As the aisles in the retail stores remind me, Halloween is just around the corner. I just received an invite to a friend’s annual costume party in Phoenix – this year the theme is Mel Brook’s movies; it will be fun to decide what to wear to that! To be honest, Halloween isn’t my favorite hallmark holiday – you see my birthday is in October – and throughout my childhood my mother thought it was “cute” to have a witch, ghost, goblin themed or (insert wacky Halloween reference here) themed birthday party for me. What if I didn’t care for spiders or skeletons? Well, it just didn’t matter – moms will be moms… enough said. Even though October is generally the “scariest” month of the year with haunted houses and jack-o-lanterns dotting the landscape, I’m in the mood to shine a good light on factoring…
This has been an amazing year so far for factors. I say amazing, but I could probably come up with dozens of adjectives and each would be fitting. Words like challenging, tough, and busy come to mind too. This year is different though; I have observed something markedly different than in all my history in this business, which is the huge amount of exposure our industry has enjoyed. Never before has the word “factoring” appeared so many times in news searches on the internet. Sometimes the stories are good, you know the ones where factoring is seen as a positive form of finance – other times the stories aren’t so great, like fraud occurring either within a factor’s portfolio or those rogue entities that raise money ostensibly for the purpose of purchasing receivables to only use the funds for anything but factoring. CIT’s troubles alone have brought factoring into the limelight. While I truly wish the best for that company and who knows how that will all end up, I suppose I am grateful that more and more of the population has heard of factoring just from reading about CIT in the news.
I have the pleasure of working with multiple factoring companies on a variety of projects – and in so doing have gained a very unique perspective on the state of the industry today – guess what, there are many new deals being booked daily all over the place! Those factors who have strong underwriting and portfolio management standards as well as their own capital and access to liquidity are finally able to grow their client base simply because other forms of finance are not available. On the other hand, there are factoring companies who struggle with access to liquidity and declining sales volumes because their client’s sales have decreased. There are also start up factoring companies opening all over the country as they see factoring as a good business to be in – as long as those folks are seeking out education and assistance and respect established standards, they should be able to do well. Unless every single factor I’ve been talking to is fibbing, they’ve all been busy putting on new deals – and don’t see their pipeline dwindling any time soon. Nope, no horror stories here.
A factoring company (just like any other business) wants to make a profit at the end of the day. This is no easy task when you consider the amount of overhead it takes to run a factoring operation. Salaries, Credit Expense, Cost of Funds, Rent, Due Diligence Expense, Lock-Box Fees are just a few of the expenditures a factor has. The smart ones also put a little away each month to build up a loss reserve should the inevitable occur. To the average person on the street, when they see what a factoring arrangement is priced at, may feel it is exorbitantly high, but when you take away the actual costs to provide this service, you’d be surprised at how little of those fees actually make it to the bottom line.
All that being said – factors have to charge what they charge because factoring is labor intensive and expensive to operate. If the factor just purchased invoices and advanced funds, they would be out of business very quickly – that translates into fewer companies providing this critical form of finance – not a good thing for the general business environment. That would be a horror story.
I think that many factoring companies (at least those that I deal with and talk to routinely) are in this business both to make a little profit and because it’s rewarding to help companies survive by providing working capital. No one I know is in the business of gouging their client base. Moreover, it takes effort to find a client, to perform due diligence confirming the factor can make a difference for that company and then to bring the client on board to provide financing. We all strive at that point to keep the client active for as long as possible – the average being 18-24 months. I recently spoke to the head of a factoring company that said they’ve been able to keep their average client to up to 30 months!
Factors actually work hard at the collection process to help keep receivables turning so that the costs of factoring remains as low as possible for their clients. These aren’t heavy handed collection tactics, merely good old fashioned solid receivables management techniques. The result is that the client also maintains a healthy bottom line. Client’s who grow or mature enough to be able to qualify for bank financing make this all a win-win situation.
