The Credit Crunch Myth: Financing Options You May Not Have Considered

March 3, 2010

Over the past couple of years, the term “credit crunch” has taken its place in the popular vernacular alongside other now-common phrases like “mortgage meltdown” and “bank bailout.”

But is the supposed credit crunch that we keep hearing so much about (go ahead and Google it—I did and got more than 12 million results!) real? While most of the media would have us believe it is, from my perspective, I’m not so sure.

Neither is Jim Blasingame, the creator and host of The Small Business Advocate Show, the world’s only weekday small business radio program. When I appeared on Jim’s show recently, this is what he had to say about it:

“The premise that there’s no money available for small businesses to borrow is a flat-out myth. Sure, lending standards may have tightened, but there are institutions out there eager to lend money to small businesses that qualify.”

In general, community banks are in better financial condition than big banks, so these are often a good place for small businesses to start their search for financing. Keep in mind, however, that it takes more work and diligence on the part of small business owners today to obtain and maintain a lending relationship. Lenders require much more control and monitoring of recordkeeping, reporting, expenses and overall performance.

Beyond Bank Loans

In addition to traditional bank loans, Jim and I talked about alternative forms of financing for companies that might not qualify for loans in today’s more stringent credit environment. One of these is factoring.

Factoring is very different from a bank loan. In fact, it isn’t really a loan at all; rather it’s a transaction: the purchase of receivables by a bank or finance company for a fee. While some banks offer factoring services, most don’t. Commercial finance companies (often called “factors”) are the most common source of this type of financing.

Here’s how it works: The factor will advance a portion of the receivable to the business when it buys the receivable—typically 80 percent—and hold back the rest as a reserve until the money is collected. Upon collection, the factor will deduct its fee and then forward the remaining amount to the business. Factoring fees typically range from 2-5 percent of the total invoice amount.

Since the factor’s payment is contingent on collection of the receivable, factors are extremely diligent when it comes to checking and monitoring the creditworthiness of their clients’ customers. In fact, this is one of the biggest benefits of factoring: In effect, you are outsourcing the credit and collection functions of your business to a partner that specializes in these tasks.

“Factoring is like bringing a financial partner into your business,” Blasingame added. “The factor drops into the middle of the transaction and gives you cash for your outstanding receivables. It can be a good way to capitalize your business if you don’t qualify for a bank loan.”

Benefits of Factoring

There are a number of reasons why you might want to consider factoring as a strategy for capitalizing your business:

Improved cash flow. This is the primary benefit of factoring, especially for companies in industries where suppliers are slow to pay invoices. Some companies can’t afford to wait 60 to 90 days or longer to collect accounts receivable—they’ll literally run out of cash during this time. With factoring, you’ll receive up to 80 percent of the receivable right away, virtually eliminating cash flow lags.
Avoidance of additional debt. Since factoring isn’t a loan, it won’t add to your company’s leverage or have an adverse impact on your balance sheet. Nor will it tie up collateral that may be required in order to secure bank financing.
Outsourcing of credit analysis and collections to experts. Many companies spend untold hours doing customer credit checks and chasing after past-due accounts receivable. A factor will become your de facto credit and collections department, taking over all accounts receivable management and collections functions.

This includes thoroughly vetting the creditworthiness of all of your customers, utilizing specialized computer databases, and taking over all collections efforts. The factor will analyze credit reports, uncover bad credit risks and set appropriate credit limits, which will minimize payment problems and help you build a roster of strong, creditworthy customers over time.
Inability to qualify for a bank loan. As noted above, if you don’t qualify right now for bank financing, factoring may be a viable alternative that allows you to obtain the financing you need to complete your cash flow cycle and continue growing your business.

For many companies, factoring is a temporary financing solution that lasts from 12 to 18 months until their balance sheets improve to the point that they can qualify for a bank loan or line of credit. However, some industries use factoring on a more permanent basis, including apparel and carpet manufacturers and furniture manufacturers and distributors.

“Undercapitalized” Small Business?

“It’s redundant to use the term ‘undercapitalized small business,’” Blasingame said during our interview. “There’s never a time when a small business owner has an extra buck lying around and can’t find somewhere to put it.”

How true, especially in today’s challenging economic environment where cash flow at many companies has slowed to a trickle. If your business needs a capital infusion but you’ve been scared off from seeking financing by all the talk of the supposed credit crunch, don’t despair. There may be options available to you after all.