By David Nordella
It is no secret that the financial industry has been subjected to dramatic, and sometimes disastrous, changes over the past couple of years. Major money center banks and brokers have disappeared or been forced into disadvantageous mergers, while others are being resuscitated by large infusions of government money. The survivors are somewhat shell-shocked and understandably less inclined to lend, especially to new and growing companies.
Ironically, these are the companies that are busy right now planting the seeds of our economic future. They are the pioneers who are creating the products of the future that will ensure our prosperity. Most new jobs come from these innovative companies, so it’s in everyone’s best interest that they survive and thrive.
But where are they going to find reliable sources of capital? One potential source is a financing technique that has been practiced for thousands of years: factoring services. The process of selling accounts receivable at a discount in order to accelerate cash flow has been used since the days of the Roman Empire. When Roman merchants extended credit to their customers, factors would advance funds to them against the future payments that were to be received. The same method was used finance trade flows between England and its colonies in North America, which would become the United States of America and Canada.
Sources of Financing
There are three ways to finance a business:
- Acquisition of debt
- Sale of equity/venture capital
The use of debt is still available to some companies. However, future business loan covenant restrictions can be expected to be tightened as banks continue to harvest losses from years of inadequate requirements reinforced by a secular bull market that was in force for decades. Banks are going to require more capital and less leverage on balance sheets in the future to offset the risk of business loans as their own capital has become more difficult to retain.
Venture capital is also still available to some companies, although VC firms are becoming much more particular about the businesses they invest in. One of the biggest drawbacks to selling equity, however, is the dilution of ownership, a percentage of which is transferred to the investor in exchange for capital.
Factoring, meanwhile, is a form of do-it-yourself financing. Proponents of venture capital, in particular, will find factoring rates competitive. More importantly, factoring leaves ownership shares and control of the company in the hands of the original owners. Future profits will flow to the innovators who produced them, since their shareholdings have not been diluted by the premature sale of stock in exchange for cash.
Factoring services tend to work best for companies that are able to generate consistent sales of products or services at the level of quality expected by a viable commercial customer. These sales should be completed and reasonably expected to be paid according to the terms of sale. The cash advanced by a factoring service can then be used to pay current obligations that support the company’s growth, like payroll, vendors and other kinds of debt serviced by working capital.
While the costs of factoring services are higher than traditional small business bank loans, they are mitigated by the additional services factors provide in their normal course of business. A factor performs all the services of a full-fledged A/R and credit department, including such tasks as backing up documents for accuracy and scanning, as well as folding, stuffing, mailing and documenting invoices and payments in a ledgering system.
Vendor Trade Support
Little consideration has been given lately to the importance of vendor trade support, but the credit given by vendors is of paramount importance to any successful entrepreneur. Isaac Newton noted that his incredible intellectual achievements were only possible because he “stood on the shoulders of giants.” Likewise, entrepreneurial success is often built on the support of those that sell to entrepreneurs and offer them trade credit.
Trade credit comes without interest, can expand rapidly and provides an owner another way to leverage financing if treated appropriately. The liquidity provided by factoring accounts receivable enables an owner to create vendor loyalty that is repaid in kind by increased trade credit lines. Often, by negotiating prompt or early payments, discounts can be realized that can improve profitability and help offset the costs of factoring services.
Wise business owners will retain and reinvest the profits from their increased sales. Establishing positive trends with respect to vendor relationships, improved liquidity and growing sales will increase the likelihood that an owner will be able to attain the next level of financing on more attractive terms.In today’s difficult and uncertain credit environment, factoring services remain an effective way for companies to leverage their current sales and accelerate cash flow. Newly established and fast-growing companies especially should think of factoring as a potential first resource to meet their financing needs.
David Nordella is a vice president and Business Development Officer with Commercial Finance Group (CFG,) which has offices throughout the U.S. Since 1974, CFG has provided creative financial solutions to small and medium sized businesses that may not qualify for traditional financing. Further information on the company and their services offered can be found at http://www.CFGroup.net or send an email to firstname.lastname@example.org.