expert advice: Lori Karpman | CEO | Lori Karpman & Company
Factoring:
How to Finance your Business without Debt or Dilution of Equity
Factoring, or “the sale of accounts receivable” is a source of funding whereby a company sells the value of their accounts receivable (less a discount in case it doesn’t get collected or doesn’t pay on time to a third party) in return for immediate payment. It has always been a choice for big business, but not so for small to medium ones with gross sales of under $5 million per year, which really isn’t that small. The small business loan program offered by the banks is still essential for the initial startup phase, but most companies need financing during the operating stage and often cannot get it from a bank for a variety of reasons. It can be because they have already borrowed the maximum available, or additional borrowing will cause them to breach their borrowing ratios under existing loans. This makes it very difficult for businesses especially seasonal ones, to ensure the steady cash flow required to run their business during the low periods, and young companies from filling big orders. 26 canadian franchise magazine
So, what, who and where does a business owner go to finance their growth? Factoring is hardly new and has existed since the days of the Roman Empire. Unfortunately, some scandals U.S. in the younger stages of the industry left factoring with an undeserved tarnished reputation that still prevails today. Factoring companies are not banks, however in the US banks may have a factoring division which is heavily regulated. It became seen as the recourse of last resort for companies in financial distress who sent their accounts receivable to collections. In fact, none of this is true; factoring is a brilliant way to fund operations without burdening the company with debt that would take years to pay back or diluting the owner’s equity. Results don’t lie; companies that factor their receivables usually double or triple their business in 2-3 years. Over $1 trillion in sales is factored worldwide annually. In fact, factoring is the champion of small business and an essential partner in managing its financial growth. Small and medium businesses often fail because of short term cash flow problems, not because the business idea is bad!
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Small and medium businesses often fail because of short term cash flow problems, not because the business idea is bad!
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The two traditional financing options are: (1) traditional bank financing, and (2) private (equity) investment. Each of these options provides a company with much needed working capital for daily operations and to service current orders, however, there are significant costs associated with each choice. A traditional bank loan burdens the company with additional debt, plus the cost of the interest being paid on the debt, creating a debt far greater than the amount borrowed. Additionally, this being a loan it shows up as debt on financial statements, making it even more difficult for a company to get a bank loan later. All revenues coming in are being used to service debt instead of upgrading equipment or buying more inventory for example. It’s difficult for a business saddled with debt to grow.
