The Factor Guru

Tips on accounts receivable financing and business practices.

Posts Tagged the factor guru

Who is Hammurabi: A Brief History of Factoring

May 5

Posted by Gen Merritt in General Information | No Comments

If you attended the April 2010 IFA Annual Factoring Conference, you may have dropped in on Factoring Jeopardy, where you were sure to see that certain categories did not fare so well for those participating in the game. For me, that category was of all things: History.

Yes, factoring does go back over 4,000 years to the Mesopotamian King Hammurabi. He was the ruler who established the world’s first metropolis, Babylon, considered the bed of civilization. The Mesopotamians are accredited with being the first to implement notes/borrowings on clay tablets between two parties. These clay ‘contracts’ indicated promises to pay; they were promises for future payments. This concept expanded trade and increased economic power for that time, setting a foundation for certain alternative forms of finance today.

Since then, factoring has evolved becoming a critical financial tool for doing business in almost every civilization that followed, the Romans included, who were the first to sell discounted promissory notes. The first documented form of factoring in the American colonies, however, was prior to the revolution.

Merchant bankers in Europe gave the American colonists advances for materials, allowing the colonists the ability to harvest their lands. Raw materials like cotton, furs, tobacco and timber were shipped from the colonies to Europe. Factors during these colonial times advanced against the accounts receivable of these companies. This practice became very beneficial to the colonists, as they didn’t have to wait for the money to begin their harvesting again.

Later, during the economic revolution, factoring became more concentrated on the issue of credit, as factors began assuring payment for certain clients (today known more as non-recourse factoring). Before expanding to varied business types after the war, factoring specifically catered to the textile and garment industries in the United States.

By the 1960s and 1970s, an escalation of interest rates and tighter credit spawned a new interest in the factoring market, with a number of private factoring companies coming into existence. By the 1980s, further rate increases combined with new regulations within the banking industry caused many small businesses to seek alternative sources of funding outside of traditional banking. It was at this time, factoring became a more popular option for many of these companies.

As many of you know, factors make funds available even where banks cannot often do so; typically, factoring companies focus on the creditworthiness of the customer (debtor). In contrast, the fundamental emphasis in a bank lending relationship is on the creditworthiness of the company itself, not that of its customers.

Factoring is a financial transaction wherein a company sells its invoices/accounts receivable to a factor at a discount. In exchange for this, the company receives immediate working capital. Three parties are involved in the transaction: the factor, the company seeking financing and their customer (the account debtor). The sale of the accounts receivable transfers ownership of those invoices to the factor, at which time the factor obtains the right to receive the payments made by the customers.

Today’s factoring still focuses on advancing funds to small to mid-size, rapidly growing companies who sell to larger, creditworthy customers. Factoring is among one of the most effective and efficient forms of financing utilized by businesses. It immediately improves the cash flow of a business.

In addition, today’s factor offers other support services for their clients including providing credit checks on new and existing customers, sending monthly statements to customers for payment, performing collection calls, processing and maintaining history on invoices and customer payments, and providing reporting for this information, typically with online access for the client. Some factors even provide additional financing services for their client companies.

After all of that, the only history question from Factoring Jeopardy that this actually addressed and answered: Who is Hammurabi? I no longer remember the other questions… maybe some of you do and want to comment…

Wishing you success. The Factor Guru.

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Missing Early Warning Signs May Be Hazardous To Your Business

May 15

Posted by Gen Merritt in Operations | No Comments

 

9f7d7e4213bb1a961Changes in a company’s performance or within their business may help identify Early Warning Signs before a potential problem occurs. Knowing what to watch for can help. Here are a few more signs and ‘changes’ you may want to be on the lookout for…

Management changes or high employee turnover exists: The question to ask is why? Are there other indicators within the company or the company performance? What is the succession plan and can the business operate effectively without that key employee or manager? What affect will their absence have on the business’s ability to provide you information? Is there a problem in the business itself that would cause management or good employees to leave? Will this change affect your collateral position?

Wiring instructions change: When a company becomes overdrawn on their account, garnishments occur, their bank begins paying down other bank debts from funds received, or other changes, the business may establish another banking relationship. Companies do not normally change their operating account without a good reason. And, I have experienced other cases where the company begins asking for checks to be issued instead of their traditional wires. Again, this is a change. Therefore, this could be a red flag as well; where is that money being deposited now anyhow? Do you get bank statements on a regular basis? Is the money staying in the business?

Payment patterns from customers (debtors) change: This may be a sign of credit deterioration in the debtor, pre-billing or overbilling by a Client, etc. When a customer has always paid their invoices at 40 days, there should be a reason that an invoice remains open at 75 days. Has the approval process changed, is there paperwork that is missing to authorize a release of that check, etc. Do you understand the debtors billing and ultimate payment process? Performing verification and collection calls on purchased invoices will help identify potential problems before they occur. One thing to remember: customers (debtors) do not typically change their payment patterns overnight.

