Debt Finance vs. Equity Finance

Ross Bienstock, Express Trade Capital

When business owners need cash flow, they have access to a variety of financing resources, most of which fit into one of two categories: debt and equity. Although both are equally useful in different contexts, there are advantages and disadvantages to choosing one funding method over the other.

What is “debt finance”?

Debt finance is simply borrowed money that will be paid back, plus interest. Common examples of debt financing include credit card charges and car and home purchases. There are several advantages to debt financing when compared with equity financing, first of which is that once the borrower pays the lender back, their relationship is over. Debt finance is also advantageous because it is easy for the borrower to predict their expenses since loan payments are consistent in amount and frequency. Since the lender does not have any equity in the business (meaning they don’t own any portion of the business), it does not decrease the owner’s interest in the company. Another advantage is that the company can off write interest paid on debt finance on their tax return, decreasing the effective cost to the company.

There are also drawbacks to using debt financing for your business. Using debt financing indicates that the entity borrowing the funds is extremely confident in their ability to pay them back. While it is obviously advantageous to be confident in one’s ability to repay debts, this arrangement leaves one with little recourse if unexpected difficulties affect their cash flow. The borrowing business may fall on hard times and end up with insufficient cash flow to pay its debts.

It is also important to be aware that the greater a business’s debt-equity ratio is, the riskier the company is going to be. Meaning if the amount of funds a business has borrowed approaches or surpasses the value of that business’s assets, it becomes harder for that business to seek out funding. This is a red flag to lenders and often means they won’t get involved with the business in question. As a result, debt finance can hinder the business’s progress and stunt growth.

What is “equity finance”?

If you have ever watched Shark Tank on TV, you have some idea of what equity is. The premise of the show is angel investors deciding whether or not to purchase equity in someone else’s business idea. Equity refers to ownership of shares of a company. Equity financing is different from debt financing because the funds come from investors, rather than lenders. As mentioned, once the borrowing business pays the lender back in a debt financing transaction, their relationship is over. With equity financing, however, the investor remains involved as part-owner of the business.

The biggest advantage to using equity financing is probably that if the business fails, the primary business owner doesn’t need to repay the investor. That may sound insignificant, but the fear of lingering debts after the business dissolves is all too prevalent for many small business owners. This method also leaves more cash flow available since it doesn’t create expenses.

The major disadvantage is also the most obvious. To acquire the equity funding, the business owner must relinquish a percentage of the business to the investor. Any time the business makes a profit or the owner needs to make a crucial business decision, they will have to consult the other partner(s).

Which is best for you?

Does debt financing or equity financing better suit your situation?  It all depends on where your business currently stands and who you know. If you and your business are quite new to the market, you may want to borrow traditionally to avoid giving up equity. If you have a close friend or trusted family member who might be willing to invest, you may be more interested in sharing equity with them to avoid accruing debt. No matter how you choose to finance your business, make sure you know the benefits and drawbacks of each option and carefully plan to avoid unforeseen difficulty.

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Why Use Purchase Order Financing?

Sadie Keljikian, Express Trade Capital

What is purchase order financing?

Purchase order financing is a trade finance solution designed to help businesses finance the production and shipping costs required to fulfill their customers’ purchase orders. This allows companies, typically wholesalers who import or export goods, to grow without selling equity or exhaustively increasing their bank lines.

In a purchase order financing arrangement, a financial institution pays for the cost of goods and shipping (or a substantial portion of that cost). Effectively, the payment is then a loan. Although a purchase order is not an asset, purchase order funders use creative means to secure their loan: in addition to filing a blanket lien on the borrower company, funders collateralize their loan with inventory which corresponds directly with the goods being provided by the supplier (and purchased by the financier on behalf of their client).

Why not just take out a traditional loan?

While purchase order financing, often called PO funding, is a remarkably useful tool for importers, exporters, and wholesalers across industries, it is also one of the least understood varieties of trade finance. As a result, businesses often don’t know it even exists and therefore miss the opportunity to fund their operations and maintain sufficient cash flow without accruing considerable debt. They usually agree to burdensome loan obligations, or relinquishing equity instead.

