances into any accounts you direct them.
The factoring company is an accounts receivable specialist. If your goal is maximizing flexibility, funds availability, credit protection, and cash flow, you need an accounts receivable specialist. Your full-service factoring company is waiting to help you.
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