Good to get? Accounts receivable financing is an alternative option for those looking for capital

Black Enterprise, March, 2009 by Donald Jay Korn

PENN, GOOD & ASSOCIATES L.L.P. HAD an opportunity to land a lucrative contract from the Centers for Disease Control and Prevention. "The CDC wanted us to start immediately," recalls Clyde Penn, president of the Washington, D.C.-based marketing communications company specializing in health and social issues. "We had to ramp up, adding more staff, to do the job."

Getting money for an expansion is not always easy for a small company. (Penn, Good b Associates has annual revenues of approximately $4 million.) A bank loan can take a while to obtain--and might not be available at all in the current lending environment. Nevertheless, Penn, 47, wasn't concerned about financing. "We factor our accounts receivable with United Capital Funding," says Garrick R. Good, 40, the firm's senior partner. "We got the cash we needed right away and were working on the CDC contract within days."

The Commercial Finance Association's latest report, through the third quarter of 2008, indicates that accounts receivable financing continues to bolster small businesses. Among the largest CFA members engaged in asset-based lending, 75% increased new credit commitments in the third quarter while total loan originations were 17.1% higher than in the second quarter of 2008.

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"Even when credit is tight, our members are still able to provide financing. In fact, our members report phones are ringing off the hook in recent months, says Andrej Suskavcevic, CEO of the CFA, whose members offer accounts receivable financing.

Paying the price. Accounts receivable financing may be available to small companies; however, there are some concerns in utilizing this practice.

For instance, accounts receivable financing is available only to companies with revenues from businesses, government agencies, and/or nonprofits. If your company sells to individual consumers, you won't have accounts receivable to sell or use as loan collateral. And, if your company has eligible receivables, using them for financing can be expensive. "Rates vary, according to the quality of your collateral," says Matthesen, "But asset-based lenders generally charge at annualized rates of 12% to 18%. That's more than a company would pay for a traditional bank loan. And factors charge even more."

Putting a hard number on the cost of factoring or asset-based lending is not easy. To see why, consider the situation at Global Networkers, a technology consulting firm in Charlotte, North Carolina. "Our receivables are purchased by Millennium Funding," says William Haygood III, 35, the company's president and CEO. "Millennium advances 80% to 85% of the invoiced amount." Thus, if his company submits $100,000 of invoices, it will get back $80,000 in cash. And typically, a factoring fee can be anywhere from 1% to 5% of the purchased invoices.

"After Millennium collects on the invoices, we get the balance, minus the fee we pay," says Haygood. "The fee varies, depending on how quickly the invoices are paid, but it might be $3,500 on that $100,000 of invoices."

Fast financing. Haygood says this arrangement makes sense for his company. "We send invoices to Millennium each week," he says, "and we get our advance money by wire transfer within 48 hours. We may have to ramp up quickly for large projects, so this cash flow is vital. Global Networkers has been growing rapidly, according to Haygood; it now has 30 full-time employees, relationships with 50 independent contractors, and annual revenues of $5 million.

Factoring might not work if your company has tight margins, Haygood notes, but the steady stream of cash can help a profitable company thrive. PennGood's principals also assert that the benefits of factoring can justify the cost. "About 75% of our work is for government agencies such as the CDC and the Centers for Medicare & Medicaid Services," Penn says. "The federal government pays within 30 days of receiving an approved invoice but it may take a while to make corrections and get your invoice approved. United Capital Funding pays within a few days."

Although factoring is often used by companies unable to get bank financing, it's not necessarily a last resort, says Penn. "We're expecting a surge in revenues from new contracts and we might outgrow a traditional bank line of credit. Good notes that it's possible to be selective about factoring: he says that PennGood generally retains receivables from private clients while factoring bills sent to government agencies.

In-house or outsource? The CFA's Suskavcevic says that some small businesses will let a commercial finance company handle their invoicing and collections. "The company's executives will decide it's not their area of competence, so they'd rather focus on growing the business." On the other hand, both Penn and Haygood say that their companies keep billing and collections in-house, for greater control.

Regardless of how you might intend to handle billing, if you're interested in accounts receivable financing you should be as transparent as possible, advises Suskavcevic. "Be prepared to open up your books," he says. Once a factor or an asset-based lender sees the type of customers you serve and how fast they have been to pay, you can get a good idea of the costs you'll recur for reliable cash flow.