Factoring – A Tonic For Financially Stressed Businesses

Posted on: October 11th, 2021

Invoice discounting

Accounts Receivable factoring, also called Invoice discounting, is a fixture of private credit markets. Usually reserved for companies deemed non-bankable, factoring offers companies valuable capital access against their accounts receivable. Post-pandemic, due to historical losses and stressed supply chains, many companies find themselves simultaneously balancing their lack of cash with the need for more capital.

Benefits of Factoring

The financial bounce that PPP loans provided in FY 2020 and FY 2021 has worn off and many companies are scrambling to improve their working capital positions for a variety of reasons. Some businesses have overdue payables they need to pay back before they can ramp up purchasing. Other businesses need more cash to place larger orders to ensure enough stock. Yet others are reintegrating their supply chains or have business development projects that require investment. Factoring provides companies that need capital several benefits:

Approval based on Customer’s credit strength – Unlike a bank loan which is a loan against your company’s creditworthiness, factoring companies are purchasing your accounts receivable. They evaluate your customer’s credit rating to ensure the receivable is collectible, so your weak financial condition is of minor concern to them. They do a cursory review of your historical financial performance only to ensure you are not imminently insolvent.
Level of borrowing is flexible – In a factoring facility, the company decides which receivables it wants to sell to the factor and hence controls the amount of borrowing. This provides a company with a strong amount of financing control and scalability.
Cost has become more attractive – Historically factoring was nosebleed interest rate type financing with effective interest rates in the 20%+ range. Given the amount of institutional capital flow into private debt markets and banks entry into the factoring industry, pricing has reduced significantly to the 8% to 12% range. While this is still high relative to bank loan rates of 4% to 6%, the cost is manageable for most companies that have a critical need for capital.
Transitional Capital – Factoring is meant as a first step for a company to rehabilitate its capital position. Usually, companies have a pressing transitional need for financing for a year or so, and then can attract conventional financing. A factoring facility is short term liquidity bridge and can be refinanced rather easily.
Speed of Capital raise – Factors run accelerated approval processes and can fund a company within 4 weeks of initial contact, provided they have proper documentation. The best factors are smaller, high-quality groups who seek to build relationships and run transparent approval processes.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.