Businesses Go to Source Of Fast Cash
Monday, October 27, 2008
Bank loans have been harder to come by, but that doesn't mean companies' need for funding has dried up. To get cash, small and medium-size businesses have increasingly turned to firms that get them money they are owed more quickly.
The firms, known as factoring companies (from the Latin word for "to do" or "to make"), say they are seeing an uptick in the quantity and caliber of businesses coming to them for funding. Traditionally used as a kind of short-term cash bridge, factoring has been avoided by some businesses in the past because it can cost more than traditional bank financing. But these days more firms that need funding -- ones that are growing quickly, are working out financial difficulties or have no assets to borrow against -- are selling their bills to factoring companies.
Even businesses with government contracts -- generally considered solid lending risks in the past -- are finding banks much more skittish.
When Robert Dozier started his government services business four years ago, he had barely hung pictures on the wall when the banks were calling to lend him money. Today, even with $12 million in revenue and a solid lineup of government contracts, he has discovered that lenders are less impressed.
"Trying to secure a line of credit has been something," he said. Banks want "a copy of your contracts, a backlog report on all your active contracts, and they want to see how much business you have going forward."
He has gotten the credit, but he's also increasingly turned to a factoring company.
Factoring allows companies to get money they're owed faster than they otherwise would. If a vendor usually must wait 60 days to receive payment but wants its money promptly, it can sell the bill to a factoring company. Factoring companies generally work one of two ways: Some pay upfront, giving the vendor the amount owed minus a fee that at many companies is 5 to 6 percent. Others pay a percentage upfront -- say 50 percent -- and then the rest, minus a fee, when the bill is settled.
Because bank loan rates are lower, factoring companies have been avoided by businesses that can scrape up the money elsewhere. But these days, the factoring business seems to be on the rise. In a recent survey of its members, the Commercial Finance Association, the U.S. factoring industry's largest membership organization, found that over the past month, 60 percent saw a greater influx of companies looking for credit. More than 40 percent said they've written more contracts, said Mike Trainor, a spokesman for the association.
Kwesi Rogers, founder and president of Bethesda-based Federal National Payables, said 80 to 90 percent of his clients are referred by area banks. He has been buying up bills from Washington area businesses for 16 years and has seen a change in the clientele recently.
"It started almost a year ago -- we were receiving referrals from banks for companies that support the residential building industry," Rogers said. "There is a higher level of scrutiny banks are placing on credit inquiries, and they are probably turning down more. And as a result, they're referring more transactions to companies like ours."
Although many businesses use factoring companies -- it's grown to a more than $2 trillion industry -- newcomers should be careful about building the added costs of the funding into their financial plans, business advocates say.
John Korpela, manager of the Maryland Department of Business and Economic Development, said he found himself caught in the spiral of rising financing costs with a factoring company when he owned his own business and began borrowing to cover costs when a customer was not paying its bill in full.
"It got us in a serious bind," said Korpela, who recovered from the cash crunch and sold the business years later for a profit. "We canceled all of our purchase orders and laid people off. We went from 80 to eight employees, and it took us six months to get out of it. It's something to be very careful about."
Banks often refer clients to factoring companies when they find their clients cannot meet their terms.
April L. Young, a managing director of Comerica Bank, said a young tech entrepreneur client ran into a cash flow jam when one of his creditors -- a large company that accounted for a large part of the entrepreneur's business -- unilaterally changed its payment schedule from 90 to 180 days. Suddenly, he was scrambling to figure out how to cover costs while he waited for payment.
She referred him to a factoring company, but ultimately, he ended up taking out a second mortgage on his house instead.
"He's like a one-armed paper hanger these days" trying to meet expenses, she said. "He was just not comfortable going that route."