BY RICHARD EITELBERG, CPA, FOUNDER-PRESIDENT OF HARTSKO FINANCIAL SERVICES, LLC, A SEVEN-YEAR-OLD PURCHASE ORDER FINANCE FIRM WHICH HANDLES ABOUT $150M IN ANNUAL TRANSACTIONS, BASED IN BAYSIDE, NEW YORK (WWW.HARTSKO.COM)

“The Great Recession” has left a lot of asset-based lenders and factors weak and lame.  Their inability during this period to access credit lines from banks, hedge funds, and equity investors often means they must restrict money to existing customers or refuse prospective clients.

Purchase Order Financing and Letters Of Credit generally looked upon as a last-resort bitter pill have seen increased acceptance as a way for a business owner to preserve a transaction opportunity.  With up front honesty, PF is expensive because of the very high risk issues involved and the intensive servicing requirements.  However, if a deal has the potential to yield a 30% profit or more—why should the business owner be concerned about sacrificing a few more percentage points over and above a traditional lender?  Is losing the opportunity to do the deal altogether, a better alternative?

Factors and asset-based lenders should realize that if they are at the end of their line with their client, referring the PF route can keep their relationship and income opportunity alive.  PF is a fast way for their client to secure funds needed to fulfill customer purchase orders and expand their business without giving up equity or trying to borrow additional funds (an option which no longer exists).

Here’s the process:

1.   The customer submits a purchase order to the client with all documents

2.   The client submits the customer purchase order to the PO financier for approval with all costs associated with transactions

3.   The PO financier will then will make direct payments to the client’s vendors so that the merchandise for the customer PO can be produced

4.   The client’s vendors deliver final product directly to the end customer or to a third party warehouse until shipped to end customer

5.   The seller then invoices the shipment and sends invoice and corresponding copy of customer PO to the factor

6.   The factor funds the invoice at his discount, paying the PO financier their loan plus fee

7.   The factor (or bank) collects from the end customer and pays the client their residual left from the advance

PF is taking a piece of equity in a client’s deal on a temporary basis, perhaps, thirty, sixty, ninety days, or 120 days.  A PF firm earns a fee on a precise part of the deal.  The PF firm doesn’t really “lend” a business money.  Most times, PF firms do not actually give a business any money or hard cash.  The PF firm’s money and equity backs up and supports the integrity of said purchase order.  It makes transactions work by opening up an LC usually overseas to procure merchandise, products, and materials for businesses.  (Or, wires are sent to domestic manufacturers to make purchases in behalf of businesses.)

PF is only transactional and temporary with the money going to fund the goods or merchandise in that specific transaction.  PF funds are not allocated to fund payroll, rents, cars, or any other business operations. Therefore, PF enables start-up companies to grow and troubled companies to survive.  Even bankrupt companies are generally able to access PF because the fees are guaranteed by the court.

Finally, in terms of the relationship, PF firms are not offended that a business owner may use this process one day, while returning to the factor or traditional lender the next day.  The PF community recognizes that PF is only going to be used when it is absolutely necessary and all other lender options have been exhausted.  The PF firm accepts that business owners and their lenders will only use it when they need it!

For more information on purchase order financing, feel free to visit www.Hartsko.com, or contact the IFA directly.

More about the author.

Richard Eitelberg is the Founder, President of Hartsko Financial Services, LLC., with offices in Bayside, New York and Deerfield, Illinois.  Mr. Eitelberg, was graduated from Michigan State University with a BA in Accounting.  He earned his license in certified public accounting (New York State).

Mr. Eitelberg has been the Chief Financial Officer for two garment industry companies: Adrian Landau Designs, and B. Lucid.  He was a Senior Auditor for Josephson, Luxemborg & Kantz, CPA’s, PC. He began Hartsko about seven years ago, assembling a group of private equity investors.  Today, Hartsko handles purchase order financing and letters of credit with some $150m in annual outstandings. (www.hartsko.com)

Mr. Eitelberg, a resident of Plainview, New York is a member of the Commercial Finance Association, the International Factoring Association (preferred vendor) and the Turnaround Management Association.

