Every day, I speak with business owners about their financing needs. If they are calling me, an alternative source of financing, it is probably because they have already been declined for a loan from a bank.
While I do not offer traditional small business loans, a company can use factoring to help them expand in today’s tight credit environment.
Factoring is not a loan, but is instead an on-going process whereby a company sells their accounts receivable at a discount in exchange for cash shortly after invoicing their client.
Since my clients do not qualify for traditional financing, there is usually something about the business that makes them “un-bankable.” Sometimes, the business is new and is not considered “seasoned” by the banks. Other times, the business may be struggling with declining revenue trends and is in default of their loan covenants. In some cases, factoring clients are well-established, successful businesses which are just growing too quickly for a bank’s comfort.
In any case, since factoring clients are generally considered more risky than a business that does meet bank lending criteria, there is a higher cost for them to access capital.
The discount or factoring fee charged by a factoring company can range from 2% – 5% for every month a receivable is outstanding. Many clients balk at this cost. They remember the good old days when they could borrow from their bank at Prime. While those days may return to the business, if they are considering factoring it is because they cannot access the cheapest business credit they once could.
An average factoring fee is typically 2.5%/mo. A prospective client will usually do some quick math (2.5% times 12 months) and say, that’s 30% per year. That’s too expensive.
I tell them it is cheap compared to their alternatives.
We encourage “non-bankable” small business owners to stop comparing factoring costs to bank lending costs. If banks were an option, we would not be talking.
One of the best things a business owner can do to positively influence their cash-flow is to clearly understand what the borrowing options are.
Options for many non-bankable clients usually include:
1) Private equity
2) Credit-based loans or lines of credit with a “credit-worthy” credit partner – such as unsecured business credit.
3) Paring down operations/Not accepting new business
With private equity comes a major change to their business. They will need to give up ownership and potentially a piece of control of their business. Factors ask for no ownership and will not join their board. They simply provide a service for a fee.
Below is an illustration of how factoring can really help a business increase their profitability.
It’s important to not only understand the “cost” of factoring but also the “cost” of NOT FACTORING. The cost of factoring is often the same or very similar to the merchant fees small businesses incur when they accept credit cards.
Chris Lehnes is a 20 year veteran of the small business lending industry. He has held positions in commercial loan documentation, credit analysis, operations management and business development at one of the country’s largest small business lenders. Currently, Chris is a Business Development Officer at Versant Funding where he provides non-recourse factoring to businesses in a wide variety of industries with from $1 – $50 Million in annual revenue nationwide. You can reach Chris at 203-493-1663, clehnes@VersantFunding.com, http://www.linkedin.com/in/chrislehnes or www.ChrisLehnes.com