Alternative financing: factoring your way out of a cash crunch.

By Any Means Necessary is the philosophy of Young Nation, the casual wear company that produces the BAMN! Apparel line. The New York firm has been faced with a dilemma typical of young, rapidly growing companies: short on cash flow but high in product demand (the company generated $210,000 last year).

"As sales increase, the cost to pay for the goods increases. If we don't get paid for 45 to 60 days after a shipment, then there's a big gap [in our cash flow]," says company president Spencer L. Perry Jr. To help remedy this problem, Young Nation entered into an agreement with a factor. So, instead of having to wait more than 30 days to get paid on a product already delivered, the company sold its receivables to a third-party investor or factor.

Factoring offers a number of benefits to cash-starved companies, which often use the money to meet payroll, fund marketing efforts or provide working capital. Essentially, the factor pays your business cash now for the right to receive future payments on your invoices. The amount factors are willing to fork over is generally from 75% to 90% of the net face value of the receivables.

Beware that most factors have service fees ranging from 1% to 5% of sales, notes A. David Silver, president of ADS Financial Services in Santa Fe, N.M., and author of Up Front Financing: The Entrepreneur's Guide. What if you withdraw money against the receivables before the factor gets paid? Then, you can expect to pay interest of 1% to 3% above the prime rate of the advance.

Companies typically known for using factoring have been in the textile and apparel industries. But today, "just about any type of business has the potential to benefit from factoring," says Anthony Jones, a certified factoring specialist and president of International Fidelity Mortgage Co. in Dewitt, N.Y.

A typical business that extends credit will have 10% to 20% of its annual sales tied up in accounts receivables at any given time, adds Jones. "Just think for a moment about how much money is tied up in 60 days worth of receivables. You can't pay the electric bill or this week's payroll with a customer's invoice. But you can sell that invoice for the cash to meet those obligations."

Unlike bank loans, which are largely dependent on the borrower's ability to pay up, factors care more about the financial soundness of the client's customers. Key to landing a factoring deal is the age of the accounts receivables. The older the account, the more difficult it is to collect. Some factors don't like to see a single client representing more than 25% of total accounts receivable.

Given that a factor will be assessing the creditworthiness of your accounts, it's important to have someone who is knowledgeable about your company's market. The best way to find a factor is to get referrals from companies similar to yours. Your accountant should also be able to provide a list of names.