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…

Imagine a box. Any type will do. It could be a cardboard box, a pink or red gift box, one wrapped in newspaper or even shiny paper. It may even have a big red bow on top. The box is yours, so picture it clearly. Only you know what is in it. The question, however, is do others know what could be in there? Could they even guess? How can you make what you do ‘stick’ with them?

Well, if they know you then they probably can guess… if they cannot, then nothing specific exist sufficiently in their mind to think of you when they have something for you… such as…

a Deal…

In work, we all have niches we provide. We have certain transactions we specialize in and others in which we choose to steer clear. You, in your job, may look at several types of industries in the clients you work with such as medical, government receivables, construction, trucking carriers and/or brokers, staffing or manufacturing. You may only prefer deals that are under or over a certain dollar size or in a set geographic area.

Do people know what you do? Do they have a good understanding? Have you explained to them enough so they could guess what’s in your box? And, almost more importantly, will they remember? Does what you do ‘stick’ with them? Or, is what they know so generic that your box could hold just about anything? What makes you any different than what everyone else does?

If not, they will probably never be able to ‘guess’ what specifically could fall into your niche, or what you may include in that very vast space where any factoring company may fall. In this, they may never know what type of transaction to send your way. Unfortunately, you would just be the same as everyone else with that same generic box. Nothing special… Nothing that stands out… Nothing memorable. The only exciting benefit you may offer may be your packaging: the big red bow, the curly ribbons, and the shiny paper… the pretty marketing-driven features.

So, how do you know? How will you know?

Are you seeing transactions that are completely out of your range, target market or pricing? Getting others to understand what you do may help.

Some marketing people give the basics of their target industry, size, pricing, and other details. They key is: will you remember? Tom Siska, with Working Capital Solutions, continues to write for The Commercial Factor, The Secured Lender, and the ABF Journal. In most of his articles, he continues to address knowing who you are and sometimes, more importantly, who you are not. I tend to agree with this.  

Successful marketing people seem to develop more effective communication tactics (not sales pitches) in helping others remember what they do (in understanding their target market). I know some talented marketers that should a deal come my way and sound even close to what they would do, then I will definitely call them. Why? Because I know what goes in their box… therefore, I know what may go around their box.  Ultimately, I know if they may be able to do the deal!

One of my favorite methods of remembering: stories. Opportunities to hear examples of deals (why they worked and why they didn’t; how they were done) are lasting. They stick. People can relate to them. Stories can help seal the deal. People remember.

After reading Made to Stick, I further believe and encourage such stories. (I also highly recommend reading this book. By the way, it is a shorter read than the 8 ½ hour book on tape — or CD as the case may be. And, yes, I have both because I have ‘issues’… as some have said). The communication styles referenced in this book may help others remember more about you and what you do.

These messages leave a lasting ‘stickiness’ factor. And, at the end of the day, if communicated correctly, I know I always remember what goes in everyone’s ‘box’ for the types of transactions they are looking to fund.

So, again, what’s in your box? How do people know? How will they remember? How will what you do ‘stick’ with them?

Wishing you success… the Factor Guru.

What I wanted to talk about in this entry was planning and measuring performance. Do you have the ability to measure productivity… performance… results? How do you know that the processes you thought you established are truly being followed? What tools and management do you have in place? (This works in any business – not just factoring).

Have you ever wondered why marketing/salespeople bring in a lot of leads but minimal results? Have you ever wondered why a collections staff can call on aging invoices all day but with limited success? Some would say it’s a numbers game in both cases. I respectfully would disagree.

Sales can be a numbers game, but wouldn’t it be better to identify who your salespeople are calling on, what they are saying, what they know about the product they are selling? Is it just the features? Or, do they know what the true benefits (and challenges) are for a prospective client? Can they outline those benefits to a prospective client to add value to any new customer? Can they breakdown a good lead from a ‘not a good fit’ lead?

Likewise, in collections, do your collectors just call to identify the status of a payment without understanding what they are calling on exactly? Do they follow up promptly? Is the reason they are calling because of an internal issue in either your company or your client’s company?

In both cases, you will notice, ‘understanding’ is required and needed to produce efficiency in efforts and to maximize the value of your organization.

Although I have lots of ideas about both — I more or less want to pose the question to readers for them to think about their operation, their company, and ultimately their success.

Wishing you success… the Factor Guru.