« Consider the Benefits of Funding Alternatives | Main | Consumers Tap into New Life Settlements »
July 15, 2005
Factoring | An Old Financial Resource, New for the Hospitality Industry
By Clayton Gilman
Factoring as a financial resource for businesses to leverage out working capital from their cash flows is as old as the Roman Empire. It’s a better known method of getting cash now to provide operating capital and enable essential business needs or purchases for manufacturing and wholesale distribution industries. It used to be that only long established manufacturers and international wholesale distributors could take advantage of this financial solution. Through the late 80’s and all through the 90’s it was used to come out of the recession and fund product exports to countries that had booming economies and favored American products. Today, hospitality and retail establishments can take advantage of factoring the same as the manufacturers and wholesalers the hospitality business might purchase from. New ACH (Automated Clearing House), EBT (Electronic Benefits Transfer) and POS (Point of Sale) technology and programming enables small and medium size consumer product and service businesses to access streams of future cash flow. Hotel, lodging, extended stay, restaurant, bar/pub/club type businesses that are established in their local community can receive working capital deposited directly to their business operating accounts from third party cash flow factoring companies. This is accomplished through the merchant service or banking transaction cycle.
A generic factoring scenario for hospitality and retail businesses today works like this. You identify a financial services factoring company and make a request for information to see if and how much your company may qualify for. This pre-qualification is based upon good business standing and established cash flows with analysis of cash, check and bankcard transactions or gross annual revenue/sales. An exchange of information and disclosure is required to identify the principal(s) and entity structure to know how to formulate the factoring contract between the factoring company and the businesses selling its cash flow. The factoring company then typically offers to purchase a portion of the future cash flow of the company for a period of 6-12 months. The amount purchased is a percentage of the verifiable total gross revenue/sales averaged for a year and is usually between 10-25%. This is typically bankcard transactions, but other automated merchant or banking transactions may apply contingent upon the factoring company. At the information disclosure stage and analysis of the gross revenue the factoring company makes a “margin assessment”, which is the percentage of capital recovered on a transaction by transaction basis, usually less than 9%; and is determined so as not to “pinch” the overall cash flow to the business. The business owner should not “feel” the automated recovery of the funds to fulfill the contract over the 6-9 month period. This type of transaction is “off the balance sheet” as is typical of large corporations and treated as “cost of merchant services” for tax treatment. Check with your CPA for other applications or options contingent upon your individual companies tax planning.
By example, the average factoring contract is about $22,000 cash for the hospitality business owner that is selling future cash flow to the factoring company. The hospitality business owner knows they get $22,000 cash now for their projects needing working capital and can achieve the full ROI (Return on Investment) that is outlined in their current project planning. This can be the purchase (down payment) of a property, compatible business, technology, advertising campaign, property improvement or other integral use that a ROI can measure. This discounted “purchase price” or “funded amount” is transmitted directly to the business owners operating account for immediate use. For this scenario it represents 20% of the annual projected cash flow, it could be less in other situations. For the $22,000 capital funding the factoring company would wait 7 months, in this scenario, and collect $29,757 at a rate less than 9% of the monthly cash flow. The factoring company does not want to “squeeze cash flow” and take too large a chunk of cash because that would be hurting their customer and their interests. The idea is to help grow and expand the business with short term capital funding. The minimum monthly gross revenue to support this purchase of future cash flows is approximately $50,000 or $600,000 a year in gross revenue/sales. The “cost of capital” in this scenario is the “specified amount” of the contract the factoring company will receive over 7 months (based on analysis of future cash flow) $29,757 minus the purchased amount, $22,000, deposited into the retail merchants operating account. In this scenario the “cost of capital” is $7,757 or $1,108 a month for the 7 month contract.
Some of the benefits of today’s hybrid factoring are that there are no fees, points, no collateral or interest is paid. After all, it’s not a loan and is not carried on the balance sheet. The factoring financial services or merchant services company makes their money on the discounted purchase of future cash flows. They also work with the hotel, restaurant or bar owner to help prevent loss of cash flow such as bad checks, identity theft, charge backs, which typically represent less than 5% of merchant transactions today. The factoring company also assures that the cash flow amount factored and purchased is guaranteed. In other words they take the risk on bad transactions, but also ask the merchant to cooperate and reduce risks through adopting compatible services or technology. These newer technologies and services are provided “seamlessly”, that is you won’t notice any difference in making the transaction, but the software, hardware and programming protect the merchant on the banking side of the transaction. Typically the business owner can log onto the factoring companies web site and get real time account disposition with dates, balances and transactions on a daily basis. Once the contract is fulfilled, they can request funding for working capital again and receive it within 24-48 hours. It’s possible to have two cycles of funding annually in most cases.
Advantages of factoring are usually “in the eye of the beholder” so to speak. The credit of a sole proprietorship is not a negative for the factoring company. Factoring is a very viable and integral vehicle for leveraging cash flow to gain working capital for a long list of business owners requirements. The principal owner(s) in the business do not have to put up their personal assets to secure factoring as is the case with traditional lending institutions and loans. Usually, for a small business owner the cost of dealing with brokers and intermediaries for “hard money” eats into the projected ROI (Return on Investment) that the net funding would provide and makes the business owners project “not viable” because it’s often “under funded” in my experience. By example, they may want to buy a second location or business, have planned and budgeted, but the net from a hard money loan typically meets the down payment requirement, but eats into the operating capital for the first 6 months of the new project. Costs of capital are paid out in the factoring scenario through the discount rate as provided in the example previously discussed here. Factoring has the distinct advantage of low paperwork and no fees to start the funding process. Another financial method to contrast is equity fundings, as with venture capital type fundings. Typically the lead underwriter or “angel” investor usually wants to become your partner, take control of financial transactions, audit, assign a manager (at salary to you) and other “monitoring” to assure funds are not misused for the wrong purpose. In reality what happens is a “forced merger” and personality conflicts, which are not fun and depending on what you read, the reports are as high as 90% failure rate of the “equity partnership”. The factoring company does not audit or ask for financial reporting from your company, but uses the data from merchant services or banking to provide the history. Thus they can lower or increase available working capital for your company contingent upon the transaction history over quarters, not annual periods.
Finally, due to advances in banking and merchant technology, factoring as an option for the hospitality industry is here and here to stay; and not just for large corporations, but for independent Mom n’ Pop and small independent hotel chains too. Investment banking and financial institutions are underwriting factoring companies more and more and the “trickle down” effects of large corporate enterprise wide financial transactions now benefits the smaller market segment.
Clayton Gilman is a National Sales Executive for several organizations and has been in small business development, venture capital and finance for 17 years. He offers factoring (AMI) to his clients in the hospitality, retail and leisure industries. He can be reached at: 918.398.0968 / ami_business_capital@yahoo.com.
Posted by dspringer at July 15, 2005 12:10 AM
