For many years this magazine has endeavoured to educate owner managers on the merits of debt factoring as a means to smooth cashflow and fund business growth. Today factoring has become accepted as a game changer; it’s time to catch up on the latest developments.
For many years this magazine has endeavoured to educate owner managers on the merits of debt factoring as a means to smooth cashflow and fund business growth. Today factoring has become accepted as a game changer; it’s time to catch up on the latest developments. By Glenn Baker.
If you are a business owner proactively looking to grow your business, and yet you don’t meet the bank’s ‘normal lending criteria’, and you’re not operating in a sector that excites investors, do not despair. Debt factoring of invoice discounting is fast becoming a ‘first resort’ for businesses in your situation. And it seems that you are not alone – an increasing number of businesses are successfully expanding or growing with the aid of their factoring partner.
Craig Brown works for one of them. Brown is general manager, lending, for Lock Finance, one of the major factoring service providers in New Zealand, and he says the majority of new clients are serious about growing their business, but their banks have not been able to meet funding needs. “This will continue to be a trend over the next 12 months. While banks still say they will support these businesses, they still only support the very established, well secured ones.”
John Blackmore, national sales manager at Bibby Financial Services, an invoice finance specialist, agrees. Feedback tells him business confidence is tentatively returning to the market and for those businesses that, for whatever reason, don’t have a profitable history in recent times, yet want to take advantage of growth opportunities, debt factoring or invoice financing is increasingly the solution.
“Our market niche is small businesses looking to be bigger businesses, and they don’t have the security that the banks require – i.e. property,” says Blackmore. More specifically, Bibby’s and similar lenders below ‘tier one’ status, target smaller, under $2 million turnover companies. “Purely because the level of borrowing facilities for a business like that might be $400k or $500k, if you add some term facilities, and the banks will only take a look if there is tangible property security.”
With debt factoring and invoice discounting well established in this country (BNZ and Heartland Bank also operate in this space), most factoring companies are now looking at adding additional services to their portfolios. Lock Finance, for example, is now offering an extension to its traditional invoice discounting service by looking to discount firm purchase orders.
“We feel this is a natural extension to what we have been doing for a number of years now,” explains Craig Brown. “Lock Finance can assist a business that has firm orders but cannot fund the import of stock, parts, etc to meet those orders. This allows a higher level of growth opportunity for the business – especially fast-growth, fast turnaround FMCG businesses or an importer whose largest cash requirement is paying the overseas supplier upfront or allowing the lead time for importing the product.”
Brown describes this new service as ‘front end’ factoring that’s unique to Lock Finance, and it’s an area of the business they’re keen to promote.
Bibby’s Financial Services have been busy too. The company operates in 16 countries and can now factor export receivables in any of those countries, just as if it was a domestic debtor. John Blackmore says they are particularly strong in the European and US markets – but to factor in other countries where they’ve less manpower, the debtor numbers would need to be quite small.
“We can factor two ways,” he explains. “When the goods get delivered to the debtor, or when we have confirmation that the goods are safely onboard a ship. The former can attract a higher funding level. But either way, we will require trade credit insurance which the client can bring to the arrangement or can also access via Bibby.”
For companies looking to increase exports, export factoring is a good way to do business, believes Blackmore. “It’s relatively simple, open-account funding – with the backing of trade credit insurance. It’s similar to a Letter of Credit arrangement, apart from the fact that the importer doesn’t have to use its credit lines to set up a Letter of Credit. The process is also faster and less administratively burdensome in that it doesn’t need to rely on the turnarounds of carriers or banks.”
New exporters with big orders are especially vulnerable because that cash is out there longer, he says. “And how do you satisfy your second order when you have so much cash tied up in the first one? This is essentially what factoring does – it brings that cash forward.”
Bibby also introduced its new bad debt protection solution to the local market, which covers bad debts up to the value of $90,000 and allows for selective debtor cover.
