Alternative Working Capital Financing

There just seem to be times when you do not have enough working capital to manage your business. Maybe you are undercapitalized, maybe you are experiencing rapid growth, maybe your suppliers are not extending enough credit, or maybe you just received that one large order that is beyond your financial means.

You went to your bank to no avail. You have maxed out your credit cards, or your spouse says no way. You searched high and low for a wealthy friend or relative but came up empty. (Just maybe if you are a regular reader of Banking on Harvey you might not be in this situation!)

One option is to align with a bigger, stronger, more financially stable distributor. You can run your business at some added expense. There must be many benefits, as we read about mergers and consolidations regularly. It must be a viable option. Of course, you have also lost some control.

One other way is factoring. While it may be more expensive than traditional bank financing, it is certainly much less than that of a merger or consolidation. Of course if the latter frees you up to sell more or improve your quality of life; I cannot put a price on that value.

Here is how factoring works.

First, you need to find a reputable factor. We have one that specializes in our industry. Promotional Capital is a business services member of PPAI.

You apply for a line of credit. There is a modest application fee. The approval will primarily be based on your customer’s creditworthiness; their ability to pay your outstanding accounts receivable back to you is the key. Your receivables will have to be free and clear of all liens.

The factor will request certain financial and corporate information. They will perform their due diligence. Once you are approved, you are “selling” your receivables (only the ones you need to sell to raise cash) to the factor. Most often, it is sold with recourse, which means that if your client does not pay, you will have to repay the advance. If it is without recourse, the factor becomes credit insurance to some extent.  You have sold the receivable. This is an option with different structure and pricing.

Generally, but based on your actual collection history, you can expect plus or minus 80% of the face value to be advanced to you. The 20% holdback covers the factor’s fee and any interest charges, as until your client pays the factor, the money is outstanding. So think of the 20% hold back as two charges, the initial fee, and the interest expense. The longer it takes your client to pay the receivable, the more the discount fee accumulates. After your client pays, the 20% holdback is rebated back to you less the fees incurred. Again, only sell the minimum that you need to steady your cash flow.

(The 20% hold back also covers the loss if the client does not pay the factor. It also covers any other costs that you may incur that obligate you to the factor.)  

Typically you enter into a one-year agreement, but if you do not owe anything and have not used the line, you can negotiate your release.

When you analyze the costs, it is more expensive than any other “traditional” financing. But the ease of obtaining needed cash to support your business may be more important to you. And it helps you to manage your uneven cash flow. Used judiciously, it can be a great financing tool for you.

There are a number of industry colleagues who take advantage of this flexible financing.

A caveat. If your working capital problems are caused by losses, no financing arrangement can cure those ills. Eventually, if you cannot right the ship, you will be out of business. Factoring sometimes hides these issues due to the ease of obtaining cash. But you cannot survive on a steady diet of factoring. Use it wisely, and it can be a great benefit to your financial plans.

There are many details involved, and I encourage you to do your homework. You can also find information on Wikipedia on the topic, and you are welcome to contact me directly as well as any reputable factoring company.

 A 1975 graduate of the Wharton School at the University of Pennsylvania, Harvey enjoyed a 20+ year career in commercial banking, exercising his “golden parachute” in 1996.  In his volunteer life, he is a past chair of the Small Business Banking Unit of the American Bankers Association, Easter Seal Society of New Jersey, the SAAGNY Foundation, PPAF EXPO, and Supplier Committee of PPAI.  He is also a past President of PPAF.  PPAI awarded him the H. Ted Olson Humanitarian Award in 2013.