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If cash is king, then the invoice is at least a prince.
Many companies sell their unpaid invoices to customers as a way to get fast cash. The transaction, known as “factoring,” is often the only way for startups to get off the ground or for bigger businesses to smooth out the peaks and valleys of cash flow. It allows them to make payroll, for instance, while waiting for a big payment from a customer.
But what was once a straightforward transaction for subpar borrowers has evolved in recent years into a hotly competitive market with ever-more-sophisticated deals that should not be attempted by amateurs.
And while fat margins have drawn new players in recent years, the number of factoring deals is falling, making the market even more competitive.
In 2003, factoring deals dropped 11% to $2.5 billion from $2.8 billion in 2002, according to the latest statistics in the ABF Journal, which covers the asset-based lending industry.
That’s largely because the newcomers arrived just as many of the industry’s traditional borrowers, such as apparel and textile businesses, have moved offshore, taking their accounts receivable with them.
how it’s done
Typically, a factor buys a company’s accounts receivable at a discount. So, for instance, if a clothing manufacturer has sold $1 million in sweaters to a department store but hasn’t yet received payment from the store, the manufacturer can sell that invoice to a factor for $800,000 upfront.
Then the factor takes the payment from the department store. The clothing manufacturer gets the rest after the factor is paid, minus a fee that is generally 3% to 5% of the invoice.
client could still be on hook
But some lenders who call themselves “factors” aren’t really purchasing the receivables outright. Instead, they are buying them “with recourse.” That means that if some of the invoices go bad, the company borrowing from the factor is still on the hook for those losses.
The invoices that are unpaid for 70 days, for instance, may be deducted from the original loan amount, says Bill Reimnitz, senior business development manager for the Chicago office of Riviera Finance, which offers mostly non-recourse financing.
“The (borrower) isn’t protected at all in those deals,” he says.
Mr. Reimnitz, who has been with Riviera since 1992, declines to name any of his customers, for fear that competitors will swoop in with misleading deals that might appear to shave a fraction off the cost. “Yes, it’s that competitive,” he says.
The only way to compete, he says, is with service. Just the day before, Mr. Reimnitz funded a new trucking deal. It was tiny-just $10,000 on the first two invoices ever written by the trucking company, a scale that will barely yield a profit. “But in about 30 days, I expect they’ll be doing about $25,000 in invoices, and growing very quickly once they have cash flow,” he says.
Moreover, he adds, about a third of Riviera’s business comes from customer referrals-another reason to lend to small borrowers that others might not bother with.
risk factors
For a higher fee, some factors will handle all the back-office work of accounts receivable for their clients, similar to how a small business might outsource payroll.
“Small business people wear 12 hats,” says Debra Wilson, senior vice-president of Vertex Financial, a factor and asset-based lender in Dallas. “They never get around to pursuing their past-due receivables.” About three-quarters of her clients include that work in their transactions with Vertex.
But becoming a factor is not for the faint of heart. The risks include fraud on the part of borrowers who might generate phony invoices, or the Internal Revenue Service seizing invoices of a company for nonpayment of taxes, even if the factor “owns” them.
“Many banks got in for a few years, and got back out,” says Vertex’s Ms. Wilson, who often speaks at conferences on monitoring accounts, and helped write a manual used by the industry.
In 2000, Bank of America opened a finance-factoring office in downtown Chicago. Today, that office is gone. “I can confirm that we do not do factoring,” a Bank of America spokeswoman says.
Factoring has become so sophisticated that some factors sell the receivables they purchase into a secondary market, much as a secondary market developed for mortgages.
“Factoring takes a lot of energy to do correctly,” says David Zarski of law firm Schuyler Roche & Zwirner P.C. of Chicago. “It takes constant monitoring. People see the yields from these things and they think, `I could do that, too.’ They don’t understand that there’s a lot of risk.”
It’s like the shakeout in subprime auto lending a few years ago, he says. When too many players jump into the market, they get burned.
Source: ChicagoBusiness.com

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