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Financing option.

More industries use factoring to capitalize small businesses

Ned Amos, owner of Amos Plumbing Co., was in a bind. As a subcontractor on a large project, he had a contract for $100,000. But 60 days after completing phase one and billing his general contractor for $28,000, he was still waiting for payment and running low on funds to operate his business.

"I had several plumbers there, laborers, backhoe operators--the whole nine [yards]. I had payroll to meet and material bills," explains Amos, 29, owner of the one-and-a-half-year-old St. Louis company.

Since Amos had a new business with little collateral and had yet to establish a track record, he knew he couldn't get a bank loan to cover expenses until the general contractor paid up. So he went to a factoring company.

Factors buy a company's invoices, advance them 60% to 80% of the face value, and then give them the rest when the debtor pays, minus the factor's 2% to 4% fee.

For example, Amos sold his $28,000 invoice to Quantum Corporate Funding Ltd. in New York. They advanced him 60%, or $16,800. When the general contractor paid Quantum, Quantum gave Amos the remaining 40%, less its 4% fee, or $10,080.

Factoring is a financing option for young, undercapitalized businesses that have the profit margins to absorb the factor's fee. The business may need the money to meet expenses or to go after other projects. Factors buy an invoice based on its creditworthiness; they don't need a small business' financial statements.

Factoring, which used to be the exclusive domain of the garment industry, is expanding into manufacturing, distribution and the service industry, says Leonard Machlis, executive director of the Commercial Finance Association, a New York-based national trade association for factors and asset-based lenders.

Part of that expansion is due to an increase in the number of nontraditional factors, which factor for small to midsize businesses on an as-needed basis.

Traditional factors, which factor million-dollar deals on a continuing basis, still comprise the vast majority of the $70-billion-a-year factor business, he adds.

Factoring is not for every business. Here's what to consider:

* Markup: Only those with a gross margin of at least 20% should consider factoring, says Paul Goldstein, president of Atlanta-based Presidential Financial Corp.

That means if your business has a profit margin of 20%, you are still making 16% to 18% after paying a factor's fees. But if your business has a profit of 10%, you are losing a third of your profit by factoring.

* Interest rates: With an average 30-day interest rate of 2% to 4%, factors are more expensive than banks.

"In factoring, however, it's not appropriate to annualize it out and say you're paying more than 36% a year [with a 3% fee]," says Craig Sheinker, president of Quantum; "because we don't require the client to use us any more than he needs us. He can use us for one invoice and never again."

* Credit protection: Factors are nonrecourse lenders. If the business--whose invoice the factor owns--files for Chapter 11 bankruptcy protection, the factor loses and the client keeps the advance. In addition, some factors will investigate the creditworthiness of a company before entering into a contract.

* Timing: Small businesses may use a factor intermittently for a couple of years until they've established a track record. Once they are creditworthy, they can then apply for unsecured money.

"We're the minor leagues in the banking business, says Sheinker. "We're the farm team. If they prove themselves with us, they get drafted and move up to the big boys."

For more information on factoring or finding a factor, check out the Commercial Finance Association Website at www.cfa.com.
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Title Annotation:factoring is an option for small undercapitalized businesses
Author:Parks, Paula Lynn
Publication:Black Enterprise
Article Type:Brief Article
Geographic Code:1USA
Date:Jul 1, 1999
Words:616
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