“We’re giving clients the chance to protect their risk from bad debts, and improving on our capabilities,” says Blackmore. He says this insurance will especially help finance those businesses that have a significant concentration of debt in just one or two debtors.
“And because we’re factoring or debtor financing the client, we can also manage the insurance policy for them. That’s one of the benefits,” explains Blackmore. “Used alongside a factoring facility, it also permits higher levels of funding whilst protecting against bad debts.”
The policy will protect up to 90 percent of the value of any insured bad debt suffered, says Blackmore. “Clients will get limits from the insurer if the debtor is over $20,000, just as they do from us, but they’ll largely be based on what the client requires.”
Cover is provided on debtors with a balance of $5,000 or more and the back dated cover on debts is up to 60 days past the due date.
NZBusiness also checked in with Scottish Pacific Debtor Finance, another significant player in the local factoring market. Scotpac’s head of business development, Wayne Goss, has seen a tendency for larger businesses to look at debtor finance as a funding option in recent times – but with a greater demand for confidential facilities rather than disclosing the factoring arrangement.
Scotpac has launched new trade finance products in the current year. “This enables us to provide additional cashflow solutions to importers,” says Goss.
Factoring has undoubtedly come of age – with the majority of business professionals now happy to recommend it. Indeed, as Lock Finance’s Craig Brown points out, a lot of their referred business now comes through accounting firms and business advisors – or perhaps a bank that can’t provide the finance facilities required. Brown would rather not talk about the small amount of resistance to factoring and preconceived ideas that still linger in the market. The interest rates charged by the factoring companies are no longer an issue he says, as they now compare extremely favourably with bank rates. New cloud-based technologies have made the whole factoring process much easier too – clients have open and unrestricted access to files through the factoring company’s website.
As to whether a factoring company will be prepared to take on a client that’s perhaps at the higher end of the risk scale, Brown says each case is treated as unique and depends on the strength of the client proposition and financials. “You could have two similar sized businesses in the same industry and with the same turnover – and while one might be just scraping by, the other could be raking in buckets of money.” A number of factors come into play, he says, primarily the quality of management and the quality of customer. At Lock Finance due diligence is carried out on all potential customers – then all the information goes through an approval process.
Wayne Goss at Scottish Pacific Debtor Finance believes there are still a few people out there who have the perception that debtor finance is the ‘lender of last resort’. “It’s not. It’s actually a smart option – the type of [funding] facility that grows with a company’s turnover and doesn’t require real estate turnover.”
He has heard the cost concern too. But he argues that, whereas a bank overdraft is just a line of credit, a factoring facility comes with a full collections service, which can save on a business’s staff costs. “Also, if a business is turning away orders because it can’t fund them, there is an opportunity cost to consider.”
As an example, Goss uses an apparel company that signed up with Scotpac in 2012, when it had a turnover of $700,000. “After being with us for 12 months their turnover doubled. The main asset in the business is the receivables ledger and they have been able to grow their business by leveraging off that asset – and without having to put up any real estate security.”
While debtor finance or factoring is a great funding option, Goss cautions businesses that they still need to look into their debtor quality, and they must use the cash for working capital.
Of course, if a debtor refuses to deal with a factoring company, in a non-confidential situation where a partnership is disclosed, it can be a real hurdle. Bibby’s John Blackmore says their fears are groundless. “The standard process for most factoring companies is that an ‘assignment letter’ goes out to all debtors, under the client’s letterhead and signed by the client. The letter basically says that, ‘as of a certain date, we have outsourced our accounts receivable function to company X in order to grow our business.” The process is very straightforward, says Blackmore – and the account number provided to debtors for all future payments is in fact a segmented account of the client. It’s not the factoring company’s general account. “It’s a trust account that the factoring company holds with a specific bank and the client gets assigned a certain suffix, which is theirs.”