Many companies sign up for products that have a strong online presence or are otherwise easy to understand but are not ideal solutions. For example, SBA loans are very popular and inexpensive but they are also typically small, inflexible and take many months to get approved, whereas PO funding has none of those roadblocks. Alternatively, a lot of companies also take on high interest merchant cash advance loans (or MCAs) because they have invested a lot in marketing. MCAs are easy to understand, have quick and easy application processes and they employ aggressive sales tactics. However, PO funding offers more flexibility and greater loan amounts at a fraction of the cost.

Is purchase order financing right for me?

PO funding is helpful for companies who need capital to keep pace with their rapid growth or whose credit histories are insufficient to obtain traditional bank lines for operational capital. Unlike banks and traditional lenders, the purchase order funder underwrites the transaction rather than the credit of the business seeking the loan. Therefore, PO funders look to the credit of the final customer (usually a retailer) in addition to that of the wholesaler. By underwriting the transaction, the PO funder is free to look at the underlying purchase order and overall transaction structure rather than solely looking to the financials of the borrower.

In general, PO financing best suits suppliers with at least a few customers who place large orders. Having big-box customers is advantageous because they often have good credit, so your funding requests are more likely to be approved and financing costs will probably be lower.

Aside from credit requirements, purchase order funders look at many other aspects of the transaction. Purchase orders should have a minimum profit margin of 20% to provide enough cushion to cover the extra cost of PO funding. Purchase orders should also be non-cancelable. Due to wishful thinking or simple oversight, companies often overlook contingencies in purchase orders and might not realize that an order is actually on consignment, which allows the customer to return whatever goods do not sell. The purchase order can also call for partial consignment, unreasonably long terms, or any number of other onerous terms and conditions. PO funders are adept at reading purchase orders and helping their clients understand and structure their transactions more efficiently.

How are PO financing rates determined?

PO financing rates are proportionally based on utilized funds, meaning the amount that the finance company pays to the client’s supplier. Once the lender confirms the utilized funds, they use the supplier and the customer’s credit to determine risk. Like most traditional loan agreements, the bigger the volume, the lower the rates. Also, the greater the risk, the higher the rates.

Purchase order financing rates vary between lenders and locations, but on average, they are determined using a similar formula:

(a) Deal Fee – The funder will charge a “deal fee” or “facility fee” to do the transaction. The fee is usually 1-3% of the loan amount requested and covers service costs (i.e. processing and administrative costs).

(b) Interest – PO funders will then charge interest on the loan amount until the client pays it back. A typical PO funding interest rate is 2-3% for the first 30 days, and around 1% per 10 days after the initial 30. This is subject to change based on the creditworthiness of the client and/or that of their customer, and the risk involved in any given transaction.

How does PO funding relate to factoring?

While factoring and PO funding are different varieties of lending, they often work in tandem. When a wholesaler enters an ongoing factoring agreement, they receive funding against their invoices, which retailers repay (barring any issues). When factoring and PO funding are utilized in conjunction, funds lent against purchase orders can translate to an advance (or portion thereof) against invoices. In other words, the wholesaler no longer needs to repay the financial institution that provided funding against their purchase orders. The financial institution is then reimbursed when they collect from customers on the factored invoices.

How do I start?

If you plan to seek funding against your purchase orders, prepare yourself as best you can. Investigate your customers’ creditworthiness to whatever extent you can. If you and your customers have good credit, your lender will most likely approve your request and offer you competitive rates.

At the end of the day, the specific details of purchase order financing agreements vary from lender to lender and from one client to the next. Risk analysis is not an exact science, but if you find yourself short on operational funds and have reliable, creditworthy customers, purchase order financing can simplify your sales process and day-to-day finances significantly.

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Benefits of a Letter of Credit

Sadie Keljikian, Express Trade Capital

If you import goods, your suppliers probably require that you provide a deposit when you place an order. Suppliers usually request this for two primary reasons: (a) by getting an upfront deposit, the buyer is less likely to default on the remainder of the balance owed because the buyer would lose their deposit; (b) cash flow – the supplier needs funds to produce the goods and deposits are essentially interest free cash. Unfortunately for importers and wholesalers, deposits tie up and divert cash from day to day operations and other revenue generating or expansion oriented uses.

