| What is Asset-Based Lending? | | | | untimely delivery or any other dispute involving |
| Asset-based financial services organizations | | | | the merchandise or its delivery, the factor will |
| (asset-based lenders) play a vital part in financing | | | | look to the client (the seller) for reimbursement. |
| the economy and are dedicated to the growth | | | | The credit and collection service is just half of the |
| and well-being of their clients. They provide their | | | | business of the old line factor. The other half, and |
| clients with cash by lending on fixed assets, | | | | for many clients, the more important half, |
| accounts receivable and inventory, and engage in | | | | involves advances of funds against the purchased |
| factoring, purchase order financing, real estate | | | | receivables. If the customer wants a cash |
| financing and leasing. They include the asset-based | | | | advance, it can borrow from the factor. The |
| lending arms of domestic and foreign commercial | | | | interest on the loan is in addition to the |
| banks, small and large independent finance | | | | commission and is usually at a rate competitive |
| companies, floor plan financing organizations, | | | | with the cost of a comparable bank loan. |
| factoring organizations and financing subsidiaries of | | | | Many factoring clients are maturity or |
| major industrial corporations. | | | | non-borrowing clients. They wait until the |
| Expert in all facets of collateralized lending, | | | | purchased receivables are paid and then may |
| asset-based lenders – large and small alike | | | | collect the proceeds from the factor. If the client |
| – possess the experience and know-how to | | | | leaves the funds with the factor after collection, |
| structure the proper financing program for their | | | | the factor will pay interest on the balances at a |
| borrowers. They specialize in financing businesses | | | | rate comparable with the factors' cost of funds. |
| and business transactions involving a broad range | | | | These balances may be drawn upon when |
| of products and services, both domestically and | | | | needed. |
| internationally. They provide: | | | | Traditionally, factoring was done on a notification |
| Operating cash | | | | basis. The client's customer is notified that the |
| Funding for an acquisition, a merger or a | | | | account has been turned over to a factor and the |
| leveraged buyout | | | | customer's payment should be made directly to |
| Debt consolidation | | | | the factor. However, a non-notification agreement |
| Turnaround financing | | | | can be worked out. The factor would still |
| Bankruptcy/reorganization financing | | | | purchase the receivables outright after doing the |
| Equipment financing | | | | normal credit check of the customer, but the |
| Inventory financing | | | | customer wouldn't be notified that its account has |
| Floor plan financing | | | | been sold. If the client borrows money, customer |
| Equipment leasing | | | | payments in non-notification accounts are usually |
| Import/export trade financing | | | | sent to lock-boxes which the factor administers. |
| Growth financing | | | | Aside from old-line factoring, there are as many |
| Factoring services | | | | variations on factoring as there are entrepreneurs |
| Growth Money | | | | who choose to use the name. There are |
| Businesses need money to grow. A business | | | | commercial finance companies, some of which call |
| cannot survive just because it has a better | | | | themselves factors, single-invoice factors, |
| product, an exclusive market or the best method | | | | purchase order factors, recourse factors, invoice |
| of distribution. The catalyst required for progress | | | | discounters and re-factors. |
| is money. | | | | • Commercial finance companies do not |
| Business owners and managers must be | | | | provide credit guarantees, but lend against |
| knowledgeable about financing, what it can do, | | | | collateral, principally receivables and inventory, and |
| why one form may be better than another. It | | | | are an offshoot of the factoring industry and go |
| can be used when: | | | | back to the beginning of the twentieth century. |
| Operating cash is tied up in receivables | | | | Largely because the commercial finance |
| The best trade terms for supplies create cash | | | | companies operate in diverse industries in contrast |
| flow shortages | | | | with traditional factoring which is still largely |
| Inventory levels are high because of client | | | | married to textiles and apparel because of the |
| demands | | | | need for credit guarantees in those industries, it |
| Sales growth is straining resources | | | | has grown much more rapidly than traditional |
| Seasonality peaks cause problems | | | | factoring. Rather than purchasing receivables, |
| No fixed assets are available for collateral | | | | commercial finance companies take assignments |
| Trade discounts and special pricing terms cannot | | | | of receivables as collateral for loans. The client |
| be obtained | | | | collects the receivables proceeds and uses the |
