Factoring - myths and facts.

Business finance is seldom a source of great contention, certainly not outside the inner sanctum of those offering services, seeking loans or aiming to differentiate their offering.

However, mention the word 'factoring' and a whole myriad of opinions will appear; the Bloke in the Pub will have more views on factoring than traffic wardens and tax collectors combined. They will invariably include 'my mate whose business went bust because he used factoring' (this 'mate' is probable a relative of the apocryphal mate who only survived an accident because he wasn't wearing a seat belt, and a distant relative of the one who smoked 100 full-strength cigarettes a day and lived to be 140).

Factoring is often used as a generic term for any facility involving advances against receivables; though in reality true factoring will include an element of collection and credit control.

It is of course utter nonsense to suggest that borrowing money against invoices or using third-party collections (unless they are truly incompetent) will drive a viable business into the ground, though there is some tentative statistical truth behind the assertions.

Myth 1. Businesses which use factoring usually go bust: Cast your mind back to the last recession, (not the one we apparently emerged from, but the last real one in the early '90s).

Whilst we complain now that banks aren't lending, the behaviour of banks in that recession was utterly deplorable. Your friendly bank manager was transferred to another branch and your new manager rang to introduce himself & invite you to a meeting. In high hopes of some support and perhaps a spot of lunch, you rolled up to the meeting to meet a stony-faced character who swiftly got to the point and advised you that the bank were not comfortable with you sector/business/utilisation and were - with immediate effect - withdrawing your overdraft facilities.
I kid you not - in the mid '90s these were commonly known as 'hatchet managers' and any business person you spoke to was adamant that they would never use an overdraft again.

The factoring industry stepped up to the mark, and became a refuge for many of those businesses who, under extreme pressure, made a move without much research and in the quickest possible time. Inevitably, in a recessionary climate and against a backdrop of forced moves, many of these businesses ultimately failed.

Factoring wasn't the cause of the failure but it was their last visible financial act prior to their demise. (Other, less visible moves might have included running up vast credit card debt, remortgaging the family home - often without their partner's consent - and refinancing every solid asset) however there has never been an urban myth that businesses who remortgage always go bust - factoring is highly visible so carries this stigma alone.

Myth 2: Your customers will stop paying / ordering from you if you use factoring: 
Very hard to quantify this one, however it might be true that some of your customers will have bought into Myth 1 above. Good communication, as ever, can allay a lot of worries on this score (as can a wise choice of factor).

When it comes to payment terms, you can divide customers into 3 categories:

1. Close customers who pay you promptly out of respect and perhaps mutual dependency: These are presumably customers with whom you are in close contact and you should have the opportunity to discuss your decisions and to reinforce your working relationship.
2. Customers who 'play the game' and pay according to a pecking order: These will certainly need to be managed, and the choice of factor or factoring product should pay close attention to this area.
3. Large customers who pay on their terms: are highly unlikely to adopt different terms for direct or non-direct payment - their policy will be, for example, to pay on the last day of the month following invoice, whoever the invoicer might be.

There will naturally be exceptions to the above, which need to be borne in mind during the negotiation or exploration process.

Factoring is not a product, it is a range of products and services, some of which may suit you whilst others may not. Most important, it is crucial that - like any service - it is bought on value and relevance and never on the basis of price alone. There are approximately 100 factoring companies out there, each of whom has specialities, market niches and strengths and weaknesses.
A good factoring broker (like ours!) will ask a lot of questions before assessing the best facility and home for your needs. They will also be prepared for you to ask a lot of questions (and to provide you with coherent answers!).

Should you choose not to go the broker route, here are some pointers for you:

DO:

• Be prepared with a detailed list of questions, and expect coherent answers.
• Have a 'beauty parade' of 3 or more prospective suppliers.
• Take time to evaluate the full package being offered.
• Seek recommendations and testimonials.
• Consider as many variables as possible.

DON'T:

• Buy on headline price.
• Be persuaded to sign documentation before you have had time to read it fully.
• Accept verbal promises.
• Listen to people in pubs.

