Financial Myths vs. Financial Facts

ign="center">with new invoices that are likely to perform.
FINANCIAL MYTHS vs. FINANCIAL FACTSOn the surface, non-recourse sounds better than
Evaluating Funding Options for your B2B Businessrecourse. But if the fees for the non-recourse
The world of commercial finance is complicated. It isfactoring are significantly higher than full recourse, is
suggested that all businesses consult with theirthe added cost to transfer the risk of payment
trusted advisors (CPA, Attorney, or Partner) beforedefault worth the expense? How many of your
entering into any financing transaction that will havecustomers will file bankruptcy or go out of business?
long term effects on their business. The followingOver a period of time it may cost you more of your
statements are the opinions based on the dictionarypotential profits to transfer some payment risk to
definitions herein below.the commercial finance company.
Merriam-Webster Online Dictionary AbridgedMost commercial finance companies offering full
Definitions:non-recourse factoring conduct extensive credit
MYTH:checks on the customer before they will pay an
Pronunciation: 'mithadvance on an invoice. This is a benefit to all
Function: nounconcerned. When it is predictable that an invoice will
Etymology: Greek mythosget paid by a creditworthy customer, the invoice will
1 a: a usually traditional story of ostensibly historicalbe purchased. This credit quality check is of benefit
events that serves to unfold part of the world viewto you because you do not want to knowingly sell
of a people or explain a practice, belief, or naturalyour products or services to businesses that are not
phenomenon.likely to pay. On the other hand, there may be
2 a: a popular belief or tradition that has grown upcompanies you would prefer to do businesses with
around something or someone; especially: onethat do not meet the creditworthiness standards for
embodying the ideals and institutions of a society ornon-recourse factoring. There may be compelling
segment of societybusiness reasons to choose recourse vs.
2 b: an unfounded or false notionnon-recourse factoring.
FACT:“Look after the pennies and the pounds will
Pronunciation: 'faktlook after themselves.”
Function: nounIf you look after the pennies, the pounds will look
Etymology: Latin factum, from neuter of factus, pastafter themselves, meaning that if someone takes
participle of facerecare not to waste small amounts of money, they will
1: a thing doneaccumulate capital.
2: the quality of being actual“Hook, line and sinker”
3 a: something that has actual existenceIf somebody accepts or believes something hook,
3 b: an actual occurrenceline and sinker, they accept it completely.
4: a piece of information presented as havingFINANCIAL MYTH: No. 5
objective reality- in fact: in truthStartup companies with a new hot product need
“A fool and his money are easilyventure capital to grow rapidly.
parted”FINANCIAL FACT:
FINANCIAL MYTH: No. 1You can grow exponentially with purchase order
Finance companies that promise funding in 24-48financing, factoring, and inventory financing from a
hours are the best choice.commercial finance company.
FINANCIAL FACT:In general, more products you sell, the higher your
Unless you are desperate for funding, you shouldrevenues and profits. The more orders you have, the
take time to compare alternatives, read themore you can sell, provided you can pay your
proposed contracts, and consult with your advisors.suppliers upon delivery. Purchase order financing is like
It is recommended that you read the proposedinventory financing for goods in transit to your
contract before you agree to terms, and carefullycustomer.
consider the risks regarding following matters:Commercial finance companies provide purchase
1. Percentage to be advanced: This may range fromorder financing to pay your suppliers, enabling you to
60% to 90% of the face value of an invoice. Will theclose the sale and deliver your orders to your
percentage to be advanced be sufficient to help youcustomers. This often involves a letter of credit using
grow profitably?the commercial finance company’s credit to
2. Your obligation to work with the finance company:guarantee payments to the factory producing the
Are you required to sell 100% of your accountsproduct, especially if the manufacturing facility is not
receivable every month, or are you permitted to selllocated in the US.
at your discretion? Are there monthly minimumWhen the goods are accepted by your customer, an
charges and if so, would you be likely to use theaccount receivable is created. An invoice factor, or
services of the commercial finance company to thiscommercial finance company that purchases accounts
degree every month?receivable, pays for the purchase order financing. You
3. Will you be more profitable if you use the financeare paid the profit when your customer pays.
companies services? In other words, can you affordThe commercial financing structure may follow these
to pay the commercial financing fees in order tosteps:
grow your business?Letter of credit (to guarantee manufacturer payment
4. Which source is better for you: a small commercialfor goods) â—º Purchase Order Financing
finance company, a large commercial finance(pays manufacturer/supplier) â—º Accounts
company, or the asset based lending department ofReceivable Financing (pays Purchase Order Financing)
a bank? With the small companies, you are moreâ—º Inventory Financing â—º
likely to work with the decision makers and theirCustomer pays â—º Factor is paid
usually is more flexibility and discretion. With the largeâ—º You are paid profits from your sales
companies, you can accomplish larger transactionsafter financing costs are paid
and this may be of great significance especially ifCommercial Finance Brokers help you determine what
your business is international. Banks may be anfinancing is available according to your circumstances,
excellent choice if your accounting is perfect and youat competitive rates.