| Letters of credit are required to supply or buy | | | | funds to pay down the loan. Defaulted receivables |
| overseas | | | | are the client's problem (but could be the lender's |
| Debtor-in-possession financing is required | | | | problem if defaults are substantial). The lender |
| Asset-based lenders often advance funds when | | | | normally provides enough of a cushion so that if |
| traditional sources are not available. They are | | | | the client fails to repay the loan, the collateral can |
| familiar with various types of businesses and are | | | | be liquidated and provides full payment. |
| responsive to client needs. | | | | • Single-invoice factors provide essentially the |
| Loan size | | | | same services as the old-line factors but they do |
| Asset-based lenders fund businesses with annual | | | | it one invoice at a time. Also, there are very few |
| sales less than $25,000 to more than $1 billion. | | | | non-borrowing clients for single-invoice factoring |
| Credit depends on the type of business and the | | | | because a company that factors a single invoice |
| content and quality of the collateral. Frequently, | | | | usually is motivated by the need for financing. |
| the credit granted is more than the net worth of | | | | • While factors finance receivables after they |
| the business. | | | | are created, purchase-order factors provide |
| The increased cash availability provided by | | | | financing so clients can fill orders that they cannot |
| asset-based lenders often makes the difference | | | | finance on their own. Once the order is filled and is |
| between profitable growth and failure for the | | | | converted to a receivable, a traditional factor |
| undercapitalized business. | | | | might purchase the receivable and cash out the |
| The phrases "too small," "too new," and "not | | | | purchase order factor. |
| enough net worth," do not deter an asset-based | | | | • Recourse factors are usually small factoring |
| funding source. | | | | companies that purchase receivables often in |
| The flexibility and cash availability provided by | | | | non-traditional industries where credit information |
| asset-based financing have enabled countless | | | | is not readily available. They buy the receivables |
| companies to grow and take advantage of | | | | but those that are unpaid are charged back to |
| market opportunities. | | | | the client. |
| Cost | | | | • Invoice discounting is similar to the recourse |
| The cost of asset-based loans is influenced by the | | | | factoring and is prevalent in England and some |
| credit risk and collateral associated with the | | | | other European countries. The invoice discounter |
| transaction. When evaluating an asset-based loan, | | | | buys receivables, but rather than focusing on the |
| borrowers should assess the cost of financing in | | | | credit worthiness of the client's customer, they |
| the context of the benefits to be received. | | | | concentrate on whether the contract creating the |
| Compared with other financing alternatives, | | | | receivable allows sale or assignment. Non-paying |
| asset-based lending is very cost effective and | | | | receivables are charged back to the client. |
| efficient. | | | | • Re-factors provide the same services as |
| Asset-based lenders frequently look beyond | | | | old-line factors, but they work with small |
| financial statements to determine how much | | | | companies, sometimes with sales volume as low |
| money they are prepared to advance at and | | | | as $500,000 (generally large factors need at least |
| after closing. Therefore, borrowers can take | | | | $3 million in volume). The re-factors provide the |
| advantage of profit opportunities in the market | | | | financing, but use the services of traditional |
| by being able to plan ahead based upon their cash | | | | factors to handle the credit checking and credit |
| availability. | | | | guarantees. They make their money from |
| Asset-based lenders are proactive rather than | | | | interest on money advanced and a spread |
| reactive and can often restructure debt during | | | | between the re-factors commission cost and |
| tough times to help avoid costly and disruptive | | | | what it charges its own clients. |
| refinancing. | | | | Accessing finance can be a real problem for many |
| Over the long haul, the benefits will tend to offset | | | | small businesses, especially if they are growing |
| the premiums associated with borrowing from the | | | | fast. One option many businesses don't consider is |
| asset-based financial services industry. | | | | factoring, or cash-flow lending as it is sometimes |
| Types of Asset-Based Financing | | | | called. |
| Secured lending | | | | While not suitable for every business, factoring |
| The lender provides funds secured by the assets | | | | can provide a revolving line of credit and a |
| of the borrower. The collateral can include: | | | | reduction in administrative costs. |
| accounts receivable, inventory, machinery, real | | | | Factoring involves the sale of a business' book |
