Sadie Keljikian, Express Trade Capital

If you need to finance your business, you will be required to provide collateral. No matter what kind of funding you seek out, nearly every bank and private financial institution will require an asset to secure the loan. This makes a lot of people nervous, the word “collateral” has developed an unfortunate connotation of expendability and brings foreclosure to many minds. Fortunately, this doesn’t mean that you’ll have to risk losing your business, home, or savings. Unbeknownst to many, collateral can take many forms and most business owners aren’t aware of the full scope of their options.

Collateral is a general term for assets against which a bank or private lender can provide your business with funding. Aside from the well-known practice of using buildings, equipment, or savings as collateral, trade financing also allows the use of accounts receivable, inventory, and purchase orders. Trade finance can offer solutions to numerous business models thanks to a variety of lending options. This means that you can receive funds to supplement your operational costs without risking your business or crucial assets.

With solutions like factoring and purchase order financing, you can borrow against existing orders for which you have yet to be paid. This is an excellent solution for vendors selling to retailers on open terms and allows you to increase your business’s cash flow without incurring long-term debt or potentially sacrificing your business.

If you own a retail shop or other store-front type of business, a merchant cash advance may be the best solution for you. MCAs are loans against your day-to-day credit card sales. You receive one lump sum and the lender takes a portion of your credit card sales until your loan and interest is repaid. Again, this means that your sales are your collateral, leaving you less at risk of losing vital capital.

The collateral you offer also helps to establish and raise your credit line in trade finance. This means that as long as you keep making sales and your customers pay on time, your credit with your lender will remain strong. You can fulfill as many orders as needed without worrying about deficient operational funds. Trade financing is also immensely helpful in padding out your working capital without accruing interest on the funds you’ve received. When your customer accepts the sale, the documentation thereof (either a purchase order or an invoice) becomes valuable for trade financing and leaves your jurisdiction. You receive payment earlier than you would have, minus fees, and are able to continue running your business without the concern of costs outweighing revenues.

In short, collateral is not a dirty word. Despite the understanding that your lender will hold a lien against your assets until you’ve repaid your debt, you can borrow funds to keep your cash flow healthy without fear of losing everything. Financing in smaller amounts and against your active assets allows you to grow with the knowledge that you are both sufficiently funded and protected from crucial losses.

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David Estrakh, Express Trade Capital

Unforeseen Costs.  Like any financing arrangement, factoring can come with unforeseen fees and high reserve requirements. Be sure to carefully read your factoring term sheets and agreements before you sign them. Factoring is labor intensive and time consuming, not to mention, risky, so expect to pay for the service.  Although interest on factoring loans are more expensive than banks, you should still shop around to make sure you get reasonable market rates.

High Minimums.  Most factors have monthly and/or annual minimums to cover overhead and ensure consistent sales, which can be difficult if everyone is not on the same page regarding expectations.  If you sign up with a factor and do not like the relationship, you may not be able to terminate without paying off the minimum commitment.  It is therefore important to make sure that the minimum is not so onerous that leaving early becomes too costly. Otherwise, you may be stuck in an unwanted relationship.

Bad Credit Accounts.  Factors look at customers’ credit in order to determine the risk of advancing funds on receivables to be paid by that customer.  This is an advantage for clients because they can know the credit of their customers in advance, before shipping goods to them.  Unfortunately, a customer with bad credit can make things difficult when you’re factoring their receivables.  If a customer has a history of late payments or delinquency, that customer’s orders may not eligible for funding.

Many factors will still advance funds against non-approved receivables, especially if those receivables are bundled with credit-worthy accounts. But the client must be aware that the risk of non-payment on non-credit-approved receivables falls to them; such receivables are with recourse to the client.  Amounts advanced on poor credit receivables are usually less than what is advanced against credit approved receivables – often up to 60% instead of 80%.  But this is not always the case and many factors will simply refuse to factor receivables from accounts with bad credit.

It is important to note that different factors treat bad credit accounts differently and factors may look at the same customers differently.  For example, one factor might approve an account that another factor will not, although most factors will make similar credit decisions when presented with the same customer information. The reasons for a bad credit determination will also affect how much, if any, advances the factor is willing to make.  When these instances arise, tread carefully, heed the advice of your factor, and handle all poor credit accounts on a case by case basis.

Choosing the Right Factor. Let’s be honest, every industry has unscrupulous and unethical business people who give the others a bad name. Factoring is no different. Factoring is, at its core, a relationship. Once engaged, factors (especially those who also provide purchase order funding) control the levers of cash flow for their clients. Flexibility, speed, and understanding are paramount for a successful factoring and lending relationship.

The above is a segment from our upcoming white paper, Factoring Basics, keep an eye out for the full piece coming soon!

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