Raising Capital: One Last-Ditch Solution
It's not cheap to raise growth capital for your company by factoring accounts receivable. But for some companies, there's no other solution to the cash crunch that often accompanies fast growth.
Consider the experience of Young Minds, a Redlands, Calif., software company. Founded in 1989, the company has grown to $7.1 million in sales. But that cash inflow is the product of an enormous cash outflow. "One of our hottest products is a software package that helps jukeboxes read CDs," explains Genene Miller, general manager. "But our customers want to buy the software and hardware together. That's forced us to purchase the jukeboxes -- which we do at 40% off list -- and then package them with our software."
By 1992 the company hit what Miller calls "the prosperity squeeze." Without a credit line, it was desperate for ways to pay suppliers for the jukeboxes it needed to sell its software. "We even ended up in trouble with the IRS because we couldn't pay our payroll taxes on time." The solution -- an initial public offering -- was impossible for a company with an IRS lien, a relatively new product, and troubled supplier relations.
Cash relief came from Reservoir Capital Corp., a factoring company based in Baltimore. "When we get an order, they pay us 50% of it up front -- which helps us buy our jukeboxes," says Miller. "When we ship the order, they pay us another 30%. When customers pay us, we receive the rest." The arrangement eases cash-flow problems but at a hefty price: "I estimate that it costs me $625 for every $10,000 in receivables we factor," says Miller. "It's steep, but it's better than not shipping." Another plus: Reservoir handles Young Minds' tax payments to the IRS, which should eliminate its tax lien by the end of 1996.