For new business, many of us have looked at more and more prospects to ultimately only fund the same number of deals. Issues arising from the economy last year have spurred additional due diligence and research on these prospective clients to ensure a long standing relationship will exist, or can exist in the first place. The question that always comes to mind: can you get out tomorrow?

So, where does that leave 2010? Well, we are well into the first quarter and business opportunities have been increasing, provided you have the capital available… but that is another discussion for another day.

By now, you hopefully have already evaluated your portfolios to determine areas of potential loss and/or weakness. You have also by now identified areas of improvement in your operations and portfolio management to help ensure proper checks and balances internally. For an extreme example, does your account manager handle the verifications, daily fundings, collections, and payment application for their clients? How would you know if something arose that should be a red flag? Maintaining appropriate checks and balances can be critical in today’s environment. Establishing certain communication protocols both internally and externally can prove to be invaluable within an operations department.

The recent increase in deal flow should, however, not equate to reducing the recently increased monitoring and account management standards. This year will be just as challenging for many as last year. Time and time again, I hear that factors are going back to the basics: maintaining verification and collection efforts, monitoring collateral trends in purchases and cash  management, reviewing and adhering to debtor credit limits, and understanding the billing of the client and what they do (i.e., industry in which they operate, etc). Factors are also paying more attention to early warning signs that may be indicators for potential concerns.

All I can say is be prepared… be proactive and not reactive, as they say. Surprises are not always a good thing.

Wishing You Continued Success. The Factor Guru.

As a follow up to the Part I weblog from May, here are some other pokerisms (if that is even a word – probably not) that may be useful in your journey as  a factor… or they may just be entertaining. Either works.

Don’t be a “fish,” otherwise defined as a bad poker player. These fish never truly understand how to play the game; they just keep playing. In  factoring, if you fund enough bad deals or make too many exceptions to the rules that result in losses, you will eventually lose… you may even lose your  business. Good factors know the rules of the game, develop them, and execute them every day. If you are not sure where to seek assistance on the rules,  attend an IFA seminar or call the IFA, an industry consultant or even a friendly competitor for help.

Don’t throw good money after bad… sometimes, when you have a problem account, you may believe you need to continue providing working capital to the company so they stay in business. After all, if you are short on collateral, how else will you get your money back? This decision is not to be taken lightly. You cannot hope your way out of a deal that has gone bad, as they say.

Do your homework. What is really going on in the client’s business? How can it be corrected? Take your time to identify your exposure and other repayment or collateral options. Understand the inter-workings and financials of the business itself. Will putting more money into the pot really help get your money back?

Learn from your mistakes… it happens. We can all become complacent in our monitoring protocols with long time clients. We make exceptions to get deals done quickly, or we believe we have covered all of our bases (i.e., seen all the options on the river) during our due diligence… only to find we missed something extremely important (or misread our cards).

However, we can only get better if we actually learn from those mistakes. Go through your history of losses. Make a list and refer back to it. What were the reasons those losses occurred? What were the exceptions, if any, you made to get the deal done? What were the common characteristics between the various transactions? What have you learned from looking at this list?

What’s that song? “…Know when to fold ‘em. Know when to walk away. Know when to run…“

Did you see the July weblog “Understanding the Story… What If,” a guest blog by Darla Auchinachie? Once in awhile, there is a voice tapping you on the shoulder saying, “Um, perhaps it’s time to leave.” And, sometimes when you listen to this voice, you live to play another day.

One bad call in judgment can destroy ten good calls. How many deals does it take to make up for a loss on one bad deal? Do the math…

At some point, you will lose. You really can’t win them all. Some elements are out of your control. Structuring deals appropriately up front will however help mitigate losses significantly. Ask yourself on every transaction you review, “Can I get out tomorrow?” If not, why not? What can be done differently should you need to collect out of the deal?

Being aggressive can be a good thing. When a deal goes awry, it is better to act and act quickly. In factoring, the entire client receivable base can turn over in 45 days. The longer you wait, the further you may be from your collateral. And, don’t forget that the longer an invoice stays open, the harder it is to collect.

