Factors To Consider

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From the client's point of view, the arrangement is akin to a guarantee that his customers will pay all his invoices at once, and he doesn't have to rely on a bookkeeping clerk to perform credit checks and pursue laggard payers. And a debtor is apt to pay a factor faster than he would pay an individual vendor, if only to keep his reputation in good standing among credit watchers. On the other side, if some abstract entity is doing the collecting, the client business feels more comfortable selling goods to a customer while not at the same time trying to collect on the last sale. Let the factor be the bad guy.

An alternate school, taken from the garment industry, varies the basic setup, but the end advantage turns out much the same. As the process is executed by Merchant Factors, the factor likewise buys the receivables, but rather than discounting them up front, this method treats the advance as a loan. A Merchant client must agree to sell the factor all of its invoices on a continuing basis and pay a onetime commission of up to 2% of the value of the invoices. He is entitled to an advance of 70% to 80% of all the invoices he can create, and daily interest at 3.5 points over prime is charged by the factor until the bill is paid. Merchant's rates tend to be slightly above prevailing factoring levels because, like originating banks that resell the mortgages they buy, the 10-man Merchant operation refactors its receivables, turning around and selling them to a prime factor, and then arbitraging the difference in costs. "We're entitled to, since we're taking small accounts and bundling them to [the clients'] advantage," explains founder Walter Kaye. "Their accounts are treated as if they're doing $40 million." Without its united-we-stand posture, argues Kaye, Merchant's 60 small-business clients, typically manufacturers capitalized at $60,000 to $150,000, selling $500,000 to $2 million worth of goods to retail stores, undoubtedly would fall outside the purview of the factoring industry's mainline firms.

The factor does all the administration and collecting under this structure as well, but the client has some exposure to the quirks of collection, inasmuch as if he takes the advance, he is obligated to pay interest until the invoice is closed out. This way, the factor is protected against collection bouts that may drag on unpredictably. However, a borrower ought not to be overly concerned with the extra interest expense if receivables exceed predicted aging, since the money -- which otherwise he wouldn't have at all -- can instantly be put back to work. Let's say, with the prime at 8%, a manufacturer taps his 70% allowance by borrowing $1,000 at 11.5%, and the receivables remain open for 45 days. Interest plus 2% commission on $1,428.57 (the amount of which $1,000 is 70%) comes to about $43. That's the equivalent of straight interest at about 34% per annum, but factors would be quick to point out that the expense is negligible in relation to the cash-flow benefit of being able to count on the money coming in. "That's the attractiveness of factoring," says Kaye. "It takes a small-business man with limited capital and enables him to compete in the marketplace."

A somewhat larger business can get better terms from such large firms as BT Factors, which, after decades of apparel and related industries, has added toys and shoes, and is looking toward housewares, electronics, paper, and, Pearl pledges, "anything we can get credit information on and that creates an invoice." As of this summer, an average client was paying 1% to 1.25% commission, plus 2 points over prime on advances. BT likes to see a client doing sales of "$5 million to $15 million, but we can go from there upward to $100 million, no problem." But, says Pearl, BT would consider as little as $1.5 million in sales if there were growth potential. "When we find someone is going nowhere, we don't have much interest. Generally if there's no growth, the firm dries up. You go one way or the other; in business, it's hard to stand still."

Beyond quick access to revenues, a factoring client is also buying insurance against bad debt. Factors' credit checks are so painstaking that few receivables are uncollected (and most of those not due to credit unworthiness but to other complications). For that reason, some companies elect to sell their receivables, but not to be paid until the factor receives his payment -- an interest-free process called maturity factoring. For a commission of 1% to 2% (depending on the average amount of the invoices), the client is acquiring both a bookkeeper and a crackerjack credit department. And its principals can sleep as soundly as General Motors's: if a financial catastrophe such as a Chapter 11 sullies the receivables, the factor pays the client immediately. Short of that, the client gets paid after an interval that both parties agree constitutes a bad-debt situation. Considering savings in overhead, payroll, and collection inefficiencies, a business doing, say, $10 million may actually come out ahead for its $100,000 fee. Besides, the fee is an expense and comes off taxable income, so Uncle Sam kicks in as well.

In addition, a client gets free business advice whether he wants it or not, since it's to a wiser factor's advantage to help the business run smoothly. "A distribution problem? How to write the other partner out? How to set up a buyout? We charge nothing extra for consulting," says Kaye.

When the chips are down but the cash isn't, an independent factor can customize financial services to fit the peculiarities of a business beyond the pledge of its receivables. This flexibility stems from the old days in the apparel industry where, based on the mere promise of a big order, factors might back a production run while the invoice was but a gleam in the hard-pressed garment-maker's eye. Merchant's Kaye claims he makes advances against some invoices that normally would be rejected because credit could't be verified "on the theory that if the businessman is willing to take the risk, he knows the customer. I have to go along with it and make money available." And Clark has set up a cash service devoted to assisting transportation brokers in contracts with carriers. Clark covers gas and breakdown costs stop by stop as a hired truck crosses the country, and pays off the driver as soon as a receipt is signed at the destination. Doling out funds en route enables him to track the truck and prevent chicanery; as to rushing the driver's pay before the invoice is issued, "it promotes stable truckers," is Clark's rationale. "Once you go into an industry, you better know about it. Asset-based lenders will take other forms of collateral, but then you get into the business of collateral liquidation. The last thing I want to do," says Clark, "is liquidate some man's home."

Find a bank so kindhearted.

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