There are a few ways to avoid leaving substantial deposits or tying up cash to start production. First, you can minimize the size of your orders to avoid depleting your cash flow, but that would inhibit your growth. Big-box retailers generally place very large orders and offer significant opportunities to growing import businesses, so unless you find a way to accommodate these larger orders, it will be hard for you to attract big buyers. You can stagger orders so you don’t have to pay for everything all at once, but at some point, if you want to make substantial sales, you will have to find a way to finance large orders.

Another option to mitigate the burden of tying up cash for production upfront is to negotiate better terms with your supplier. If your company is large or you have a good history and/or trusted relationship with your supplier, you may be able to obtain goods on credit.  If you can get this option, use it.

A third option, if you want to take on larger orders and cannot obtain terms without leaving a deposit, is to offer your supplier a commercial Letter of Credit (“LC”) instead of a deposit. This gives your supplier a bank guarantee, which is an asset they can often use to obtain funding directly from their bank.

How do Letters of Credit work?

A letter of credit is a conditional assurance of payment provided to the supplier’s bank when the importer places an order. The LC is issued by a bank or financial institution on behalf of the buyer/importer and eliminates the need for a deposit by ensuring that both sides respect the conditions of the transaction.

Both parties benefit from an LC. The supplier becomes the beneficiary of a financial instrument they can use as collateral to obtain funding. They also obtain a bank guarantee of payment in addition to the buyer’s promise to pay for goods if all obligations are fulfilled. The buyer avoids the risk of tying up funds overseas and gets better control over the transaction. If the buyer uses a third-party provider, they can even obtain an LC without typing up collateral or cash lines with their own bank or financial institution.[1]

A commercial LC gives buyers comprehensive control over their importing process. It covers the cost of the goods themselves as well as shipping costs, allowing purchasers to keep their money until the goods are approved and shipped. While an LC may add to transaction costs, it grants the purchaser more control and more capital flexibility while giving the supplier more cash flow and some assurance of full payment.

Letters of credit benefit both the buyer and the supplier.

A letter of credit also serves as a layer of protection to ensure that you don’t waste time and money on an order that may not reach you on time or as expected. While your agreement with the supplier provides some degree of assurance that you won’t be left without your goods or money, there are no guarantees. Depending on the supplier, you may find yourself with faulty, defective, incomplete or late orders. Untrustworthy vendors can compound the issue by keeping your deposit regardless of their errors or inability to complete the orders as agreed. Without an LC, buyers can still take legal action against their supplier, but justice is uncertain and costly, particularly if the supplier is in another country.

In contrast, an LC requires collection of documents proving that the order is as expected and sent on time before the bank releases any payments to the supplier. The bank is basically acting as an escrow agent to ensure compliance by all interested parties. Thus, importers purchasing inventory overseas never need to worry about lost working capital due to failed or incomplete orders, and suppliers can still obtain the cash flow they need without burdening their customers.

Interested in discussing Letters of Credit or other trade financing and supply chain management solutions further?  Speak to one of our specialists.

One of the most important, often hard-won lessons is how to protect one’s self and one’s assets in transactional proceedings. Letters of credit are a safe, simple way to protect yourself and your purchase, especially in the case of international import/export agreements. You and your vendor are legally and financially protected, so you can even place orders from less-than-trustworthy vendors with confidence.

[1] Express Trade Capital specializes in issuing LCs on behalf of client without requiring cash collateral or deposits. We tie up and freeze our own lines on behalf of qualified clients undertaking verified commercial trade transactions.

Hidden Dangers of Loan-Stacking

Sadie Keljikian, Express Trade Capital

One of the most consistent difficulties one encounters in the process of expanding a wholesale business is the cash flow “crunch” that can occur when your customers want to order more of your products than you can afford to sell at once. Most customers don’t realize that wholesalers must pay their suppliers, shipping costs, and operational funds in the process of selling their goods to retailers. There are a few ways of handling this without having to turn down the sale. Many businesses choose to take out traditional-style loans as needed, but this can actually create more difficulty in managing your business’s finances.

It’s best to borrow conservatively.