Factoring (or invoice / debtor finance) might be the best financial tool for your business. Only with some detailed exploration will you be sure.

For more information contact Business Funding Portal

Short term funding - the new overdraft.

About a year ago I spent a jolly hour in my local pub laughing quite loudly at the APRs quoted on Payday loans (or MicroLoans) - the highest I have seen to date is 16,000%.

How we laughed that people would pay those rates; surely it couldn't be legal?

In the cold light of day I felt it would be interesting to do a cost comparison between, say, setting up an overdraft and getting a 3 week loan at (what appears average) 4,500%. Obviously there are very many variables to take into account and crucially, many 'typical' customers are unlikely to be forthcoming with real detail on circumstances and requirements (this discretion being part of the attraction of online lending), however over a range of circumstances it is apparent that in many cases a loan at 4,500% can actually work out cheaper than an overdraft at 14%.

Couple this with harsh current realities - that banks are not keen to lend on overdraft and that the financial circumstances of borrowers might be weak - and there is a whole new cost angle - the real and reputational cost associated with bounced cheques - charges for bouncing are up to £50 per item, plus 'unauthorised borrowing fees' whilst the 'bouncee' might also levy a charge - all of which can add up very quickly to far more than 16,000% interest if they came within APR calculations.

PayDay loans are the heavy cost end of short term finance which, seen in the above light suddenly becomes a very credible alternative for businesses looking to take up an opportunity, fulfill an order, or simply to resolve a short-term problem. The beauty of most facilities is that they leave existing facilities intact and in some cases, are invisible to other parties.

In most cases, information required for short term facilities is not onerous, often hinging on the security offered moreso than the underlying financial of the borrower so, for example, if you want to hock your classic Aston for 3 month and can prove ownership, you can probably raise about 60% of its value in 24 hours. Legal complexities on property or transactions can take a little longer.

Like most forms of funding, terms and turnaround improve with repeat business.

Crucially (with the specific exception of MicroLoans), most short-term facilities hinge around specific security which might be:

• Debtors (individual or small groups of invoice).
• Confirmed orders for finished goods.
• Freehold property (commercial or residential).
• High - value personal assets (shares, jewelery, artwork, cars, boats etc)
• Solid business assets.

By taking the time to understand these products, and putting cost in to context, it is clear that short term finance - used wisely - is a real and valuable resource for business in today's climate where overdrafts are rarer than hens' teeth!

If you want to know more, drop me an email mark@fundingportal.co.uk

The elephant in the room; bad debt in lending

I'm aware that I have banged on a bit about my views on Government's rhetoric on 'forcing banks to lend' yet the message from media and Government continues to be confused in the extreme. This article in the Telegraph doesn't break any new ground, but it is unusual in one respect, which is that Angela Knight, chief executive of the British Bankers’ Association touched on the hidden topic - that of risk or - to put in in more raw terms, bad debt.

We all love SME business - they are the lifeblood of our economy and are also proving very cuddly to the media - but, let's be absolutely clear, the risk of bad debt in lending to small business is always present - and is significantly increased in economic downturn; there are 2 reasons why banks are failing to lend - and spite isn't one of them. The first reason is that they simply lack the resource to do so, the second and more enduring reason is that they are in absolute dread of bad debt - which can quite easily push them back to illiquidity.

Bad debt from customers is a real problem to business, but a problem that can be mitigated to some extent. To a lending institution it isn't an external or secondary risk, it is at the very core of lending and pricing policy. If you read the legal section of any business forum or journal, you will often find advice being given to business owners on how to avoid paying out on personal guarantees - it is entirely undestandable that people want to keep what they have worked for but- let's be clear - this isn't about bankers' bonuses or profiteering, the effects are passed directly to small businesses in both price and underwriting.

It is impossible to have a coherent discussion about lending without talking about bad debt, so please - we are all big grown-ups here - lets not pretend it doesn't exist or hide it behind the curtain with the elephant - if you are going to talk about bank lending, lets actually admit what the issues are!

CrowdFunding - The power of the crowd!