Facts on fees
Most factoring companies will agree that there are misunderstandings about the fees involved in factoring arrangements. So what fees are you up for exactly?
Blackmore uses the example of a company that turns over a million dollars and has been trading for one to two years. Typically a bank would leave it alone. It has a debtors ledger of say one-and-a-half-months trading, worth $130k to $140K. “We would lend 80 percent against the invoices – say up to $100k – at an interest rate of up to 12 percent per annum. The company draws down as and when needed.
The major players also charge a factoring or administration fee on the GST inclusive value of each invoice, which essentially comes off the company’s gross margin. That fee is influenced by the financial performance of the business; the level of factoring service (full service?); and the amount of invoices being issued by the company concerned. A high number of small-value invoices might put the company in the top fee bracket.
On set-up, all factoring financiers charge a one-off application fee which varies considerably, but may be half a percent of the ‘notional limit’ (where the financier thinks the borrowing level will end up). And, as with most business arrangements, there are legal fees involved.
Bear in mind that when it comes to interest rates and fees – they vary considerably from financier to financier, but it is largely a case of ‘swings and roundabouts’. Also, typically factoring arrangements last two to three years – because that’s how long it takes for a business to go through a growth or recovery phase.
Factoring arrangements can be set-up relatively quickly – with decisions and indicative offers coming within 24 hours which, says Blackmore, can test the commitment levels of the business owner. He also says factoring provides an additional level of security on a company’s financial transactions, thanks to regular on-site audits which match orders with despatch notes, invoices, monthly statements and payments – something worth considering in light of the number of fraud-related cases coming before the courts in recent times. Factoring companies operate under strict processes and procedures and will verify all client contact information supplied by their customers to ensure everything is legit.
Good systems and procedures are required on both sides of a factoring arrangement.
“Confidential factoring facilities should only be offered to firms that are financially stable and have good systems and procedures in place,” says Blackmore. “So if the factor company is ever required to enforce an invoice, it knows that those systems and procedures are good.”
And if you’re wondering why factoring companies typically advance 80 percent on invoices, with the balance (less fees) on settlement, it’s generally to mitigate the risk for the financier from the occasional debtor who doesn’t pay. “At the end of the day, 80 percent should cover most businesses’ cost to produce those goods. So ideally it’s just the profit margin that’s not getting advanced – and that shouldn’t be required immediately to run the business anyway.”
Glenn Baker is editor of NZBusiness.
And then there is debt purchasing
Baycorp is aware how important cashflow is to businesses of any size. “We work with our clients to understand how their terms of trade and credit management policies and processes are impacting their debtors ledger and ultimately their cashflow,” explains Kerry Boielle, Baycorp New Zealand’s national sales and client service manager. “What many businesses are unaware of is that they may have a dormant asset which they could realise value for today.
“We also look into the impact that debtors drip feeding payments into a business can have on cashflow, cost of capital, and so on. An immediate discounted lump sum payment is much more attractive than a trickle of cash. After all, a sale isn’t a sale until the money is in the bank, and unfortunately many businesses find themselves in the unfortunate position of having provided their products and services free of charge.”
Debt factoring is where a third party pays a percentage for a debt which is not yet in default and the invoiced customer is allowed to continue to use the services or buy the products of the creditor on credit – whereas ‘debt purchasing’ is when a group of customers is almost always in default and/or is not expected to have a continued relationship with the creditor.
Debt purchasing is a specialty of Baycorp. Boielle provides an example where, whilst some customers were not in default, the creditor/customer relationship was to be extinguished due to the creditor closing down its operations here. “We purchased a ledger that had a starting face value of $72,000, the debts aged between 0–120 days, and we delivered a very happy client with a significant cashflow injection,” she says.
As a general rule, Baycorp is happy to consider purchasing debtors ledgers with a face value starting from $100,000.
“Unfortunately we still find that many businesses think that their debtors ledger is too small and haven’t bothered to seek us out for advice,” says Boielle.