Vendors start requiring shorter terms, cash on delivery, or post dated checks: When was the last time you received an updated accounts payable aging? When cash is running tight, companies may rely on their vendors for an additional source of working capital. However, at some point, this money trail could end. Vendors tend to have closer connections with the company and in their industry than you may have; Pay attention when those same vendors suspect financial distress within your Client. (Oh, and, start requesting and reviewing those payable listings if you are not already…).   

If you begin to see one of these situations occurring, this does not mean you need to over-react. However, you do need to act. Understanding the reasons behind these occurrences is essential. You can’t fix what you don’t know.

Identifying Early Warning Signs can help eliminate or mitigate potential losses before they occur. Dealing with concerns quickly can only help your collateral position as a factor. Should an issue exist, more than likely your Client’s business has already been impacted. Don’t let their problems also become hazardous to your business. Watch for Early Warning Signs.  

Wishing You Continued Success. The Factor 

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Plan Accordingly: We haven’t hit bottom yet

Jan 7

Posted by Gen Merritt in General Information | No Comments

After reviewing a prior blog, A Bumpy Ride: Plan Accordingly, Hold on Tight, I realized so much has happened since that time so long ago… yes, that whole less than six months ago. But, have we really planned accordingly? I don’t think many of us realized at the time just how bumpy this ride would be, especially for the factoring industry. Yes, for many factors a silver lining radiates from the economic cloud as new opportunities arise and as deal flow tends to increase during a recession. For some, however, tough times lie ahead with the ever changing credit markets expected to continue through much of 2009.

For one, what do factors typically rely most heavily upon when determining extending credit facilities to prospective clients? Their customers’ credit: the debtor credit. And, what is currently happening around us? Is there anything you read anymore without seeing businesses of all sizes filing for bankruptcy, restructuring or losing their financing lines? Probably not…

A recent article that came out on The Secured Lender’s email updates further expanded on this theme, focusing on certain industries.  Their take and others: we haven’t neared the bottom yet.

For a factoring company, continued vigilance on reviewing customer (debtor) credit must remain a priority. Further, special attention should be adhered in carefully looking at the underlying documentation supporting the sales made to these debtors (the receivables). If a debtor begins struggling with cash flow and a reason exists allowing for discounts, returns, credits or other offsets, then factors and their clients may begin experiencing more challenges in collecting on those receivables.  

Hence, the importance of sticking with the basics of factoring: continued focus on the debtor credit and underlying documentation supporting that sale.

Then two, it did happen; Prime went lower than LIBOR. But that’s not the big news. As Paula Cole sang, “Where have all the [lenders] gone?” After significant layoffs, even institutions such as Textron Financial Corporation ceased providing credit facilities to finance companies in late 2008. More and more banks and financial institutions are restructuring as well, causing a delayed effect on the small factor and their ability to finance their clients. And, what about the hedge funds who financed factors? Or, are we no longer allowed to talk about them… did they ever even exist?

With all these changes occurring, where is the factoring industry headed? Does anyone really know? Many factors with prudent monitoring procedures, a solid capital structure, and flexibility within their organization to contend with the new credit landscape will continue to grow, maybe even more during 2009 with the influx of new opportunities also resulting from the current credit market and conditions.  The question remains, however, have we really planned enough? Have you?

“A man who does not think and plan long ahead will find trouble right at his door.” ~ Confucius

Wishing you success through 2009. The Factor Guru.

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A Good Deal for Factoring

Dec 2

Posted by Gen Merritt in Underwriting | No Comments

As someone who has specialized in credit and operations, I do have to on occasion empathize with the business development team. Once in awhile, a deal comes along that you know is a good deal. Don’t let me confuse you though. I don’t mean a deal that is a good ‘factoring’ deal… I just mean a good deal. You know the one: the company that is profitable and has strong customers; the owner(s) have good personal history and experience in the business along with great personal credit… oh, and the product has ‘mostly’ been delivered.

Wait, that’s it: “mostly” delivered. That’s the word that factors have a hard time with… mostly.  The fundamentals of factoring rely on delivered products and services performed in full. Nothing remains to be done. The sale is final. The invoice will be paid.

With the word “mostly,” however, the product is not definably delivered, today. Many technology and consulting businesses have services predicated on something else occurring. The services are not yet finished. They may need something else to happen for payment, or they may not. It just depends, right? The invoice, therefore, may at the end of the day still be disputed. So, what do you do?

Well, the best thing would then be to get a confirmation from the customer that the invoice will be paid in full, without offset, without dispute, and, hopefully, the factor is ensuring the payment is going to them pursuant to Article 9 of the Uniform Commercial Code, as outlined under the notification of assignment letter that is sent to the customer (account debtor). If you have never heard of a ‘no offset’ letter or an ‘estoppel’ letter, then call your legal counsel. Check out the International Factoring Association for legal counsel, if you don’t already have someone to prepare one for you.

Now, as a business development person, try telling this to the client. The company may not  understand. They have never had someone not pay; it just hasn’t happened to them. It’s only happened to other people. So, why do ‘you’ need this letter (the factor – the independent third party)?

This type of transaction may have been structured and approved under the ‘we did it before, so why don’t we do it now’ mandate. Remember, however, that was when working capital was at a surplus, when factors and lenders were aggressively competing in the financial marketplace.