3 years into the banking crisis, and still the newspapers carry headlines like this one in a recent edition of The Telegraph indicating that - whatever the veracity of lending statistics - it is abundantly clear that relations between banks and business remain less than cordial and will presumably remain so for some time to come.

One potential White Knight riding onto the non-bank funding scene comes in the shape of 'Crowd Funding' where wealthy individuals can get a return on their money by lending it at commercial rates to businesses or private individuals. The lending might take the form of term loans (typically 1 - 3 years) or equity funding.

On loan facilities the investors effectively bid for each proposal thereby setting the sell rate based on its popularity, whereas equity investors are liable for their own due diligence and will reap rewards based on the performance of their specific investment, just as if they had invested on traditional stocks and shares.

I have been watching Crowd Funding closely for almost a year, really to see whether it took root or whether it was just 'another Internet concept'. Pleasingly it seems that some strong players have emerged and that peer-to-peer loans are rapidly becoming acknowledged as a credible alternative to traditional bank lending.

Moreover, some of the founder organisations have come together to create a code of conduct designed to keep rogues out of the market. Of course there will always be the fear that this will restrict competition, a scenario which should be avoided but applied wisely, should avoid borrowers falling victim to less scrupulous operators who always circle the money business.

The symbiotic relationship between banks and their business customers was simultaneously their greatest strength and their greatest weakness; it was very easy for a customer requiring finance. From a glance at a screen the bank could get a thumbnail of turnover, trends and a snapshot of financial health and make a swift judgment. On the downside, if things started to go wrong this could swiftly knock on to all business and possibly personal finance arrangements in many cases leaving the customer with nowhere to turn. The ease with which these arrangements could be made or terminated resulted in the cliche of banks handing out umbrellas in the sunshine only to take them back when it started to rain. With an external lender they have no up-front knowledge so are reliant on the customer supplying good quality, current information - something which was often overlooked in the hedonistic pre-crash era.

By using an external loan provider, banking lines will be left untouched and as long as payments are maintained there will be no interference with trading or security position. It is early days but common sense suggests that it is more economically intelligent to nurse default cases than to tear in with guns blazing.

Overall, I can see Crowd Funding, or Peer-to-Peer lending as a viable and sustainable business tool - it really is banking without the bank; the lender gets a rate of return well in excess of bank deposit rates, and the borrower gets a commercially sensible borrowing rate - truly a win-win situation! So, what are the pitfalls?

I have touched on issues of integrity, which could range from marginal operators who might be under-capitalised to out and out villains, though the industry is typically good at weeding these out.

More concerning is the issue of bad debt - particularly in equity models - extensive due diligence is not financially viable and simple statistics indicate that as many as  two thirds of investments will not generate sufficient return to cover investment - whist as many as a third might completely fail. This is clearly an inherent risk of share investment, but if investors complain en-mass they might stir the FSA into paying special attention to the sector and potentially strangling it with regulation. The effects will be less with loan products, but it is not yet clear if investors are really fully aware of its impact, or whether they will simply turn away from the scheme when returns are hit by debts.

Overall, my though is that the sector is doing a pretty good job of regulating itself and is worth researching further if you are looking for business loans or capital or, indeed if you have a spare few bob for a mid-risk investment.

If you want to know more about Crowd Funding, or conventional business finance, call me on 07932 075754

The bank of Jeremy Kyle?

Whilst our world leaders grappled with the Eurozone crisis, I can safely say that I enjoyed a full and enjoyable weekend. I did, however, take time out to contemplate the parallels between pubs and banks - in particular at the start-up stages.

As any seasoned publican will tell you, when a new  and inexperienced licensee comes to town (particularly to a town centre pub), they will inevitably have several waves of customer before - hopefully - finding the clientele they were actually looking for.

The first, and least desirable wave of customers will be those who are banned from every other pub in town - drunks, drug dealers, fighters and generally those people who will drag you to your knees without careful management. With the best will in the world, as a newcomer to town - and to the industry - you might struggle to identify these people. The heavily tattooed bruiser who looks very dodgy could turn out to be your best and nicest customer, whereas the well-spoken chap in a suit might turn out to be the local drug dealer and loan shark. Besides, you have a business to run and cash in the till is better than no cash, surely?

