Factoring: An alternative source of financing during a crisis

By Chris Lehnes, Factoring Specialist

A primer for commercial finance brokers

• A challenge each commercial loan broker faces is understanding the options available to their clients.
• As the commercial lending markets enter unprecedented conditions, these options are changing and the onus is on the broker to stay informed.
• You have all see seen that the COVID-19 pandemic has caused many commercial lenders to tighten their lending standards or put an outright freeze on new loans as they assess its impact
• The initial funding allocated to Small Businesses under the CARES Act have been exhausted
• While some businesses may be able to wait for the next round of government funds, B2B businesses with strong customer bases have an alternative: Accounts Receivable Factoring
• Factoring Definition: Sale of a company’s accounts receivable  in order to obtain working capital
• Types of factoring include recourse/non-recourse, full notification/non-notification
• With recourse, if a customer is unable to pay, the client is responsible. Under non-recourse, the factor takes on the customer’s credit risk
• Some will underwrite both the business and the quality of the accounts receivable (resource)
• Non-recourse factors are usually more focused on the receivables and put less (to no) weight on the performance of the business
• Your client must be a B2B business with a strong customer base to qualify
  • Manufacturers, food producers, distributors, wholesalers, service business – staffing, trucking
  • Most factors exclude construction & third-party medical accounts receivable (insurance company, Medicare, Medicaid) but there are specialists which are focused on these niches
• Focus of this piece will be on full-notification, non-recourse factoring which is best positioned for today’s credit environment.
• Typical terms:
  • Usually consists of an initial advance of 75 – 90% against accounts receivable
  • Factoring fees range from 1 – 3% of the invoice for each month the invoice is outstanding
  • Lower rates are typically reserved for recourse factors with a greater focus on business performance
  • Some factors charge both a factoring fee (aka discount) as well as an interest rate on funds advanced
  • Be careful to “read the fine print” as there may be other charges from many factors
  • Term: 6-24 months
  • Size: $10k – $10 Million+ per month in factoring volume
    • Different factors are focused on the low and high end of this range.
  • Some factors set no cap on their facility and will allow fundings to grow as the client’s business grows as long as they keep selling to creditworthy companies
  • 1^St lien on AR will be required – Ask your client early in the process if they have any outstanding liens on their AR
• The approval process:
  • For a non-recourse factor, little information over and above a recent Account Receivable Aging and Customer list should be necessary to obtain a proposal.
  • Factors which perform more of a hybrid analysis may also require a standard commercial financing package including current and historic financials.
• The funding process:
  • Can differ from factor-to-factor
  • Your client does what they do…ship products, complete services, invoice customer
    • Factoring is very different from PO financing.
      • With Factoring the goods must be delivered or service completed.
  • Notification: Invoice will include payment instructions to factoring company
  • Invoice is sent to factor
  • They will verify the invoice by contacting the customer (also known as the account debtor)
  • Upon verification, they advance your client 75 – 90% of the invoice – often the same day the invoice is issues
  • When the factor receives payment from the customer, your client will be sent the “rebate” The remaining 10  – 25% less the factoring fee.
  • Most factors will fund their clients as often as daily, or less frequently as needed by the client
  • If an invoices goes over 90 days
• Client Profile:
  • Small to mid-sized B2B companies with annual revenues from $100k to $100 Million
  • Businesses which need liquidity and can’t afford to wait 30-90 days for their customers to  make payment
  • Declined by traditional lender for reasons such as:
    • Start-up/Insufficient operating history
    • Fast-growing – needs more credit than a lender is comfortable extending based upon the history of the company
    • Seasonal businesses – erratic revenue
    • Companies with historic, current or projected losses
  • Client’s customers are large corporations, municipalities or other government agencies
• Use of factoring proceeds:

Most factors put no restrictions on how funds may be used, but can include:

• Project Financing
• Business Growth Financing
• Business Acquisition Financing
• Bridge Financing
• Financing Working Capital Needs
• Realization of Supplier Discounts
• Preparation for High Season
• Crisis Management
• Debtor-In-Possession (DIP) Financing

• Choosing your factor:
  • Reputation matters
    • Google the company
    • Ask about their funding source
      • Many rely on lenders or other factors for funding
        • Will those funding sources continue to fund their business if markets continue to deteriorate?
    • Ask about industry expertise
    •  
      • The right factor for your manufacturer client may not be the best suited for your staffing client.
    • Ask for references
  • To learn if your client could benefit from factoring, contact Chris Lehnes at 203-664-1535 or clehnes@chrislehnes.com Connect on LinkedIn
  • Request a Proposal