Factoring as we know it is defined as the purchase of accounts receivable, discounted at some percentage, to provide immediate cash to a business. In return for cash, credit and collection services, the factor charges a fee for its services.
Factoring can take many forms ranging from recourse/discount, non-recourse/traditional, full notification, non-notification and so on. However, one thing is clear: It is becoming a much more recognized way to finance early-stage and high-growth companies and carries much less of a stigma than it did in years past. Factoring companies have an opportunity now, more than ever, to educate entrepreneurs about the power and possibility of utilizing factoring to grow their business. The interest of business owners is piqued like never before as they seek new and non-traditional means to finance their companies. It is critical that factors provide them with clear and relevant information and also demonstrate the dramatic impact that this type of financing can have on their business in order to ultimately generate greater adoption, acceptance and excitement around factoring receivables.
Today, companies of all sizes can use some version of factoring. It ranges from a small business owner just starting out financing its first invoice to a large corporate entity selling off its receivables to a third party at quarter end to clean up the balance sheet. No matter the size of the company or the industry these companies are in, factoring is an easy way to generate cash for the business.
Since I started in the factoring business in 1993, I have seen many companies utilize factoring for their operations. Some used it very effectively and others used it to disguise a flawed business model. My first exposure to factoring was with a company that had plenty of cash and a bank line but, being in the retail business, it wanted to leverage the factors expertise setting customer credit limits. The client used factoring as a form of credit insurance, in addition to receiving some cash flow. The factor put in place a non-recourse agreement where it assumed the risk of the client’s customer/debtor filing bankruptcy and the client relied on the factor to determine how much should be sold on open credit. Having a few more dollars in the bank account was a secondary benefit.
Fast forward to the recent Great Recession when bank lending tightened and credit seized even the strongest factors, and asset-based lenders became lenders of first resort, not last, as they were viewed in years past. Times have changed and discussions with potential factoring clients changed from, “What will my customer think about us factoring?” to “I need cash to maintain my business and my customer will understand why I have chosen to factor my receivables.”
In addition to the change in the perception of factoring, the viewpoint on the cost associated with factoring has shifted as well. Our company has a policy of transparency and is the first to admit that if a company can obtain a bank line of credit to finance their business, they should take that approach since it is a lower cost of financing. In a climate where credit is tight, whether it is due to the economy, a company’s financial track record or it just makes good sense to leverage your receivables, clients have come to justify the additional cost associated with factoring.
All of us in the industry have stories like this, but one in particular I recall resonates well, as it involves a father-and-son team who landed their largest order with a Fortune 500 customer they had been courting for years. A $3 million sales commitment spanning 12 months was like winning the lotto for a family business generating $2 million in total sales the previous year. With solid margins on the new order and a bank that they worked with for years, how could they not receive the line of credit increase they needed to double their sales? “If you only had more real estate, we would be happy to help,” said their banker. As their CPA reviewed the contract margins and explained why he thought factoring would make sense, they decided it was a viable solution. It turned out to be just what was needed.
After financing $3 million in sales and having to give up a small portion of their margin to do so, they were left with the ability to pay off the bank at the end of 12 months and control their own destiny. The client saw the factoring cost as an investment. They gave up a small portion of their margin to finance a bigger project that not only generated significant income over 12 months, but gave them exposure to a whole new customer base and new opportunities. As I said, we all have these success stories.
Factoring has always been a simple product to use, even 20 years ago. Today, with factors leveraging technology and online reporting, it truly can be a 24- to 48-hour turnaround from an initial inquiry to funding. As technology becomes increasingly mobile and information can be exchanged with relative immediacy, the flexible nature of factoring will continue to respond to the evolving needs of business owners.
As the economy recovers, (which it will, although some days it seems like it may never happen,) and when the pent-up demand is presented to small- and mid-sized companies, factoring will be a perfect solution for them to take advantage of new opportunities. Banks will increase their lending to business owners but, as we have seen in the past, they cannot help every growing company. Factoring will be the source of credit for early-stage companies due to their insufficient track record as it always has.
As existing mid-sized companies are faced with new projects and increased orders, they will be able to leverage the incremental solution that factoring brings to those with current bank lines of credit. It is the perfect way to complement a bank line of credit and over the last few years, we have seen many more banks being receptive to signing subordination agreements and allowing their clients to fund incremental sales through the use of factoring.
As for our industry, we are seeing more traditional banks build ABL divisions to complement their traditional lending products, while factoring is being left largely to the independent, entrepreneurial finance companies. As we review industry trends, factors once focused on small-ticket clients are seeing their prospect list grow. The challenge for them, like most non-bank owned factors, will be access to capital.
Since there are not many lender finance players in the market, addressing factoring companies that need less than $3 million on a line of credit, Hennessey Capital has decided to launch its own financing for factors called FACTOR FINANCE. This ABL product is focused on factors with a lending need less than $3 million in size, which we feel it is an underserved market. Our cap limits will increase as we determine the need in the market. The FACTOR FINANCE service was created in direct response to what we see as increasing and critical demand on the part of factors. The specialized nature of the business can often make traditional banks hesitant to extend a line of credit and this new offering strives to mitigate that issue. We see factoring having a significant place in the financial spectrum as the economy rebounds and we want to assist factoring companies by helping their clients prosper.
With all the economic uncertainty in the market and traditional credit struggling to return to normal levels, one thing is certain: Factoring will remain a solution to help small- and mid-sized businesses with their cash needs. Factoring has a long history in the world of credit and has stood the test of time when it comes to financing a growing business.
Michael A. Semanco serves as president and chief operating officer for Hennessey Capital, which provides working capital solutions and business coaching to small-l and mid-sized businesses. Semanco has over 20 years of experience in the financial service industry. Prior to the start of Hennessey Capital in 2002, he spent over eight years with Crestmark Bank holding various sales and credit positions. Semanco began his banking career working with a Michigan-based credit union and commercial bank while attending college. He received a Bachelor of Business Administration in Finance from Walsh College in 1991 and a Master of Science degree in Finance in 1999. He remains active with the college including serving on the college’s Board of Trustees, past board member of the Alumni Association, and his company is a corporate sponsor of the Walsh Institute. He was named the 2006 Walsh College Distinguished Alumnus. Semanco is active within the local business community by serving on the Detroit Regional Chamber Board of Directors and Citizens Research Council. He is a director of the CFA, member of the ACG and TMA. Semanco was named Crain’s Detroit Business 40 under 40 Class of 2007 honoree and was named 2008 Michigan Financial Services Champion from the SBA. He has written several industry articles and participates in many panel discussions on small business financing and strategies.