If you receive multiple loans to boost your business’s cash flow, each one can hurt your credit, especially if you receive them in quick succession. When a business takes out multiple loans quickly, it implies that the business carries significant debt and very little collateral, which in turn, indicates high-risk to lenders. In addition, the more loans you take out, the harder they become to acquire, especially if the financial institution from which you borrow performs “hard” credit inquiries.

You may or may not be familiar with the concept of hard credit inquiries, but you’ve certainly been the subject of one at some point. Financial institutions perform hard credit inquiries (as opposed to soft inquiries) when a business or individual is actively seeking credit. This can be in the form of a credit card, credit line, loan, mortgage, and sometimes other financial commitments, like rental agreements. Hard inquiries reveal more details about your business’s credit and bill-paying habits, so a high credit score doesn’t necessarily guarantee approval.

When an institution performs a hard credit inquiry, your credit score will inevitably drop a few points, which isn’t typically a problem unless your credit is already compromised. Again, taking out multiple loans in a brief period will deplete your credit score more noticeably, so avoid it wherever possible.

Know your options and choose wisely.

A popular fix for mounting interest charges on multiple loans is debt consolidation, or “loan stacking.” Debt consolidation companies help you to pay off your debt fully and more quickly than you could on your own by decreasing your interest rates and combining your payments. Sounds perfect, right? But beware, there is more to your creditworthiness than simply your credit score.

The problem with loan stacking is that although it can help you get out of debt, it can also further deplete your credit (though not always noticeably) in the process. For this reason, it is vital to remain informed throughout the lending process, regardless of what method you choose to pay off your debt. Often, loan consolidation companies assist you by providing another loan to pay off your debts. Again, it sounds appealing, but you need to bear a few things in mind if you choose to do this.

Issues can arise when your hard credit inquiry reveals excessive borrowing or any loan stacking. Lenders often avoid taking on customers who have a history of loan stacking because it indicates a few unfavorable habits. As mentioned above, stacking one’s loans is usually a symptom of multiple unpaid debts that accrue overwhelming interest. Obviously, this indicates to a lender that you not only have poor bill-paying habits, but that they may not receive the interest they are owed if you struggle to pay and choose to consolidate again.

Alternative lending may be a better option.

Consolidation is a double-edged sword. Repaying your debts as quickly as possible is good for your credit score, but using consolidation services can still hurt your ability to borrow funds in the future. An excellent way to manage an ongoing need for working capital is to instead implement some form of trade finance, particularly factoring.

With trade finance solutions, you consistently receive funding against your purchase orders or receivables to avoid depleted operational funds. Since the funds are only provided against confirmed sales, they are typically in smaller amounts and often don’t require further action from you. In the case of factoring receivables, your financial institution buys your current receivables and collects from your customers. This means that your cash flow is sped up, you needn’t pay back any of what you receive (barring a chargeback), and you are no longer responsible for those collections.

The long and short of it is this: business loans are useful, but be aware of how much debt you carry and make a specific plan to pay your debts. Even with sometimes helpful solutions like debt consolidation, borrowing more than you can reasonably pay back on time is unwise in the long term. When making decisions about your business’s financial future, be as conservative as possible and consider how your decisions today might affect your ability to grow or recover if you need funding in the future.

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Asset Class Break-Down

Sadie Keljikian and David Estrakh, Express Trade Capital

What are asset classes?

Assets are valuable properties owned by a business. There is a wide variety of assets across different industries and business structures, each of which affords different financial risks and opportunities. Assets can include stocks, bonds, real estate, fixed income, invoices / receivables, commodities, cash equivalents and personal investments.

Beyond the security of possessing a diverse portfolio, holding a variety of assets allows businesses to leverage their assets as collateral to in exchange for financial assistance from a bank or other financial institution. As a rule, the wider the variety and greater the number of assets, the more potential options there are to finance the business.

Here is a collection of the most commonly used assets and how they can best be used to finance a business:

Stocks as Collateral

Stocks are shares of ownership in publicly held companies. Since the value of a business can fluctuate quite dramatically with little or no warning at any given time, stocks can be more volatile in the short term. In other words, the value of stock assets can fluctuate significantly. Therefore, if stocks are used as collateral, banks and other lenders will offer significantly less funds relative to the current value of the portfolio. Advances of 50% are common, but it depends on the lender’s level of confidence that the current value of the portfolio will not decrease beyond the amount borrowed (or the interest due on principle).