| estate, patents, trademarks or other assets | | | | debts on a continuing basis. Usually, the factoring |
| where value can be determined. | | | | firm will buy the business' sales invoices at a |
| The secured lender may establish a revolving loan | | | | discount of between 70 and 90 percent. The |
| where the borrower provides a pool of collateral | | | | factor then collects the invoice amounts from the |
| that the lender translates into operating cash or | | | | business' customers. The business receives the |
| working capital. The borrower uses the financing | | | | cash, less the discount, from a credit sale quickly |
| to buy more materials, expand marketing, | | | | (usually within 24 to 48 hours) and maintains a |
| improve productivity or other improvements and | | | | healthy cash-flow even though the debtors may |
| sells the resultant product. The sales create | | | | not pay for the sale for another 60 days or so. |
| receivables that are pledged for cash advances | | | | Usually, the factoring firm takes the difference as |
| and the payments received on the invoices pay | | | | profit; however some factor companies prefer to |
| down the loan. These increases and reductions in | | | | provide a percentage up front, the remainder on |
| the loan balance are cyclical, hence the revolving | | | | collection, and charge interest and fees on the |
| nature of the loan. | | | | transaction. |
| Some receivables have less collateral value, for | | | | The use of credit cards in the retail industry is a |
| example, progress billing, past due receivables, and | | | | form of consumer factoring, where the retailer is |
| receivables subject to "set-off". Raw materials | | | | paid immediately for goods or services and the |
| and finished goods are normally acceptable | | | | credit card company collects the payment from |
| collateral, but work-in-progress generally is not. | | | | the customer. Some US banks offer asset-based |
| Equipment and real estate may also be used as a | | | | cash-flow lending but have generally found limited |
| source of financing. | | | | interest in the products - with many businesses |
| Non-recourse factoring: The financing institution | | | | put off by higher interest rates charged to reflect |
| buys the receivable and assumes the risk of | | | | the risk of lending against assets not secured by |
| customer credit. The factor guarantees against | | | | property. |
| credit loss, unlike a secured lending facility. The | | | | Several Options |
| factor will also check credit, undertake collection | | | | Factoring firms can offer several levels of service. |
| and manage bookkeeping functions. | | | | The premier service usually involves taking over |
| Full-recourse financing: The financing institution | | | | the complete management of the business' |
| accepts assignment of the receivable but does | | | | accounts receivable, including administration, |
| not assume the credit risk. The client retains | | | | confirmation, and collection of invoices, regular |
| responsibility for managing the receivable portfolio. | | | | reports and monthly ageing reports on all |
| Generally, the lender will finance invoices up to | | | | accounts processed. |
| ninety days from delivery of goods or services, | | | | This is usually coupled with a seamless, confidential |
| then charge them back to the client. | | | | service, where the customer of the business is |
| Discount factoring: The factor purchases the | | | | unaware of the relationship between the business |
| receivables at a discount to compensate for | | | | and the factor and all communication between the |
| paying prior to the due date. | | | | factor and the customer is branded as the |
| Maturity factoring: The factor purchases the | | | | business. In other cases, the factor may only |
| receivables, assumes the credit risk and advances | | | | take over aspects of the accounts receivable |
| cash to the client as the invoices mature. | | | | function. |
| Non-notification factoring: Account debtors are not | | | | The level of service provided by the factor is |
| notified of the sale of the receivables and the | | | | often related to the value of the debtors book. |
| invoices are either paid to a lock-box or to the | | | | While it may appear complicated at first, |
| shipper. This is similar to a receivable loan. | | | | outsourcing accounts receivable can significantly |
| Notification factoring: Account debtors are notified | | | | reduce costs. More importantly, it is particularly |
| of the purchase of the receivables and are | | | | useful for businesses that are growing or moving |
| directed to make payments to the factor. | | | | in a different direction with a view to improving |
| Spot factoring: A "one shot" transaction, generally | | | | profitability. A growing business can quickly |
| out of the normal course of business. | | | | outgrow an overdraft secured by fixed assets, |
| Floor plan financing: Certain industries require | | | | yet it may not be able to obtain finance on an |
| significant high-priced finished goods inventory. | | | | unsecured basis. |