Good luck. Wishing You Success in the Game. The Factor Guru.

I recently became involved in underwriting an application for a factoring facility that brought me back to a session I co-instructed at the 2004 IFA Annual Factoring Conference. The title for that session: “Understanding the Paper you are Buying.” One of the ideas presented focused on how cutting corners in the due diligence process may lead to disastrous results. That was true five years ago, and it is even more so today.

It’s been said that it is very difficult to correct a bad underwriting decision, and anyone that has been tasked with a client “work-out” can echo that sentiment. The role of a factoring credit underwriter is to try to accurately predict that if a prospect is accepted for financing then that relationship will perform as expected – and to structure the facility in such a way that monitoring that performance can be effective. After the underwriter has recommended the prospect for financing, it becomes operation’s responsibility to employ the necessary procedures to protect and preserve the factor’s capital.

When you think about it, initial underwriting is a really tough job; even after you get past all the obstacles we understand academically, you still have to rely upon what your intuition tells you. And, after that, you have to determine if you are being too conservative or not conservative enough.

So, back to my original story about this application package, it was neat… too neat. Robust financials, plausible agings, strong guarantors, dare I say it – a factor’s dream. Of course there were issues a seasoned factor would spot such as the nature of the receivables having a “little hair on them” and the customers, while nicely spread out and quasi-governmental, still thin on the credit side. Of particular interest was the volume – it was substantial for the small non-traditional market. Who wouldn’t love funding a new prospect with a receivable base of several million, especially if it could be done for a desirable rate?

Personally, I wasn’t comfortable with the deal. It wasn’t necessarily the receivables themselves; it was more about the “Conditions” of the deal – Conditions is one of those “C’s” of credit we should never forget when underwriting. You see, the company had experienced tremendous growth in the past fiscal year, and by tremendous growth, I mean well over a 150% increase in revenues. But wait…

In this economy today, what industry could possibly support that kind of growth? I’m not talking about a startup company whose revenues might be expected to grow at a steep pace. This was a company that had been around for decades and had never experienced such a sharp increase in sales.

Another interesting Condition was that the prospect already had a factor funding their receivables. Usually this is not a cause for concern. In fact, it’s quite common to see an applicant who is already factoring. As part of the initial qualifying stage, the business development officer contacted the current factor and was given a glowing recommendation: the factor loved their client, had experienced zero dilution over the course of a multi-year relationship and wished they could keep funding the client. It was the client’s growth that had outstripped the factor’s ability to fund.

However, here is where the story becomes a little more interesting…

The prospect urged the incoming factor to “rush” funding. They needed the capital to continue operating during this explosive growth cycle. One should ask, “Why?”

Well, common sense and experience were telling me something was not quite right: the recent growth, the current factor volunteering there had never been any dilution over the course of a long funding relationship, and now the company needed to rush the initial funding for a payoff. Why was a participation arrangement not being considered or requested?

I know many factoring companies and believe that most have very capable and honest folks, but this factor in particular was relatively new to the industry and now had a several million dollar deal that had outgrown them. I’d never met this factor at any industry event; I even called other factors to see if they had any experience or knowledge of this financial source – no one did. Because of this, I recommended that my client (remember the one who originally engaged me to review the application) fully and strongly verify the receivable base before getting too far down the road. My client asked me, “Why shouldn’t we rely upon the existing factor’s story and records?”. And, this is what brought me back to that class in 2004…

It was after that session when a factor approached me stating they wished they would have attended this course before taking on a rather large client. They had relied upon another factor’s story, similar to the one described above. To their detriment, they funded the prospect’s receivables. You see, the incoming factor didn’t have a large enough staff to fully verify the invoices, and the payoff was also a “rush” situation. As it turned out, there was not enough true collateral. The incoming factor had wanted to appease the client and get the deal done. They had “assumed” the information received from the prior factor was accurate. Therefore, the incoming factor only made a few random calls instead of following their normal procedure of verifying a large percentage of the collateral.

