In general terms, the banking industry has turned its back on the small and midsize business owner. Statistically, banks reject 70% of all loan applications that pass over their desks. With the national mortgage crisis continuing to spiral out of control the entire banking industry is under immense pressure and it has tightened its stoic grip on lending standards. Just ask any business owner who is currently seeking financing from large prominent banks and small community institutions. Everyone will tell you that these establishments are simply not extending financing to small and midsize businesses. According to a recent New York Times article, a Wachovia banking executive was quoted as saying, “We’re saying NO to almost everybody” when it comes to small business loans. And frankly, if a business has little history, marginal credit, and no tangible assets they need not apply at all.
The major problem is that business owners are mentally programmed to go to banks when they need money. (After all, these owners have been putting their hard earned money into the banks and the banks have been making considerable profits from the deposits, so it only makes sense for the bank to grant the business owner a loan when it is needed.) However, when the bank rejects the request of the owner, the owner feels there are little or no alternatives for the funding of his business. But, there is an alternative to traditional bank financing and as an informed business owner it is imperative that you understand what options you have.
One of the best kept secrets in American small business is the idea of FACTORING. This financing medium provides an almost limitless source of working capital for growth and is a proven powerful financial source for small to midsize businesses. Factoring, in its purest form, is simply the process of buying the accounts receivable of a company. As a small business owner, it is not financially feasible to wait 30-90 days for payment. But, if we are marketing to large businesses and governmental agencies, these entities expect extended payment terms. If those terms are not granted, the small business owner will forfeit the sale. Factoring allows the small business owner to offer terms of payment and still receive the funds immediately, in essence receiving a net zero term on invoices. With a factoring relationship in place the small business owner can meet weekly payroll concerns, pay taxes and vendors in a timely manner, and purchase necessary materials.
One point that should be duly noted is that this method of commercial finance is NOT A LOAN. The factor actually purchases the invoices. A typical scenario works like this: A business needs working capital for some immediate purpose. The owner contacts a factoring company and a financial relationship is started. When the factor purchases the accounts receivable of the business, the factor directly advances 80% of the invoice face amount at the time of purchase. This means that if $100,000 in total invoices were submitted for factoring, then an initial working capital advance of $80,000 would be provided. The $20,000 balance that is not advanced is called the reserve. The reserve is used as a cushion against potential non-payments. When the reserve is distributed to the business owner, the factor will calculate and deduct any fees for services and additionally will chargeback any invoices that have aged beyond the factor’s normal holding period, generally 60-90 days. The factor’s fees can range anywhere from 1.5% – 3.5% for advances.
Factoring companies are the mirror image of banks. The most important feature is that factors are not lenders, which means that a factor can provide financial assistance to companies that are growing without the traditional restraints of conventional financing. There are no cumbersome applications, no loan committees, and no rigid formalized production. Factoring is quite the opposite. The application process is fast and straightforward. Most factors require only a two-page application and can have funds to the small business within days of approval.
Furthermore, a business owner may consider factoring as an alternative because the business qualifies based on sales, not on assets. If a business generates $1 million in annual sales, it is a valuable operation. However, if it only has $50,000 in hard assets, that business will not qualify for much of a loan. In factoring, the issue is the strength of the receivables being sold, not on the collateral of the business – which is a major criteria for banks.
Another feature of factoring is that since factoring is not a loan, your business will not incur further debt. This is important for startup businesses that want to become “bankable” in the future. With factoring, there is no compromise on your balance sheet, you simply sold an asset.
One last vital element of factoring is that this form of financing is one of the few alternatives for businesses in bankruptcy. Banks cannot be involved with companies in bankruptcy, because they are lenders. Factors are not lenders, they are purchasers.
Any business that invoices another business for goods or services will qualify for factoring. Usually, businesses that are in the startup or expansion mode are the ones that benefit from factoring. But, factoring is designed to meet the needs of any business that has little credit history, is undercapitalized, or lacks tangible assets.
Factoring, as a funding source, works best for businesses in the service sector industry. Businesses such as employment staffing, janitorial, commercial landscaping, advertising agencies, security services, and consulting are prime candidates. These are the businesses that have human resources, but no tangible “loan-able” assets such as real estate, equipment, inventory, buildings or other structures.
For companies for whom bank financing is not a viable option, factoring provides access to cash. Companies in financial need are able to retrieve working capital from their accounts receivable quickly, easily, and without acquiring more debt. Factoring has gained popularity since the mortgage fiasco has overwhelmed the banking industry. Since small to midsize businesses are routinely being denied loans by banks, the owners of these companies have no choice but to at least ask, “What is factoring?”
Now, you know.
If you would like more information about this topic, or to receive a free booklet of “When Banks Say NO!…a Small Business Guide to Factoring” , please visit our website at www.KeyWorldFinancial.com. To schedule an interview please contact Annlette Key at 1-877-539-4321, or email info@KeyWorldFinancial.com
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