| Examples: automobiles, refrigerators, washing | | | | A business may also need the flexibility to cover |
| machines, televisions and stereo systems. These | | | | sudden increases in order levels. Factoring |
| are supplied on extended credit terms to retailers. | | | | provides funding in line with sales growth. |
| Retailers usually do not purchase this expensive | | | | This form of finance can also be useful for |
| inventory outright; rather a finance company will | | | | start-up businesses that need to pump cash back |
| provide credit to purchase the inventory, secured | | | | into their business to build their inventory, but |
| by the product "on the floor". | | | | have difficulty obtaining overdraft or working |
| Leasing: The lessor purchases the equipment | | | | capital facilities due to a lack of trading history. |
| needed to fulfill certain obligations and the | | | | Service, manufacturing and wholesale businesses |
| equipment remains the property of the lessor | | | | are often suited to this type of finance. |
| even after all the borrowed funds are repaid; or | | | | Businesses that mainly sell on cash terms to the |
| existing assets are sold to and leased from a | | | | general public may find credit cards or overdrafts |
| leasing company to release capital needed for | | | | more cost effective. Those with complex |
| working capital purposes. | | | | products or terms of sale such as trial and return |
| Purchase order financing: Working capital financing | | | | clauses or those in the construction industry, |
| is secured by a security interest in existing | | | | where customers are invoiced in stages, are also |
| purchase orders and the proceeds of the | | | | less suited to factoring due to the complexity of |
| purchase orders. Normally the security interest is | | | | the supplier/customer relationship. |
| perfected by the lender taking possession of the | | | | Pros & Cons |
| inventory or raw materials. | | | | As with all business finance, factoring offers |
| Real estate financing: the mortgaging of land and | | | | advantages, disadvantages and potential pitfalls. |
| or buildings to raise working capital. | | | | The level of benefit from factoring will vary from |
| More about factoring | | | | business to business. |
| The origin of the factoring industry has been | | | | But it usually provides: |
| traced to the days of the Roman Empire or even | | | | * Immediate cash-flow access to 70-90 percent |
| earlier, but the industry as we know it today in | | | | of the value of debtor invoices. |
| the United States goes back only about 200 | | | | * Working capital for growth without |
| years to the early nineteenth century. | | | | requirements for a strong balance sheet or |
| Factors evolved from U.S. selling agents for | | | | substantial net worth. |
| European textile mills. The European mills used the | | | | * A good interface with the supplier and, as a |
| agents to sell their fabrics in the U.S. and paid the | | | | result, a seamless transaction for the customer. |
| agents a commission on sales. The agents also | | | | * Outsourced debtor administration and associated |
| warehoused merchandise and did the shipping for | | | | cost savings. |
| their European clients. As these selling agents | | | | * The ability to increase sales by offering credit |
| prospered and became more familiar with their | | | | which the business may have been unable to fund |
| own customers, they began taking on the job of | | | | otherwise. |
| establishing credit terms and advancing funds to | | | | * The ability to take advantage of creditor |
| the European mills. The oldest documented | | | | discount terms, improve credit rating by being |
| factoring firm traced its roots to 1810 and several | | | | able to pay creditors promptly and an enhanced |
| others were established in the first half of the | | | | ability to capitalize on larger orders as required. |
| nineteenth century. | | | | * The option to free up property from being tied |
| Traditional or old-line factoring is fairly | | | | as security. |
| straightforward and is designed for long-term | | | | Some issues that should be considered if looking |
| relationships. It involves the purchase of | | | | at factoring as an option include: |
| receivables without recourse and with notification | | | | * Complexity. Rather than simplify the |
| to the client's customer. The factor buys the | | | | account-keeping, factoring may add complexity to |
| receivables created by a client's sales and then | | | | the business depending on the level of integration |
| collects the proceeds directly from the client's | | | | of account-keeping processes. |
| customer. After the factor buys a receivable, it | | | | * Culture. If the culture of the business and the |
| assumes the credit risk on that receivable. If the | | | | factor are at odds, the arrangement may |
| client's customer doesn't pay because of a credit | | | | interfere with the relationship with customers. |
| problem, the factor must assume the loss. | | | | * Bad Debts. In most cases, the business still |
| Essentially, an old-line factor offers its clients credit | | | | wears the non-collection risk and may end up |