are good at dealing with strict requirements. Banks“Play hardball”
are regulated institutions with safety and soundnessIf someone plays hardball, they are very aggressive
requirements which generally make banks morein trying to achieve their aim.
conservative than private lenders. GFS works with allVenture Capital Funding
three types of lenders.The Venture Capital Industry:
5. Choice of law: If you are in California, and anyVenture capital is money provided by professionals
dispute must be litigated in New York can you affordwho invest alongside management in young, rapidly
the risk that you might have to travel to protectgrowing companies that have the potential to
your interests? Where are disagreements or disputesdevelop into significant economic contributors.
to be decided? Is there binding arbitration?Venture capital is an important source of equity for
6. Penalties for early termination: Some yearlystart-up companies.
contracts provide that if you want to leave theProfessionally managed venture capital firms generally
commercial finance company, you are liable forare private partnerships or closely-held corporations
“the greater of Two percent (2.00%) offunded by private and public pension funds,
the Maximum Credit Line, or the number of monthsendowment funds, foundations, corporations, wealthy
remaining in the agreement multiplied by the Monthlyindividuals, foreign investors, and the venture
Minimum Fee”. Is the termination fee riskcapitalists themselves.
affordable?Venture capitalists generally:
7. Penalty interest if you client fails to pay on time:• Finance new and rapidly growing companies;
Some lenders provide that if a client defaults, you• Purchase equity securities;
can substitute another invoice and not be charged a• Assist in the development of new products
penalty. Other lenders may require that if a client failsor services;
to pay an invoice within 90 days, you are charged• Add value to the company through active
20% of the invoice face amount plus 7.5% perparticipation;
month until payment is made. What does the• Take higher risks with the expectation of
commercial financing agreement require when yourhigher rewards;
client does not pay on time?• Have a long-term orientation
“Economical with the truth”When considering an investment, venture capitalists
If someone is economical with the truth, they leavecarefully screen the technical and business merits of
out information in order to create a false picture of athe proposed company. Venture capitalists only
situation, without actually lying.invest in a small percentage of the businesses they
FINANCIAL MYTH: No. 2review and have a long-term perspective. Going
Finance companies that promise lower rates are theforward, they actively work with the company's
better choice. For instance, Co. “A”management by contributing their experience and
offers 3% per month; Co. “B”business savvy gained from helping other companies
offers 3.25% per month. Co. “A” iswith similar growth challenges.
the best choice.The advantage of venture capital investment is that
FINANCIAL FACT:you get money that enables you to expand your
Contract terms and conditions determine your actualbusiness and obtain market share before someone
costs based on when your clients pay. This requiresbeats you to it. Venture capital is not a loan that
analysis.needs to be repaid; rather, venture capitalists (VCs)
It is recommended that you carefully consider theinvest their money in exchange for equity (an
contract terms regarding how interest is charged andownership share) in your company. VCs get their
your experience regarding how your customerscash out only when your business is acquired by
typically pay to project the true costs of financing.another company or "goes public," that is, when its
Here are several examples:shares can be publicly traded on a stock exchange.
1. You sell an invoice with a face value of $100.00.The disadvantage is that you are no longer the sole
Assume the contract charges are 3% for 30 days,owner of your company and may lose control.
with an 80% advance to you and your customerMoreover, a VC may move your company towards
pays the commercial finance company the fullan Initial Public Offering (IPO) of publicly traded
amount due on the 30th day. You take an $80.00shares faster than might be best for the long-term
advance on day 1 and your customer pays thehealth of the business.
commercial finance company $100.00 on the 30thIn general, the earlier the stage where you receive
day:v Suppose Lender “A” chargesfunding, the more you have to give up. A few VC
1% for every 10 days period. Assumecompanies or "angel investors" might invest in what is
“Payment date” is defined in thenot yet a real operating business but just a concept.
