5 Ways Factoring Can Help Your Business Grow

By Toby Dahm, Senior Vice President, Hennessey Capital 

As businesses across the country slowly emerge from the worst economic crisis since the Great Depression, a stark reality is hitting many of them.  That reality is that even though sales are rebounding and they are even showing positive earnings, they are starved for cash.  What is going on?  The problem is they are experiencing working capital pressure.  After stretching vendors as far as they can, as orders pick up, so must inventory and accounts receivable, which increases the cash that companies have tied up in working capital.  For many companies that do not carry inventory, or have become lean managers of inventory, this pressure is solely the result of the growth in accounts receivable that comes with the uptick in sales.

What can a business owner do to relieve this pressure and to continue to seize opportunity?  One excellent tool for growth financing, which is often overlooked, is factoring.  Quite simply, factoring is the sale of an invoice (account receivable) to a lender (called the factor) in exchange for a fee.  The factor will advance up to 85% of the invoice value and will provide the remainder of the invoice value, less a small fee, to the client when the invoice is paid.  This frees up cash that would otherwise be tied up in accounts receivable for 45 days or more.  There are many benefits to using factoring as a liquidity tool.  We will explore five of them.

Quick and Inexpensive Closing Process:

Unlike applying for and closing on a loan, the process of closing on a factoring agreement is simple, quick, and inexpensive.  The application is brief, and the information required to close is focused on the accounts receivable to be financed, the strength of the paying customer (account debtor) and the ability of the factor to confirm the validity of the invoices.  It can usually be accomplished in less than one week and at a nominal cost to close.  Also, numerous factoring companies will not require a minimum financing volume commitment or term obligation which means that the client is free to try factoring and terminate the agreement if they find that it is not advantageous.

Accommodates Rapid Growth:

Traditional lenders are looking for highly creditworthy and stable companies, which is often not compatible with rapid growth.  Such high growth companies often have financing needs that are well in excess of what a bank is willing to lend, due to the focus of traditional lending on past results and financial strength.  Factoring, on the other hand, is focused on the current opportunities that a client has and the quality of the accounts receivable they generate.  Most factors will provide unfettered growth financing to a client as long as the client demonstrates that it is a viable business that generates high quality accounts receivable. 

Complementing a Bank Line of Credit:

A borrower does not necessarily have to choose between a bank loan and factoring.  Banks and factors often work together to form a mutually beneficial financing arrangement that enables the client to maintain the low cost bank loan and use the factor to provide the incremental growth financing it needs.  This is most often implemented by identifying certain accounts that the factor will finance, with an understanding by all parties that the factor has the first claim on those accounts while the bank enjoys a senior collateral position in all the other assets it formerly held as collateral.  This also enables the borrower to grow at a much faster rate than without factoring.

Small Relative Cost:

There is a misconception that factoring is prohibitively expensive, which is not the case.  For a growing company with a decent gross profit margin, factoring is a very smart form of financing as opposed to missing a sales opportunity or giving up equity to increase the capital base.  It comes down to margin. Often the cost of saying “no” to a prospective client is far more detrimental than having the ability to say “yes” to an opportunity that grows the relationship and can lead to increased business. Sacrificing a small percentage of profit margin and executing the new order or job effectively, may pave the way for enhanced business with your client in the future.  

Gaining an Experienced Partner

Many factors have decades of business experience, often as entrepreneurs themselves.  They can bring this experience to bear in many areas, including evaluation of credit extension to customers, advice as to the structuring of payment terms, collection assistance, accounting assistance relating to accounts receivable, as well as more general business advice and support, such as introduction to new sales opportunities they become aware of.  Most factors view their success as being linked to the success of their clients.  A positive relationship with a factor can be a valuable asset to your business.

It is a little known fact that factoring is a centuries old form of finance.  It was initially used to finance trade between England and the thirteen colonies.  There is good reason that it has persevered, and is gaining popularity today….it makes great business sense!