Financing Businesses In Consideration Of Alternative Financing
Collateral is require by most banks, investors or loan institutions in order to do asset-based lending
. Risk is also involved in asset-based loans. It is difficult to do asset-based loans for business that have specialized equipment. Tangible equipment or things are not the only assets available to be offered as collateral.
Assets are not just tangible things or equipment. Assets also include accounts receivable. There is a way of leveraging those accounts receivable as well as vehicles or other tangible things. It involves selling the accounts receivable to a factor. It can be considered a debt-free line of credit since it is actually the sale of an asset. It doesn't adversely effect the balance sheet.
In essence, a company is extending a 30-day interest free loan to another company or government entity when extending net-30 day terms. The net-30 days invoices can be sold for a discount to a third party. The process is similar to a merchant selling credit card invoices to a credit card company. The credit card company pays the face amount of the invoice minus a percentage of discount. In essence, the merchant is selling the invoices at a discount.
Factoring is also selling invoices at a discount. A factor pays a second installment minus the discount. Once the invoice has been paid in full, the factor pays the reserve amount minus a discount. Thus, instead of receiving one installment, the business receives two installments. The reserve is considered collateral until the client has paid the invoice. Several invoices with reserve amounts provide security to the factor.
If a merchant is set up to receive credit cards for products or services, the validity of the credit card is based on the user's credit rather than the credit of the merchant. Likewise, a factor looks closely at the clients of a business wanting to factor invoices rather than the business benefiting from invoices factored. Ultimately, the factor will receive money from the clients of that business.
Another difference between accepting credit cards and factoring is that factoring is only for business to business or business to government invoices. Factors generally don't factor invoices involving business to consumer. A business invoicing government entities is considered pre-qualified because the government is considered a good credit risk.
The main purpose of factoring is to receive immediate cash in order to operate more efficiently without acquiring debt. The line grows automatically as the business grows. It is particularly beneficial to growing companies. When a company expands by filling more and larger invoices, there is no need to apply for additional funding. The funds increase automatically as the company grows.
If invoice factoring is not an option, and the business is unable to qualify for conventional funds, it is possible to obtain money for a company's future credit cards sales in exchange for money up front. In this scenario, a percentage of future credit card sales is automatically deducted to pay back the money. This is flexible because the amount being paid back takes into consideration a variable amount from week to week. More money will be paid when sales are up and less when sales are down. The flexibility makes it easier to work with the variability of sales.
It is very common for businesses to have uncollected accounts if the company has been in business for any length of time. It is common for companies to sell consumer debt to companies who specialize in that type of collection. A company usually only gets pennies on the dollar to sell that type of debt but the amount adds up when selling thousands, tens of thousands even millions of dollars worth of bad debt.
Companies knowing state laws concerning the statue of limitations and other laws concerning collection are able to collect on some of the accounts. Some people simply can't pay the debt when due but are able to pay once they get out of a financial crisis. Not all accounts will be collected but the fact that the accounts are bought at a large discount and that some will pay is why collection agencies will buy the accounts.
Alternative financing should always be considered time-sensitive and transitional. Ultimately, a company's goal should be to position in order to finance with less expensive conventional funding. The reason for obtaining alternative financing in the first place is to take advantage of the time value of money. Money badly needed today is worth more than more money tomorrow. Alternative financing is more expensive but in consideration of its time value, it is worth paying more to have immediate cash available.
by: Russell Wardle
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