Stock Raises and Equity Financing

Equity financing is a practice typically reserved for businesses that would like to raise funds to finance growth, but do not otherwise have sufficient assets or credit to obtain traditional lending facilities to finance their growth. The most popular variety of equity finance is venture capital, which is typically a high-risk, potentially high-return investment. Equity financing requires building business proposals and selling investors on business model that they believe can be executed with sufficient certainty.  After all, why invest in a company unless you believe it’s going to grow, become more valuable and therefore give you a good return on your investment?

Fixed Income

Fixed income securities, or bonds, are investments that provide returns in the form of scheduled payments over time and eventually provide full return at maturity. The payments may, however, vary in amount over time. Depending on the credit debtor of the bonds, the value is of such assets does not fluctuate as compared to stocks. The note will be at face value and fluctuates only with inflation and the creditworthiness of the debtor. US government bonds, for example, are considered extremely secure when used as collateral.

Fixed income securities can be leveraged as collateral better than stocks because the lender can better rely on the asset maintaining its value from the time the loan is given until it is repaid. This allows lenders to give higher advances relative to the value of the asset. For example, while a lender might only provide 40-50% against the value of stocks, they might advance 60-90% to the same borrower against their bonds. So, while stocks have much more potential to increase in value, the reliability of such fixed income assets allows this asset class significantly greater collateral leverage.   Therefore, when used as collateral, fixed income assets should unlock more cash flow vis a vis stocks used in the same way.

Real Estate/Commodities

Real estate, which is also a form of equity, is extremely useful in financing. The most commonly known varieties of real estate financing are mortgage loans. However, in business finance, there are other ways to use real estate and commodities to fund day to day operations. Commodities can include precious metals like gold, agricultural land, and oil.

Personal Property Assets

Property assets are quite unique. They are often items of value that will depreciate, or even lose their value entirely over time, including things like cars, art, construction equipment, computers, and even race horses. Such assets can also be sold or leveraged as collateral. However, since they are not as easily bought and sold as stocks and bonds, their value is less liquid and thus, lenders price the extra risk into the cost of borrowing funds. This also impacts how large a percentage of the value of the asset lenders are willing to provide.

Due to liquidity concerns and depreciating value, borrowers should expect higher interest rates and lower advance rates. Lenders giving only up to 30-50% of the value of collateral is not uncommon. There are lenders who specialize in certain assets (e.g. art) and are better able to protect themselves against the risk. These specialized lenders can therefore provide higher advance rates and more accurately price the asset and any secured loans against it.

Common Business Assets

Invoices, equipment, machinery, and inventory are typical business property assets and are very appealing to lenders as a form of collateral.

Although these are all business assets, they are not created equal. For example, the value of an invoice depends on the creditworthiness of the customer who must pay that invoice and the likelihood that they will pay the full amount. In contrast, equipment and machinery loans are typically given by banks or specialized lenders who know how to price and sell machines if the loans default.  Inventory also fluctuates in value depending on the nature of the inventory, how easily it is sold, how much its price fluctuates, the business owners’ track record for selling similar inventory, and other potential factors.

Other Types of Assets and Getting Creative

While an asset usually has a fixed value and can be readily bought and sold, some transactions require more creative tools. For example, many wholesalers obtain purchase orders from their customers in advance of production but don’t have enough funds or credit lines to pay for their goods. Certain lenders specialize in outlaying funds to pay for production in exchange for either interest or a share in the profits of the underlying transaction.  This is called purchase order fund or “P.O. funding” and it is unique because it is neither a regular unsecured loan to a company based on financials, nor is it a secured loan against assets. Such lending is basically a hybrid of an inventory loan (since the funds are being used to pay for pre-sold inventory and the inventory purchased is used as collateral to secure the loan) and regular business line of credit.

Technically, a purchase order (or “P.O.”) is not an asset because it has no inherent value; it is simply a customer’s order to produce goods or services at an agreed upon price. While the PO funder is secured by the inventory that they finance and they often take a security interest against other assets of the business, the PO itself does not have any value until the goods are delivered as per the instructions of the customer. However, once the PO is complete and the customer is invoiced, many lenders are happy to take the resulting assets (i.e. receivables – invoices with payment due on a later date) and advance cash against them. This is called factoring. Unlike PO funding, which has what we might call “soft assets” or no assets, a factor advances funds against the value of a receivable, which is a common, bankable asset.

