Mention factoring and bankers sneer, venture capitalists roll their eyes and veterans of financing wars moan.
But as much as corporate finance executives love to hate factoring -- selling accounts receivable for quick cash -- they have to agree the practice has saved many companies from bankruptcy.
"It's expensive as hell," admits Bret Kelly, senior vice president of Allstate Financial Corp., a factoring company in Arlington, Va. "But it's working."
Generally, factoring is a two-step process. First, a manufacturer sells some or all of his monthly customer invoices to a commercial finance company, the factor. The factor assumes the risk and responsibility of collecting the money.
Then, the factor advances a sum to the manufacturer, usually 75 percent of the invoice value. If the manufacturer sells $10,000 of receivables to a factor, he'll get a $7,500 cash advance within days. He can use the money to buy new equipment and supplies, to pay down other debt or simply to meet operating expenses.
The factor handles collection of invoices and pays the manufacturer the 25 percent balance once the customers pay their bills.
Sounds great, but such convenience comes at a high cost. Factors may charge 1 percent to 2 percent of the invoice value as commission to collect the bills for the manufacturer. On top of that, they may charge a monthly fee ranging from 5 percent to 8 percent to advance money to the company. That fee is
known as a factoring discount.
Factors say selling invoices for ready cash best suits growth-oriented companies with enough profit to pay for the factor's high cost of funds. But it can also give companies on the edge of solvency the chance to regain their financial footing, especially when others around them begin to fall.
"Think of factoring as credit protection," says Walter Kaye of Merchant Factors Corp. in New York. "It guarantees payment to you from your customers," even if those customers go bankrupt.
Mr. Kaye describes how a factoring client with about $1 million in sales sold Merchant Factors $75,000 of invoices to collect from a large customer. When that customer filed in federal bankruptcy court for protection from creditors, the factors took the loss, not the client. "If he had to take that loss on his own, he'd be out of business," Mr. Kaye says.
In better economic times, companies might use cheaper financing, such as bank loans, before turning to factoring. But banks now are skittish of risky, rapidly growing companies.
"A lot of our business is coming from a banking community that has been restricted in renewing their loans," says Mr. Kaye. "We have seen 12- to 15-year relationships terminated because there was a loss on the prior year. Banks are just not as understanding anymore."
Brent Thompson of the National Association of Manufacturers in Washington says factoring is a legitimate way to improve cash flow.
"Companies have to seek the lowest cost of capital they can
find," Mr. Thompson says. "But if a
firm is looking at bankruptcy vs. higher cost of capital, of course they'll go with higher cost of capital."
Cash from factoring has allowed MPG Inc., a direct-mail printing company in Capitol Heights, to take on new customers, finance new printing equipment and pay down other loans. It helps owner John Yatsko keep MPG afloat. That doesn't mean he likes it.
"We've been factoring since last November. We're not excited about it," Mr. Yatsko says. "With factoring, our profit margin is 1.5 to 2 percent. It would be at least 5 to 6 percent without factoring, which is the industry standard.
"But it's better than the alternative. Factoring allows me to keep in business, just stay alive. We're hoping that by November, our one-year anniversary of starting the factoring, if the economy improves we'll be able to attract a better rate of financing from a bank or an investor."
Mr. Kelly says MPG is the type of firm factoring companies like Allstate can help the most.
"MPG went through a growth period with us," he says. "They [brought] on salespeople, someone to process orders, all the necessary hands to get the job done. They postured themselves to handle crisis, to handle two and three times the business. They just [didn't] have the cash."
With funds from factoring, Mr. Kelly says, "MPG turned the recession into an opportunity, rather than pulling in their horns."
He thinks more companies would consider factoring if they knew more about it.
"People have been conditioned to believe that when you need money you go where you have your checking account," Mr. Kelly says. "You ask the banker about a loan and he says no. And that's where it ends because people don't know there are other means. They go to a venture capitalist who says we want 25 percent of your company. So they go back and try to stick it out.