| protection, collection, bookkeeping services and | | | | following a restrictive process to maintain the |
| financing. In addition to advances against | | | | facility. |
| receivables purchased, once a relationship is | | | | * Cost. It can be expensive depending on the |
| established, factors often provide clients with | | | | interest and costs charged by the particular firm |
| over-advances during peak shipping seasons. | | | | such as finance charges, administration charges, |
| Factors also offer financing services and | | | | mailing charges, etc. |
| accommodations such as inventory loans, letters | | | | * Asset control. Some factors take a floating |
| of credit/import financing and equipment financing. | | | | charge over all the business' assets not just |
| Export financing is also available through alliances | | | | debtors. Consequently a business may need to |
| with international factoring networks. Principally | | | | obtain a release from the factor to sell any of its |
| because credit guarantees are important in | | | | assets. |
| textiles and apparel and because of factoring's | | | | * Value. The factor may only finance a |
| roots in the textile industry, about 70 percent of | | | | percentage of the debtor value and may |
| the volume of old-line factors is still in textiles, | | | | undertake its own audit of the business' accounts. |
| apparel and related industries. | | | | * Customer relations. Some factors will take over |
| Since the factor takes the credit risk on the sale, | | | | the entire debtor ledger which may cause |
| it must first approve the sale through its credit | | | | difficulties if a business wishes to remain in control |
| department. Thus, the client is relieved of the | | | | of some accounts that are particularly sensitive or |
| cost of running a credit department. Because of | | | | vital to the business. |
| the credit guarantee, old-line factoring is limited to | | | | * Security. Some factoring firms now require |
| industries in which credit information is available. | | | | small businesses to provide property as security |
| The charge for the credit and collection service, | | | | in which case it may be cheaper and more |
| called the factoring commission, varies with the | | | | effective to arrange a bank overdraft. |
| sales volume of the client, the size of the | | | | One of the most common traps for small |
| transactions and competitive conditions. | | | | businesses using factoring is the assumption that |
| The economic rationale for the factoring service is | | | | outsourcing the function means outsourcing the |
| fairly obvious. With thousands of suppliers selling | | | | responsibility. |
| to the same customer, without factoring, each | | | | The benefit of using a factoring facility still |
| seller would have to do its own credit appraisals | | | | depends on good management of debtors and |
| and collections. This involves an incredible | | | | the finances of the business. Every business must |
| duplication of effort. With factoring, a single credit | | | | manage their terms of trade, and ensure the |
| department operating for hundreds or thousands | | | | terms they offer and the credits they receive |
| of suppliers, eliminates much of the duplication and | | | | are appropriate for their particular business. They |
| promotes efficiency. And with the aid of electronic | | | | need an effective debt collection system and |
| data processing, the cost of the credit and | | | | simple internal controls to prevent errors. |
| collection operation has been reduced exponentially | | | | Factoring could cause additional problems for |
| and the savings are passed on to the client. | | | | businesses without a good handle on cash-flow |
| Technology has revolutionized the industry, | | | | management and cost budgeting. They may find |
| eliminating tons of paperwork and providing clients | | | | themselves in a downward spiral, spending debtor |
| with valuable on-line information. The system can | | | | receipts on current overheads and not paying the |
| generate a host of reports on sales analysis and | | | | current creditors and then wondering what went |
| other information to help a client analyze its own | | | | wrong. They need to understand the money flow |
| business. | | | | of the business and use short-term funding such |
| It should be noted that the factor's guarantee, is | | | | as factoring on short-term assets. |
| a credit guarantee and does not apply to anything | | | | With good management, the use of factoring can |
| other than the financial inability of the client's | | | | be a very useful source of finance particularly for |
| customer to pay. The guarantee does not apply | | | | a young business that is growing fast. However, |
| to merchandise disputes between the buyer and | | | | there are plenty of traps for the unwary, and as |
| the seller. If the receivable is not paid because of | | | | always, if in doubt get advice before committing |
| buyer claims of defective merchandise or | | | | to any form of finance. |