I know several factors who would say they would never do such a thing: fund a large client without full verification – but what about those newer factoring companies? We’ve seen the number of factors steadily increasing over the years, and yet many of these businesses may not survive. I think this story provides a good reason why newer factoring companies tend to fail. They do not understand (or believe) that fraud exists, that there are people waiting for opportunities to intentionally defraud factors or lenders out of their capital. Further, they believe they can correct their cutting corners on the initial funding by performing post funding verifications. Really? I think if this is the plan, you will just know sooner that you have a fraud. Once the money is sent… it may really be gone.

Yes, it is important to talk to the prior factor and hear their story. However, you should not solely rely on what they say… especially where your interests are not the same. Perform your own due diligence.

Newer factors might not have experienced a fraud; they may assume the current factor has strong procedures in place that mirror their own. But, what if the current factor hasn’t figured out what they have on the books isn’t any good? Or, what if the current factor knows but is hoping someone takes them out of the deal? And then, what if the incoming factor just doesn’t have sufficient resources or time to verify the accounts? Well, that sounds like just too many “What if’s?”

Be aware of what your intuition tells you. Or as my friends in Texas say, “Go with your gut feel.” Business is tough for everyone, and we all want to fund new deals. But, just because you catch a nice fish on your line doesn’t mean you should take it home and fry it up – sometimes catch and release may be better off for the longevity of your factoring company.

Oh, and just in case you were wondering about that deal I was engaged to review… the factor did start calling to verify invoices before they funded even with the glowing recommendation from the prior factor. The result: Declined. While I won’t go into great detail, remember that a factor’s best friend can be the Internet and that searches and reverse phone number searches on customers can be easily checked.

Until the next time…

It also brought about something else: help others, acknowledge those that are learning and work to help them succeed. Several people, industry veterans as I would call them, always went above and beyond, out of their way, and more to help me learn more. I was lucky, I guess.

For this weblog posting, a friend of mine and one of my mentors, Darla Auchinachie, a 17-year veteran in the factoring industry and a long time speaker, board member and advisor for the IFA, agreed to write an article. To maintain this trend of helping others in the industry and showing her continued dedication to the industry, she has shared an article with us that rings true… for factors, clients and others. Pay attention. I always did.

This is an open letter to every factoring company executive. 

                Unless you’ve been stranded on an island the past year, you probably haven’t been able to escape the news concerning the biggest economic crisis to hit since most of us embarked in the career of factoring.  As we enter the new year the media claims we just can’t wait to get this behind us.  But wait, the factoring community simply can’t go along as business as usual expecting to avoid being impacted by the crisis merely because a new year is upon us. 

                It’s time to take a serious look in house and be prepared to engage in some strategic planning to take your company through these incredibly challenging times.  I spoke to a trusted friend recently, his comments keep ringing through my ears.  He says, “Its bananas out here”.  Yep, that sums the economic crisis up, especially to the all the factoring companies, bananas just bananas. 

                The economy is shrinking, but wait it’s the perfect storm for us – banks will get out of our space, we’ll be flooded with opportunities is one point of view.  Another says yeah, but credit is our biggest concern right now, and it should be retailers, the auto industry, the oil companies in our account debtor base, the bankruptcies are sure to start stacking up come the first few months of the year.  Yet others are concerned for their own liquidity and access to capital. 

                Bananas, heck we have a whole fruit salad. 

                I call on every factoring company to consider taking action on a few items which will see them through the murky times ahead.  Look, no one knows what’s going to happen; we truly are in un-chartered territory, most fear to make predictions, some believe that we will be on our way to recovery by the end of 2009, and yet others are planning how to best benefit through it all. 

                How can you benefit when you can’t even be sure which way the economy will turn or how long this recession will last?  Well, you can’t control the future but you can be informed and prepared, lest you are blindsided by any number of salvos which will surely come your way. 