commercial finance contract as the date the financeFor $500,000, they might take a 60% ownership in
company receives payment from your customerthe company, and put in their own management
pays plus ten (10) banking days. Ten banking daysteam. If they decide that this can become a viable
are two calendar weeks. You will be charged for 44business ("proof of concept"), they might fund the
days. One percent for the first 10 days, plus 4company for another $5 million, taking yet more
percent for the next 34 days equals a charge of 5%.equity. By the second round of financing, the original
Your cost = $5.00.v Suppose Lenderbusiness owner might retain only a 5% to 10%
“B” charges 1.5% every 15 dayownership.
period. Assume “Payment date” isWhat are the Pros and Cons in having Venture
defined in the commercial finance contract as theCapital Funding as a partner?
date the finance company receives payment fromPros:
your customer plus three business days for check- Financial strength for global competition
clearance. You will be charged for 33 days. You will- Share buy-back opportunity
be charged 4.5%. Your cost = $4.50.v Suppose- Easier to get listed on a stock exchange
Lender “C” defines- No conflict of interest
“Payment date” as the day they- VC network can enhance the company's business
receive the check or wire funds transfer. ThisVC’s provide experience, advice, and
commercial finance company stops the interest clockmentoring. They are objective, helpful with
on the day they receive payment from yournetworking and hiring the right people. They add
customer. You will be charged 3%. Your cost =credibility and prestige to your business, share the
$3.00.v Suppose Lender “D” definesrisks, and help eventually to sell the business.
“Payment date” as the day theyCons:
receive funds and charges daily interest only on the- Lose part of the ownership
actual funds advanced, also know as per diem- Cannot manage the company as a family-run
interest. Since you are being charged 3% on $80.00business
your cost = $2.40.The risk of working with a VC may be their concern
2. In every contract the definition ofis more for a profitable and mandatory exit,
“Payment date” and method ofcompared to your concern for your employees and
interest calculation are critical to anticipate your actualcustomers. You loose independence to manage your
costs of financing. All of the above methods ofbusiness and the VC’s may have the right
calculation, except Lender “A”, mayto fire you and your management team. It can be a
be reasonable on account of the risks inherent in thefull-time job to manage the venture capitalists that
transaction. Gregg Financial Services works to obtainare funding your business. Venture capitalists usually
the most competitive rates and terms for ourask for:
client’s initial funding; and GFS works to•Anti-dilution protection. If the company's
reduce commercial finance costs as you grow.stock price goes down any time in the future, they
3. If you customers typically pay in 60-90 days, aget additional stock for free.
contract that requires a minimum interest charge for•Dividends. In addition to stock, they get a
60 days is not unreasonable. This condition may be aguaranteed rate of return.
required for medical accounts receivable financing.•Liquidation preferences. VCs get their
4. Consider whether the commercial financeprincipal and dividends back before anyone else gets
company’s contract requires you to sella penny.
every invoice (100% of all invoices) on the day you•Participating preferred. They get to double
issue them, or may you sell individual invoices up todip—they first get their investment plus
59 days past due, according to your needs? Theredividends, then the value of their stock.
are tradeoffs: lower price vs. flexibility. It is very•Mandatory redemption. This requires the
much a question of assessing your commercialcompany to buy their stock back by a certain date,
financing requirements and your gross margins to payestablishing a deadline for an exit event.
for financing costs.•Demand registration rights. The VCs can
“Easier said than done”force the company to file a registration statement
If something is easier said than done, it is much morewith the Securities and Exchange Commission to
difficult than is sounds. It is often used wheninitiate an initial public offering—another way
someone advises you to do something difficult andof forcing an exit event.
tries to make it sound easy.•Approval rights. The VCs must approve any
FINANCIAL MYTH No. 3new financings and have the right to participate.