Your second wave will be regulars in other town pubs. Their visit will be mainly inquisitive though they might be swayed if they like what they see. These people often move in groups, so you might well end up becoming the favoured establishment bikers, students, or, indeed train spotters. This of course can have its own advantages and disadvantages.

Finally, you can work on developing your target audience; except that you are unlikely to attract the fine wine and gastro brigade if your bar is like the Green Room at the Jeremy Kyle show.

A seasoned publican will have developed a personal sense for good and bad clientele; whilst not unerring he will be reasonably in control and sufficiently astute to act swiftly with problem customers.

Similarly, a local person will often know who to avoid by face, name and reputation.

And so to banks - or finance companies.

The moment you announce that you have £x million to lend to XYZ customers, a queue will form at your door.

At the head of the queue will be those who have been declined for finance elsewhere. Many will be honest and decent and will come across well, but will still represent a higher than average risk to your business (think of the affable customer, who just always has a bit too much, picks a fight and is sick on the carpet); others will be blatant fraudsters whilst others will just be chancers and nutters.

When that queue has subsided, you will be visited by those who have alternatives but are commercially astute and are interested to see what you can provide. Ultimately you will only get their custom if you have something of value to offer.

Finally, you can establish your market niches and develop relationships and knowledge within your chosen sector from which - if you have not been drowned in bad debt first - you can grow a successful finance business.

George Osborne has yet to reveal any detailed plans for 'credit easing' for small, business, though he has indicated that ultimately he would like to bypass the main banks and has used the term 'Small Business Bank'. My personal instinct is that it won't be a bank in any meaningful sense of the word, but something more akin to a 'pop-up-shop' type of finance company.

The genuine concern is that, in by-passing the banks, this 'Small Business Bank' will be every inch the new publican in town. There is little or no evidence that the people behind the plan have any real comprehension of business, lending, bad debt or, indeed the inevitable fraud that they will be faced with.

Presumably they will bring in some big names and advisors who can provide intelligent input but still won't have been at the coal face for some time. Besides, they will be thwarted by the entirely mixed motivation for this venture.

In the pub / bank analogy, the one big discrepancy is price - low cost finance will attract good quality business, whereas 2 steak and chips for a fiver is unlikely to appeal to fine diners. The more direct link is between pub prices and bank underwriting; set your prices high and you will drive away a portion of the bad clientele; set your underwriting standards high and you will weed out many of your potential bad debtors. The problem here is that you will be directly in competition with the banks (who are still lending to their best customers) and other organisations like Peer-to-Peer lenders and private finance companies. Ultimately, your Business Bank will add very little to what is already available.

Besides, the key here is to help struggling business. You can't sell prime fillet steak at 2 for £5, and you can't lend to sub-prime credits at prime interest rates - bad debt is the cancer of business, and never more so than to a finance company. Good gate-keeping and significant knowledge and experience can keep this under control, even in a sub-prime environment, but naivety and lack of management control will bring the thing toppling down quicker than a house of cards.

So, my message to George Osborne; small business will welcome some relief, but Government has neither the experience nor the commercial acumen to operate a bank - you will swiftly become the Bank of Jeremy Kyle.

You can save the taxpayer a lot of money by using the resource already available - established banks and finance companies. Revisit the EFG - re brand it if you must, but  above all, make it workable, transparent and actually a guarantee (as opposed to a carefully wrapped PR exercise) - your easing could then be on the market now, when it is needed, rather than some time next year.

Looking for business funding or just testing? (is your business investment ready?)

Precis of a telephone conversation yesterday:

Customer: I'm looking for £50,000 to finance scaffolding, but no-one will do scaffolding at the moment.

Me: Yes, scaffolding is tricky, there are lenders out there who will do it, but they need to be comfortable that the credit is good.

Customer: So you can do it?

Me: Yes, if the underlying information is strong enough.

Customer: So what do you need to see?

Me: I need [list of underwriting requirements for unsecured lend]

Customer: What do you need all that for?

Me: [explain underwriting process]

Customer (clearly frustrated): So If I get that information you can do the deal?

