Low fee cash advance

A Big Factor In Expansion - Selling accounts receivable for a fee is a source of cash for small businesses

Roberta Reynes is a free-lance writer in Spencertown, N.Y.

Selling accounts receivable for a fee can be a valuable source of quick cash for growing companies.

For a growing company, factoring-converting accounts receivable into cash by selling them to a financing firm for a fee-can play a critical role in enabling expansion. Just ask Phil Nagel, owner and president of first Pro, Inc., a temporary-staffing company based in Atlanta.

He started his company-which provides temps in information technology, skilled trades, and other fields-in 1985 arid signed with a factor two years later to get working capital to expand.

This was just after the company was awarded a contract to supply workers to Coca-Cola Co.'s regional bottling plant in Atlanta, and his firm needed to expand to fulfill the contract. Nagel used the financing technique steadily for 10 years, selling invoices each week to The Commercial Finance Group (CFG), his factor.

"firstPro was going through growth of 30 percent to even 70 percent in some years," recalls Tracy Eden, CFG's Southeastern regional manager, based in Atlanta. (CFG is headquartered in Bin-bank, Calif., and has 22 U.s. offices.)

Today, firstPro's sales are $30 million, the company has "graduated" to bank financing, and Nagel is planning an initial public offering. "Factoring allowed me to grow at a faster pace than would have been possible otherwise without selling my company or any stock in it," Nagel says. "It was perfect for us."

In factoring, after the business owner sells some or all of the company's accounts receivable to a factor, the financing company typically advances 50 to 80 percent of the face value of the invoices. The factor assumes the risk and responsibilities of making collection. When the factor collects on the receivables, it takes out its fees and pays the balance to the business owner.

While the process can be expensive, it allows an entrepreneur to turn assets into cash in a few days, as opposed to waiting 30 days or longer for customers to pay.

Another plus is that the factor will "check out your client very thoroughly," says Nagel. "You don't have to worry about their creditworthiness." The key to being a good candidate for factoring is to sell to solid companies that have good credit-or to the government.

Opening Doors To More Firms

Because financing decisions turn primarily on the creditworthiness of customers rather than that of your business, even a company in dire financial straits might be able to obtain money through factoring.

Factoring used to be confined to the textile and related industries, but the doors have opened wide to others.

"We see a tremendous growth in smaller factors who finance industries that the bigger players would never have considered," says Bruce H. Jones, deputy executive director of the Commercial Finance Association, a trade group based in New York City.

"The biggest players are banks, and they account for the lion's share of the roughly $75 billion that is factored annually," says Jones. But he adds that "hundreds of small factors now finance companies ranging from florists to truckers. Any small business with solid customers can check in with a factor."

Indeed, you don't have to be big. "If your revenues are in the $10,000- to $20,000-amonth range, you should be able to find factoring," says CFG's Eden.

Nagel explored alternative types of financing before settling on factoring. During the first couple of years, he funded growth with money from his personal portfolio of assets. "But I have five children," he says, "and it was really starting to hurt me. I, as a stockholder, ran out of money to finance the business at the rate I wanted to grow it."

He had quite a few offers from private-placement specialists, he says. "I could have sold 10 percent to 40 percent of first Pro, but I wanted to keep all the stock."

Next, Nagel's personal banker recommended factors to him. He spoke with their representatives, checked references by calling some of their clients, and chose CFG.

In determining your costs, says Jones, a factor will consider not only the creditworthiness of your customers but also how long you've been in business and your company's history-for instance, whether it has a higher rate of returns than is common in its industry The size of the transaction and the amount of administrative work it entails will be taken into account.

For example, the factor will want to check your inventory for collateral. The inventory can be examined more easily and at lower cost if it is all in one area rather than scattered throughout several states.

How The Charges Are Set

Factors use two different types of pricing, says Eden. The smaller your business, the more likely you are to be offered so-called discount pricing. "This is an all-inclusive fee for the credit, collections, costs of funds, and servicing," explains Eden. At CFG, the rate ranges from 2 percent to 7 percent of the invoice.

While some large businesses that use discount pricing might get the 2 percent rate, small firms usually are charged an initial fee of at least 3.5 to 4 percent. There typically are extra charges if an invoice is unpaid after 30 days.

For example, suppose your company is doing a volume of $10,000 a month with a factor The factor buys one of your invoices, of $1,000, and advances you $800. You might be charged 4 percent, or $40, if the invoice is paid during the first 30 days, but if payment is not made until the second 30-day period, you might have to pay 2 percent more, making the charge $60.

Under the second type of payment-the more traditional structure for factoring- the costs are divided into a commission for administrative services, credit, and collection, plus an annualized interest rate on the funds employed.

"For a business of 100 employees, you are probably going to see, on the low side, a commission in the range of 1 percent and an interest rate of prime plus 1 percent to 2 percent," says Eden. (The prime rate is the rate at which banks lend to their best customers.) "On the high side, you may see a commission rate of 2 percent and interest of prime plus 3 percent or 4 percent."

Using the same figures as in the discount-pricing example, your costs might work out this way: The factor charges a commission of 1 percent of the $1,000 invoice plus an interest rate of 12 percent (prime plus 4 percent) on the $800 advance. If the invoice is paid off in 60 days, the total cost is $25.78. Which pricing method would be cheaper for you depends on variables such as how fast your receivables turn, your volume, and other particulars of your contract.

Tips For Making A Choice

Factors are easy to find. "Any bank or CPA will recommend them," says Nagel. (See "Finding A Factor," below.)

In selecting a factor, avoid those that request application fees, advises Eden. When checking references, you may want to talk to the factor's lenders and clients. Before signing, make sure the factor's fee structure and reports on payment activity are clear so you and your CPA or controller can audit the factor's numbers precisely.

CFG, for example, provides "accounts receivable agings"-reports on the amount of time that has passed since the customer was invoiced-and a daily "cash receipt journal" showing checks received by CFG.

As Nagel and many other business owners will attest, factoring can be a powerful source of immediate working capital for small firms facing a cash-flow crunch that threatens their potential for expansion.

Finding A Factor

The Commercial Finance Association offers a free packet containing members' names, information on the industries and geographic areas they cover, and the size of transactions they handle. The CFA is at 225 West 34th St., Suite 1815, New York, N.Y. 10122; call (212) 594-3490.

The CFA's World Wide Web site, at www.cfa.com, also has a list of members. In addition, the site has a search feature; you type in the amount of financing you'd like and your location, and the companies that might handle your business are listed.

The Commercial Finance Group's Web site, at www.commercialfinancegroup.com, has interactive spreadsheets that business owners can use to calculate what factoring might cost them. CFG offers a free educational audiotape, "Financing Options," which includes information on how to check a customer's credit. To order, call 1-888-240-4068 or send a request by electronic mail to tracy@cfgroup.net.