The point is that certain situations require creative solutions to accommodate the business and the transaction. Knowing how to leverage your assets (and sometimes even your non-assets) can be the difference between growth and stagnation or success and failure.

The bottom line is that in each of these instances, a business can leverage assets it already has and requires in its normal course of operations. By leveraging its assets as collateral, a business can access funds that are otherwise locked or frozen in value of those assets usually while still controlling, possessing, and deriving the full benefits of the assets. So, you can run your machines while using funds advanced to you by giving the lender a security interest (or “lien”) in the machine.

If a business intends to grow, it is, in the vast majority of instances, preferable to finance as much as possible through unsecured credit lines and credit lines secured by assets because interest will almost always cost less in the long run than selling equity (and often control) in your business for much less than it would be worth once you’ve had a chance to increase revenues through traditional financing vehicles.

What to Know Before Signing a Factoring Agreement

Sadie Keljikian, Express Trade Capital

If you plan to work with a factor to fund your business, it is vital that you do thorough research prior to signing anything. Obviously, it is important to be educated before signing any legally binding document, but the ongoing nature of trade financing solutions makes them the perfect trap for hidden fees and requirements.

Before you sign on the dotted line, here are some important questions you should ask your prospective factor:

What percentage of my invoice values will I receive in advance (i.e. what’s my advance rate)?

The percentage that you receive as an advance on your invoices is called an “advance rate.” Typically, factoring companies provide up to 80% of the total value when they receive an assignment. It is important to know your advance rate up front so you can predict available cash flow based on receivables.

What is the minimum sales volume required by the factor?

This is one of the primary points in determining whether the factor will accept your application or not. Most factors have a minimum sales volume for clients to ensure that each relationship will be profitable.

You should know that unfortunately, if your sales volume is low, your rates will be higher than that of a comparable business with higher sales volumes, even if it doesn’t keep you from successfully signing a factoring contract. Factoring is still a labor-intensive industry with high overhead so each client has to have enough volume or high enough rates to justify the cost of acquiring a new client.

What fees (beyond the standard rate charged on each factored invoice) will I incur during my contract?

Most factors include fine print in their agreements, which often contain the dreaded “hidden” fees that many have come to expect from banks and financial institutions. These can include termination fees if you end the agreement before the contract is up, annual minimums charged on a monthly basis, credit check fees, misdirected payment fees, invoice modification fees, and a myriad of other miscellaneous charges.

Occasional fees are to be expected, but if they seem excessive or confusing to you, there’s a chance that the factor is unopposed to taking advantage of less informed clients.

Does the factor perform credit checks in house? Is there a fee for credit checks?

All non-recourse factoring companies require a credit check of all customers whose invoices are factored. Since a non-recourse factor provides credit protection on their client’s receivables, the factor needs to know the payment habits and financial soundness of the end customer (i.e. the debtor on any assigned invoice). Credit worthy customers receive credit protection and are therefore considered non-recourse receivables. Non-approved accounts are not insured and therefore they are called “with recourse” because the factor has recourse to their client if the receivables fail.

Ask your factor if they insure your receivables (i.e. are they recourse or non-recourse factors) and, if so, whether they charge a fee for providing credit checks on your customers.

What varieties of factoring does the company offer?

It is very useful to know what types of factoring the company in question offers for a number of reasons. First, it is important to find out if your factor offers recourse factoring, non-recourse factoring, or both. This will determine whether you will be responsible should any of your customers declare bankruptcy without paying all of their factored invoices.

Once you’ve established recourse vs. non-recourse, you want to find out if your factor can adapt services to suit your needs. Practices like spot factoring or selective factoring are helpful if you find that you only want to factor a handful of your receivables. Bottom line, it helps to know if those options are available from the onset.

Does this factor have experience with businesses in my industry?