When I hear of “client horror stories,” I am disheartened by the hyperbole. I guess I come from the side of the fence that a client horror story is one wherein the client figured out the perfect fraud and then absconded with big piles o’ cash. While there is press that suggests that factoring companies are Good, Bad or Evil – these are all emotional terms – working capital shouldn’t be emotional.
If a business needs a factor they can look to any number of resources to find the best arrangement possible. Price and Structure should not be the only deciding factors (pun intended). One company may offer a low rate but then require monthly minimums and a term of one year, while the next company may offer a higher rate with an easy out and no minimums. Some companies even offer programs that adjust with the client’s sales volume. If you spend the time to understand the differences, you’ll probably find that in the end most offers are relatively equal in costs (plus or minus some basis points). So if all terms are equal, what can a business seeking a funding source do?
The answer: get to know the factoring company. Ask for client references, and then… actually call them. Does the factor have a history of taking care of their clients? How long does the average client stay with the factor? Is it only three months? Or is it two years? What other services does the factor provide? Same day funding on schedules received by noon or does funding take 48 hours or more (routine funding not the initial funding)? Does the factor understand your business? How well do you relate/communicate with representatives of the factoring company? Is the company secure – do you think they will be there when you need them? Are they in the same time zone as you, and if not does it make a difference (to some it might – to others it won’t). Are you working directly with a funding source or through a broker? How do you know the broker is really looking at the best deal for you? There are so many other issues besides price alone! If sales volumes can be maintained, maybe the smaller fee with minimums is the way to go. If not, then the higher priced deal may look more attractive.
If I go back to how I started this article, I was shopping… so, look at it this way, when you buy a plain white shirt from a low cost retailer, you probably don’t expect for the shirt to last very long – seams unravel, it gets stretched out, etc… Buying a similar shirt from a more expensive retailer probably means the shirt will cost more, but the stitching will be different and the fabric might be stronger, and generally speaking, that shirt ought to be in your wardrobe for much longer than the less expensive one. Which do you buy? That’s a personal decision. For me, I’d spend extra just to know I would have something of quality… something that would last.
One more thing, you know that factor that quotes a lower rate but then imposes minimum volumes – well, I’ll be willing to bet that can be negotiated. The negotiation however probably won’t be that the factor will maintain the same low rate without minimums – they simply can’t afford to do business this way. In order for any transaction to work, it has to benefit all parties – everyone needs to “win.”
It’s a shame when clients don’t fully understand what they’ve signed up for though. I was taught early on to never sign something that I either didn’t understand or didn’t agree with. I make it a matter of practice to fully read any document I need to execute and if something isn’t clear to me, then it’s my duty to learn more before signing, and that’s just personally. Shouldn’t a business owner follow the same rule? Imagine signing a three year lease and then three months into the lease deciding that you no longer wish to rent the space. There will be penalties from the landlord to break that lease, why should factoring be any different?
So, I don’t have any horror stories, even though Halloween is near. Factoring works because those providing the capital know what needs to be done in order to protect that capital, and clients understand that having access to that capital comes with a price. Clients need to look at their business critically to determine if factoring works for them or not. The business that has very low margins probably shouldn’t factor; the businesses that have some room to absorb the costs of factoring almost always benefit by having the working capital to sustain and grow their operations. Most factoring companies probably have tons of success stories, and even those that do will have experienced a relationship that did not end well.
I think it’s up to us as an industry to maintain how positive factoring arrangements can be for everyone – not just the factor and not just the client. This is the business we’ve all chosen to be in and I’m proud to be a member of this community. I don’t want to dwell on situations that I’m not directly involved in, and I try not to lay blame when the facts aren’t public. I’d rather shout out that factors are here to serve the businesses that need our funding, and we’ve got the capital to be able to help.
Let’s all take advantage of these current economic times by continually promoting that factoring is a great form of finance! Lift up our industry for the greater good.