So, after you see a deal like this, talk to them, maintain a good relationship with them, get prompt and accurate information from them, it is definitely hard to then say, “No, we cannot do your deal (the way you would ideally like),” or however you approve a transaction with certain requirements that the client ultimately then says no.  

When it is all said and done, sometimes you have to step back and say, “Can I get out of their transaction tomorrow?” That’s my motto, right? So, why is it so hard when you are so close to the client and the owners… just after a few phone calls and an in-person meeting? Well, because the answer to your own question was, “No,” even after all that.

So, once again, that is what I have to remember: honesty and candidacy is the best policy. You have to explain how a deal needs to be structured and also monitored. You have to tell this to the prospective client. You have to further explain and describe why this is the only way you or your company can approve their request. If their request to approve the transaction cannot be done, then it just can’t…or it can’t be done by your company. Maybe they can find financing elsewhere; however, with the current credit environment, I have to say there are slimmer pickings.

At the end of the day, a factoring company has to ask themselves, “Can I get out tomorrow?” They have to have an exit strategy. If the answer that comes back is anything less than a “Yes” then maybe the transaction is not meant for factoring. Sometimes, you really do have to say, “No,” even when you want to say, “Yes.”

Wishing you success, without regrets. The Factor Guru.

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A Bumpy Ride: Plan Accordingly, Hold on Tight

Sep 29

Posted by Gen Merritt in Economy, General Information | No Comments

Okay… so only those of you who know this person will understand, “Are you kidding me?” Yes, that is what I said. The events of the past few weeks seem utterly surreal. Before you can process what just happened, another headline appears on your computer’s home screen. It’s all anyone talks about… the wild ride on Wall Street… and, it is downright scary when you think about it all. So, get ready…

Let’s recap on a few of these events since the Fannie Mae and Freddie Mac debacles roughly two months ago, although that wasn’t really the beginning was it? (More of an aftershock from deeper rooted decisions).

Bear Stearns, Lehman Brothers Holdings bankruptcy, Merrill Lynch, and the government takeover of American International Group, Inc. followed — we thought that was shocking at the time, now,

JP Morgan Chase bailed out the largest bank failure in U.S. history with Washington Mutual even after the $700 billion bailout was rejected by the House,

Wachovia Corporation was sold overnight to Citigroup Inc after a roughly $200 million win in their competitive bid against Wells Fargo,

Yesterday, the stock market fell over 400 points in less than five minutes; quotes from this day included “worst decline since 1987” and “the sum of all fears,”

There are now only four national banks (Citigroup Inc., Bank of America, JP Morgan Chase, and Wells Fargo… or would that be six with the other two changing their charters last week).

And, it’s not over yet…

The auto industry just received a $25 billion bailout of their own,

The government is still pumping in billions of dollars into the financial system and housing market, 

Congress has been in the midst of marathon sessions.

And, let’s not gloss over the other sideline headlines, further evidence that the buck didn’t stop there.

National City stock plunged yesterday and was downgraded begging questions relating to their future (…not going to go there but I will note their stock was trading less than Wachovia Corporation at the close of business). There are many others lingering in the sidelines; just a matter of time (or days as the events of the last few weeks have shown). Some experts anticipate up to another 1,000 bank failures over the next six months. Not all of these can be ‘rescued’ by the Fed. And, we haven’t even touched on the global market effects. 

Someone asked me yesterday, “What does all of this mean?” Honestly, how do you even keep track, or explain the fact that it would be like cutting everyone’s credit cards in half… all at once. And, that assumes they have jobs and will still have an income. Unemployment is expected to be over seven percent by 2009, the highest it’s been since the 1990-1991 recession.  The Secured Lender referenced an article that equated this ‘crisis’ to “depriving a body of oxygen.”

Of the banks left, there are some that are now implementing floors on pricing and even escalating pricing on already sent proposal letters for new commercial loan transactions, including for asset based lending deals. I guess this is better than the alternative… dare I say it… not making loans.

Even in this market, that may seem like a drastic measure, until you take a deeper look. One reason may be that LIBOR jumped to over three percent and may still rise; Prime may drop below this. Can you imagine? 

Stop — think about what I just said. Doesn’t that mean that some companies with low interest commercial loans would actually pay less than some banks or financial groups pay for their money? It is a Mad, Mad, Mad, Mad World (as Mark Sunshine’s First Capital blog noted).  

And, for factors, it will not be any easier. Yes, factoring companies may see a rise in business and in new fundings during this time period. But, what’s underneath? Take a careful look: What is in your existing portfolio… your existing client base? Can your portfolio handle the ride? 

Bailout, no bailout, we all have differing and apparently passionate opinions on this matter. However, we will all be affected. Who’s to blame, who should be held accountable, who comes out ahead, who suffers the most, who should correct it, and who should pay… the list of questions continues. At the end of the day, no one knows for sure. I just wanted to highlight what we should already know. It will be a long road until we get there. We will make mistakes. We will have to live with them. It will be slow. It will be painful. And, hopefully, the market will correct itself over time. Until then, stay the course, plan accordingly and hold on tight. Because, those headlines are right: We are all in for a bumpy ride.

 

 

 

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