Me: If it all stacks up, yes..

And so the conversation continued to circle around the actual provision of hard facts, with a slightly uncomfortable reliance on promises and assertions.

On the back of this - far from unusual - scenario, I did a thumbnail analysis, and concluded that 70% of enquiries fail to result in information being supplied. I spoke with a good friend in the factoring industry who opined that, in his case the figure was closer to 90%, so it is by no means isolated to lease broking.

Put into context, this is almost entirely information that most business owners or FDs should have at their finger-tips; we aren't asking them to prepare business plans nor, in most cases, projections.

We can only guess at reasons, but with many years' experience I would put this down to one of 2 factors:

The information is bad, so they don't want to provide it:  Fully understandable (interestingly pre-crunch we had many customers who would cheerfully send the most appalling information then act surprised when it was questioned) but I am always at pains to stress that underwriters do understand recession,and that they don't necessarily expect positive trends, nor even  profit - they are looking to understand where the business is now and where it is going to.

The customer isn't fully engaged, but is just testing the water: In my opinion, the more likely in most cases. As a broker I rely on long-standing contacts - in some cases contacts of 20-years plus. I am very happy to test the water and have general discussion on the assumption that we will talk again when a real need arises - feel free to tell me you are just exploring and we can have an open chat!

This brings to mind the recurring stories about how businesses are afraid to apply to their banks for funding for fear of losing their existing facilities. Really? Your business is thriving and moving forward, but you are frightened of losing your facilities?

So, what is the point here? well, fundamentally it is about having some clear goals and definitions; by all means test the water, but you cannot judge any situation by a response based on insufficient or indeed, misleading information.

Most important, if you actually are looking for business funding, then you must be prepared to back up your application with solid, current and coherent information. Obviously what will be read into that information will depend what you are looking for - if it is a refinance proposition there will be some assumption that business is tough, whereas if you are looking to open new branches, we will need to see that your current business is working.

VCs and equity funders have long used the term investment ready - perhaps a similar criteria should now be applied to applications for finance 'Why will a financier want to invest in you?'.

I've been in the game a long time, give me the facts and I will provide honest feedback

Is Venture Capital the right source of funding for your business?

Despite being one of the most difficult sources of business funding to secure, many SMEs see venture capitalism as an attractive funding option. There are hundreds of VCs in the UK with money to invest and a successful pitch could see your business provided with millions of pounds in financing, the counsel of highly successful business people, access to a huge network of established contacts and even the possibility of increased media exposure. However, despite the many advantages evident, the fact remains that the criteria set out by venture capitalist firms, and the commitments resulting from a successful funding round, are often very specific and not suited to a lot of small businesses.

There are a variety of factors that could influence the suitability of Venture Capital for your business:

Very high returns:       It is not uncommon for VCs to expect a return of 5 to 10 times their initial investment. The majority of small businesses cannot provide the potential for growth to generate such returns.

Short exit periods:       The desired exit period for a lot of VCs can be in the range of 3 to 5 years. If this is in line with your goals then no problem, but if you are considering long-term investment then venture capital may not be for you.

Large cash injection:   This is good for helping the small proportion of companies for whom a cash injection of £3-30 million will materially increase their growth rate and chances of success. If this is not the case for your business, is it worth the high level of dilution that such a large equity investment will incur?

Large proportion of control:   Often, a prerequisite for a VCs investment is a high level of control within the investee company and therefore a major influence in the decision making process. This requires a lower level of independence for an entrepreneur in areas such as the direction of the business, business strategy, management decisions etc.  If you want to be an individual and retain a large proportion of control in your company, VC funding is probably not a suitable option.

Time consuming process: Obtaining equity investment can be time-consuming, with deals typically taking 6 months or more to arrange. So if you require a quick cash injection into your business, VC may not be the best funding option for you.

It may be that venture capital is not a suitable funding option for your business. However, this should not be cause for concern as there are a wealth of other business funding sources available in the form of grants, loans, angel investors or crowd funding to name a few. 

This guest post was kindly provided by Business Funding

Author  Joe Corringan.