While it isn’t necessarily crucial to your relationship with your factor, you might be surprised what a difference it can make if your factor has experience in your industry. Each industry has its own unique structure and potential difficulties to consider and when you bring a financial institution into the equation, so it helps if they’ve dealt with the difficulties specific to your industry. Some factors specialize in certain industries. Where possible, try to work with a factor who specializes in and knows your industry.

What is the maximum credit line that will be available to me?

Depending on the factor, there may or may not be a flexible limit on the credit line they can offer you. Typically, a factor is either a department at a bank, or has a close relationship with one or more banks. This allows them to offer substantial credit lines, provided that your customers have good credit. Some smaller factors, however, can only offer limited hard caps on cash lines due to limited access to funds. Ask before you sign to determine if the factor is suited to meet your financial needs.

In general, it is important to research the business with whom you are working, particularly when your sensitive information is involved. The best practice is to familiarize yourself with the factoring industry in general, that should inform any questions you might need to ask in order to be prepared to sign anything. Also ask for references to ensure that other clients have been satisfied with their experience. Use your instincts and do your homework. Your diligence will be rewarded.

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Factoring Checklist: What You Need and Why

David Estrakh and Sadie Keljikian, Express Trade Capital

You’ve done your research, vetted private lenders and banks, and found the funding arrangement you need. You’re ready to enter a factoring agreement. However, before you do, you should know that all factors will require some business and financial documentation before factoring your receivables. Here is a list of the materials you will need and why factors ask you for them.

  1. Factoring Application.

This is step one in your relationship with your factor. The application usually requires basic information, including the name of your business and officers, a description of the business, ownership structure and other general information that helps your factor get to know you professionally. Beyond surface details, the application will often ask you to provide the following: (a) your certificate of incorporation (or the equivalent), (b) federal ID number, (c) owner’s photo ID, or (d) other state or federal documentation. This is to verify your business’s details and protect the factor from fraud and wasting time on companies that are not a good fit.

  1. Customer List.

Although many factors include a section in their factoring application that allows you to write in your list of customers, this is sufficiently important to warrant its own section.  Since non-recourse factors rely on the quality of your receivables to provide advances against your invoices, it is of paramount concern that the debtors on those receivables (i.e. your customers) are credit worthy.  Although recourse factors are usually not as concerned as their non-recourse counterparts with the quality of customers comprising your receivables, all factors will want to have at least some idea of your customer base and their credit worthiness.

Non-recourse factors need to know because they are going to underwrite the credit of credit worthy customers and make a lending decision based on their credit determination.  Recourse factors need to know because they might adjust the amounts they are willing to fund based on your customer’s credit-worthiness and because they need to know how likely it is that the invoices will pay on their own to price their lending.  For example, if a recourse factor knows some accounts pay poorly, they know they will have to rely more heavily on their own client’s credit-worthiness to assure payment in the event of default.

  1. Corporate tax returns and financial statements.

Not all factors require a company’s tax returns and financial statements but it is a common request. As discussed, factoring companies and banks that provide receivables factoring are generally concerned first and foremost with the creditworthiness of the customers.  However, the client’s financial background is requested sometimes in order to verify sales volume and revenue. Also, recourse factors do want to see that your company is healthy enough to repay receivables advance if your customers default.  If your factor asks for corporate financial details, it is best to present a thorough audit performed by an independent third party accounting firm to provide maximum transparency.  Otherwise, at least make sure the information is clear and accurate or it may affect your lending arrangement and put you in default if the factor later discovers inaccuracies or impropriety.

  1. Current aging of accounts receivable.

This is an important part of the equation for several reasons. It provides your factor with a snapshot of your customer list, which is very important to your factor, since customers pay factors directly in most agreements. It also lets your factor know how timely your customers are with their payments and how much bad debt you carry as proportion of your receivables. Since factoring is lending against receivables, your customers’ credit is more important than yours, so it is vital that the customers whose invoices are being factored pay on time.  Since factoring prices depend on expected factoring volume, a good A/R should comport with your own assessment of expected annual sales.  If you ask your factor for a rate given to companies making $10 million or more in sales annually, then your receivables should be substantial enough to support that claim.

