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By David Kocharhook
Senior vice president
Midland American Capital
Find a Smart Way to Bootstrap a Business
Invoice factoring generates capital without debt’s drawbacks
Abusiness has a few choices when it runs into cash-flow problems. It can use other
people’s money to solve the problem,
selling off pieces of the business to an
investor. Or it can go into debt to raise
cash. Neither are desirable choices.
The company also has a third
choice: using its own assets to raise
quick money, a method called bootstrapping. In any economic climate,
good or bad, bootstrapping is a better
choice than incurring debt for a business in a cash-flow predicament. It
eliminates the potential downsides of
Of the available bootstrapping
methods, the preferred tool is invoice
factoring, which is when a company
sells its accounts receivable invoices
to a third party, typically at a discount
of 2 percent to 3 percent of the invoices’ face values.
Invoice factoring is a specialized
business that presents another opportunity for commercial mortgage brokers. It’s a good niche for brokers to
learn and master, giving them another
available service to offer when a cash-strapped business client calls for help.
The demand for it is always present.
Businesses run into cash-flow problems all the time. Since cash makes
a business go, company owners and
managers have no choice but to solve
these problems. And often these leaders don’t want to lose any of their professional independence, the outcome
that may come with selling off a portion of their business to an investor.
Debt, on the other hand, can be
an albatross around the company’s
neck. The monthly repayments put
constant demands on cash flow, placing the company at risk of default and
lost assets. No such monthly payment
requirements are involved in invoice
When considering a bootstrapping
option, a company in need of cash
should understand all of its assets
and how to capitalize on them.
For companies doing business with
other companies or government agen-
cies, one of the best assets to exploit is
its own accounts receivable. Accounts
receivable is what is owed by custom-
ers to a company for a product deliv-
ered and/or service rendered. It is also
a debt that another company or govern-
ment agency owes to the business.
Unfortunately, a business in need
of a quick influx of capital can’t
spend its accounts receivable. That
money is not in the bank. It can’t be
used to meet payroll, buy materials or
pay taxes. A company, however, can
convert accounts receivable to cash
without pressuring its customers to
change their payment terms. The so-
lution is to factor the invoices.
Invoice factoring involves selling in-
dividual outstanding invoices for cash.
The transaction stays exclusively on
the asset side of the ledger. The com-
pany is not borrowing money; it is sell-
ing an asset. Therefore, there is no
liability entry on the company’s books.
Although a few larger banks have departments that do true invoice factoring,
many do not. Generally, the underwriting criteria for invoice factoring differ
from traditional business loans. Because banks are regulated by the Federal Reserve, the larger institutions that
engage in factoring typically apply the
same approval criteria to it as they do
lending. This means they look closely at
the personal and business credit of the
cash-strapped company applying for a
factoring facility. If the company’s credit
scores are not good, the application will
almost certainly be declined.
Independent financing companies
have greater leeway. These companies
primarily evaluate the credit-worthi-ness of the parties obligated to honor
a business’s invoices — in other words,
they are looking at the customers owing the cash-challenged business the
debt. Customers with good commercial
credit ratings are strong candidates to
have their invoices sold. The business
or personal credit scores of companies
selling the invoices should have little
impact on the decision to fund.
A business in need of cash can set
up a factoring facility with a financing
company quickly — generally within
10 business days. Once established,
the facility can be used again and
again, and typically offer a 48-hour
turnaround. It is also designed to be
a “use-as-needed” service. In other
words, a company only needs to factor its invoices and incur the accompanying service fees when it has a
cash-flow shortfall. It is under no obligation to sell its invoices always.
Every factoring transaction is discrete. The company in need of cash
sells an invoice, which is a separate,
uniquely identifiable financial instrument. The financial services company
purchases the invoice at an agreed-upon price. Each invoice has a distinct payee, which is the customer
obligated to pay for a product or service. That price is determined by a
prearranged discount rate.
For example, if the factoring agreement calls for a 3 percent discount
rate, a $100,000 invoice would be
purchased for $97,000. If a company
factored a $100,000 invoice each
month for 12 months, it would have
consummated $1.2 million in business with its customers. At a 3 percent discount, factoring will result in
a business expense of $36,000 and a
net profit of $1,164,000.
At the most basic level, factoring
enables a business owner to collect
immediate payment from customers.
It is much like a credit card transaction, where a consumer buys a good
or service on a credit card and the
merchant, for a fee, receives the
funds immediately from the credit
The bottom line is that invoice factoring is no more expensive than taking payment by credit card or offering
special payment terms to customers.
Commercial mortgage brokers have an-
other persuasive reason to suggest in-
voice factoring when a cash-challenged
client calls: It is not a loan and doesn’t
carry the same liabilities.
The act of borrowing forces a double
entry on a company’s balance sheet.
Although the income from the loan be-
comes a cash asset on the books, an
offsetting liability also must appear.
That money does not belong to the
company and must be paid back.
Borrowing increases a business’s
debt-to-equity ratio, which impacts a
company’s financial health. As the ra-
tio rises, the company has a greater risk
of defaulting on its loan obligations.
Businesses with higher debt-to-equity
ratios can have trouble borrowing ad-
ditional money. Vendors also may be
unwilling to extend payment terms to a
company heavily in debt. A highly lev-
eraged company can be judged a poor
credit risk, causing vendors to demand
cash payment for merchandise.
Invoice factoring, in contrast, will
not affect a company’s debt-to-equity
ratio because the entire transaction
stays on the asset side of the ledger.
When confronted with a cash-flow
problem, many business owners automatically look to borrow money. But
borrowing has the following downsides:
• It adds a liability on the balance
• It affects a business’s credit rating.
• It raises the company’s debt-to-equity ratio.
• It imposes an additional monthly
demand on cash flow.
• It creates the possibility of default
Bootstrapping using invoice factoring has none of these downsides, and
offers a quick and effective way for a
company to use its existing resources
to solve a potentially devastating financial problem or to give itself a
rapid infusion of capital. It is comparatively inexpensive and, by law,
almost universally applicable.
Invoice factoring expertise is a potent tool in a mortgage professional’s
arsenal of services that helps clients
survive in difficult times and thrive
during prosperity. •
David Kocharhook is a senior vice president at
Midland American Capital (MAC) — a factoring and purchase-order financing company
headquartered in East Meadow, N. Y. MAC
provides professional best-practices factoring
and purchase-order-financing services. Kocharhook’s office is in Sunnyvale, Calif. Reach him
for additional information or consultation at
or (800) 753-3300.
by David Kocharhook
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