                They are saying that we are entering into a period of economic Darwinism.  That is to say, only the strong are going to survive.  For example, Wal-Mart will no doubt end up stronger because of the smaller retailers who will fail due to the downturn of the economy.  Here are five steps a factoring company can undertake to make sure they live to factor another day.

#1

                Re-underwrite every client in your portfolio.

                Yes, now is the time to know what you have, the good, the bad and the ugly.  Trust me; every portfolio has some ugly in it.  There is no better time than now.  Sure, most factoring company’s resources are already stretched beyond the limits due to the influx of new business, but if you don’t stop to take a look at what you already have, you will be in for some trouble.

                While the economy had been growing by leaps and bounds and credit had been so readily available, every factor benefited; we took on clients whose risk profile was higher than we would like to admit.  We cannot bury our head in the sand anymore.  You have to know what portion of your portfolio is performing and which portion will become plagued by the recession.

                If you do not have current financial information on your clients, now is the time to request it.  If you don’t have a recent UCC search, why not run a new one?  When was the last time you engaged in a background check on existing clients?  It’s time to look beyond historical dilution and trends, instead it’s time to take a reading on the client’s overall financial health as that is the indicator which will foretell their ability to survive. 

#2

                Re-structure Relationships

                When you find those clients most negatively impacted or the clients whose financial risk profile has changed, you must seriously consider altering the structure of that relationship.  For example, you may have taken a secured position on a piece of commercial real estate as secondary collateral to support a factoring relationship whose risk profile was not in line with your traditional limits.  What is the value of that real estate now?  What is the financial health of the client now? 

                If revenues are down, how is that affecting the business?  What can you really do when you are already in a relationship?  Make sure you are utilizing every collateral monitoring and availability tool in the book.  Don’t let invoices age; don’t take on unnecessary credit risk.  Counsel your clients on being very careful about extending credit terms to marginal customers.  Start building additional reserves if necessary.

                Reduce your exposure whenever possible.  Make sure your client’s maintain some skin in the game.  Consumers are walking away from the value in their homes because they just can’t make ends meet.  What decisions will your client have to make with their business?  How does that impact your existing A/R?

#3

                Get your house in order and have a contingency plan.

                Since we don’t know what surprises are on the horizon for the next 12 months, it might also be a good idea to keep your books and records in manageable order.  Whether you have $500,000 of your own funds employed or you work for a company who has $200 million employed, there is a very real possibility in 2009 that a factoring company’s access to additional capital will be slim to none.

                Be prepared for an audit either from your capital provider(s) or from which you are seeking capital.  The better your files are, the better your audit results will be.  It doesn’t hurt to triple check that your documentation is in order, proper names, trade names, and all that.  By the way, when was the last time you checked to see if a client was still operating under good standing status in their state, update everything in your files!

                Factoring companies may find it hard to raise capital in the form of subordinated debt; others may find that their institutional funding has dried up.  Worse still, your lender could exit the business abruptly.  Have you taken the time to review your portfolio and operations to make sure it remains attractive to capital providers?

                Seek out assistance within the industry or outside of the industry, but do something and have a plan in place should something like this occur.  If you make it past 2009 and the economy heads upwards you may breath a sigh of relief – until then, how prepared are you?

#4

                Keep employees educated and motivated.

                Factoring is such a unique business, there is a human element deeply engrained in this profession.  Make sure the folks on the ground know how to sniff out problems.  Account Executives shouldn’t let a week go by without having some contact with the principals of your clients.

                Stay involved in providing continuing education to every member of your team.  Let them know that the playing field has changed out there.  It’s not all about proper verification and notification anymore.  Your team should be looking out for different kinds of stresses such as signs of employee theft as well as pre-billing, over billing, and the like. 

#5

                Don’t be afraid to take action. 

                Sometimes, as a factor we are faced with making unpopular choices, especially when it comes to calling a client in default and entering into a realization phase.  Now is not the time to use hope as means to operate, it is the time to deal with facts.  Clients who do not have the ability to cash flow even with the factor’s funding may simply be too big a risk to continue servicing.