  1. Copies of any and all UCC filings on your Company.

This is crucial. Factors generally need to have first position liens on receivables and inventory since they are providing funding against these assets.  In order to secure their collateral, factors take a security interest in the assets classes they fund. A first position lien (or “security interest”) means that the factor has priority over anybody else to collect on or seize those assets. For example, if the factoring client declares bankruptcy, the factor is prioritized in benefitting from liquidation of the goods against which they have financed. For non-recourse factors, if the debtor on the receivables goes bankrupt, the lien allows the factor to claim payment of the receivable debt in bankruptcy court.  Thus, without a first position security interest, the factor has minimal security or protection in the event of default.

  1. Any current licensing agreements.

When you enter a factoring agreement, your factor relies on the value of the goods you sell. Consequently, should the value of your goods be damaged, your factor would be the one to suffer. If your goods are in violation of a copywrite or trademark, this directly impacts the value of your goods because you will not have a legal right to sell them. Even worse, the licensor may have a legal right to the goods or to legal damages.  Therefore, factors ask for any licensing agreements your company currently holds in order to confirm that you are not in violation of any licenses and thus, that your goods will retain their value.

Like anything, factoring requirements vary from one to the next, but the above should serve as a universal checklist for the most commonly requested pieces of documentation. When you sign on with your factor, do not be afraid to ask lots of questions, especially if you are being asked for any unusual or particularly sensitive information. A good factor will always be able to explain why they are requesting certain information or documentation and should be open to providing Non-Disclosure agreements under reasonable circumstances. If you’ve chosen your factor well, they will be very happy to educate and reassure you about the process.

Factor your receivables with Express Trade Capital.

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On Deck Capital Shares Plummet

After record losses in Q4, online lender On Deck Capital suffered a drop of as much as 24% in their shares Thursday morning. The abrupt drop led Tybourne Capital, the company’s largest shareholder, to sell its entire stake.

Since the company went public two years ago, it has yet to gain profitability and reported a loss of $85.5 million in 2016.

Read more from Wall Street Journal.

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Trade Finance vs. Bank Loans Part II: Your Options

Sadie Keljikian, Express Trade Capital

There are several varieties of trade finance that offer working capital flexibility well beyond that of a traditional bank loan. Whatever causes your particular cash-flow problems, chances are there is a trade finance solution perfectly suited to your needs.

Factoring and Purchase Order Financing are two of the most common varieties of trade financing. Both methods are ideal for vendors who sell large orders to retailers on open terms. Factoring is an agreement whereby you sell your open invoices to a company, known as the factor, and they then typically provide you with approximately 80% of the value of the invoices immediately. Your customer(s) then owe the factor the invoice total and you receive the remaining balance, minus factoring fees, when your customer pays your factor.

Factoring is an excellent solution for those who need payment for their outgoing orders immediately but are reluctant to decline offering open terms to their customers. Since factors usually advance funds based on a percentage of your invoices (i.e. your receivables) the credit line is only limited by how many invoices you can generate. Factoring allows you to fulfill as many large orders as you receive without worrying that your working capital will be held up or depleted by waiting to get paid on invoices.

Purchase order financing (also called “PO funding”) is similar, with some subtle differences. When you apply for PO funding, you must provide accurate, up-to-date purchase orders from your customers. Once the purchase orders are confirmed, you receive a percentage of the total value of the PO. Receiving payment ahead allows you to use those funds to pay for manufacturing and shipping costs which frees up your working capital, allowing you to take on more orders.

If your business has been hindered by suppliers, particularly if those suppliers are located internationally, a letter of credit may be the best solution for you. LCs replace deposits, cost of goods and shipping costs you provide to your suppliers and provide an extra layer of protection for both you and your supplier. A letter of credit functions somewhat similarly to an escrow in the sense that it assures the supplier of payment, but only on the condition that goods are shipped on time and received as expected.

Trade finance allows you and your business to grow and adapt by drastically increasing cash flow on multiple fronts. A growing business has more cash flow issues than most people realize and your company’s growth should be handled carefully, with the help of experts. Trade finance professionals understand that your business needs funding in order to operate and will not trap you in a cycle of debt and inflexible lending terms that will ultimately hurt your expanding business. By following a transactional model, trade financiers target funds to ensure that both the borrower and lender are made whole and protected all throughout.

Learn more about Express Trade Capital’s trade finance solutions here.

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