You can determine the best finance company to•Reps and warranties. You'll also have to
work with by simply by comparing several differentaccept personal liability for representations you've
websites.made about key aspects of the company. They will
FINANCIAL FACT:have the right to sue you for all you own if you
Websites are advertising. Knowledge of the lender,forgot to give them any bad news.
their reputation and business practices are essentialCONCLUSION: There are no easy choices. If you
to choose wisely.have orders for your product with a sufficient gross
KEY POINTS TO CONSIDER:margin, commercial finance companies may be your
When assessing the most appropriate commercialbest choice. If you need to develop your product
financing company to use, make sure:and lack the capital to fund your business to develop
• the provider is a reputable companythe product, market your brand and receive orders,
• your contract corresponds with any verbalventure capitalists can be the best thing that ever
or written quotationshappened to your company. If you commit to a
• you are aware of any financial penalties ifcommercial finance company, you can terminate the
you wish to end the agreement earlycontractual relationship. If you commit to a venture
• the financing credit limits are sufficient forcapitalist, the exit strategy is in their domain.
your initial needs“Make a mint”
• you have read the contract carefullyIf someone is making a mint, they are making a lot
before signing it, checking the amount of financingof money.
and notice periods“Feel the pinch”
• you understand all terms and conditions,If someone is short of money or feeling restricted in
and the costs you will have to paysome other way,they are feeling the pinch.
Commercial Finance Brokers work with manyFINANCIAL MYTH: No. 6
dedicated commercial finance companies and banksAll finance companies charge interest on 100% of the
across several businesses of all sizes. There are manyface value of the invoices you sell to them.
areas of specialization, such as purchase orderFINANCIAL FACT:
financing, accounts receivable financing, inventorySome finance companies base their charges only on
financing and SBA financing. Most commercial financeactual amount of money you receive.
companies limit their services to one or two of theseThere is a large range of pricing in the commercial
categories. A commercial finance broker will assessfinance business. Although competition tends to hold
different companies and match you with one thatprices down, different industries may be charged
best fits for your business needs. They also keep amore because of historical risk. For instance, medical
close watch on commercial finance companies thatand construction accounts receivable financing will be
may charge non-competitive fees and will not matchmore costly than commercial financing for a staffing
you with them. In addition to comparing rates, thereagency.
are many points to consider when choosing services.At one extreme, some commercial finance companies
To anticipate problems with customers that inevitablyrequire that 100% of invoices be sold and interest is
arise, find out what level of customer service theycharged on 100% of the invoices. This may be
offer to help resolve problems. Do they providereasonable because the business is high risk and if
telephone support and in-person meetings, e-mail helpyour company goes bankrupt, the commercial finance
and live chat, or a combination of services? Choosecompany cannot collect any of the funds that have
the commercial finance company that offers multiplebeen advanced.
ways to reliably address concerns or answersThe best pricing available is computed with regard to
questions. Consider differences in where you arethe actual funds advanced with interest payable on a
located and the time zone where the commercialdaily basis for the period the funds are utilized. This is
finance company is located. How will this affect cutcalled per diem interest. Most banks and some
off times for funding? How will this affect your abilitycommercial finance companies offer this option which
to reach your key finance representatives?may be described as a “line of
You may want to ask for a list of references beforecredit” or “asset based
you do business with them. Make sure to ask suchfinancing” for larger transactions.
questions as:Assume a commercial finance company charges a
• Were they able to quickly process your3% monthly fee and you sell an invoice for $100.00.
funding requests?Assume further that you customer pays in 5 days.
• Was the approval process simple? HowHere is a range of costs you would pay, based on
long did it take?various minimum contract time and payment terms:
• Was the company easily accessible throughBased on 100% of the invoice:
phone and email?59 day minimum term = $6.00 cost
• How long did it take before you received30 day minimum term = $3.00 cost
funds?15 day minimum term = $1.50 cost
• If you had a problem with your account,10 day minimum term = $1.00 cost
what did they do to resolve it?Per Diem interest 5 days = $ .41 cost
• How did your clients react to working withBased on an 80% advance Per Diem for 5 days = $
the commercial finance company? Did they handle.33
them appropriately?“Leave no stone unturned”
• Would you recommend this company?If you look everywhere to find something, or try
“Face Value”everything to achieve something, you leave no stone
If you take something at face value, you accept theunturned.
appearance rather than looking deeper into the“Game Plan”
matter.A game plan is a good strategy
FINANCIAL MYTH: No. 4FINANCIAL MYTH: No. 7
A non-recourse contract means you do not have toA finance company contract with no term is better
pay the finance you to pay unless your company ifthan a contract with a one year term.
there is a default.FINANCIAL FACT:
FINANCIAL FACT:If you will need financing for one year and rates and
Most contracts require you to pay unless your clientterms are lower, the one year contract may be a
files bankruptcy or goes out of business.better choice.
There are two general types of factoring: recourse“Keeping your options open”
and non-recourse. Recourse factoring is the mostIf someone is keeping their options open, they are
common. With recourse factoring, the commercialnot going to restrict themselves or rule out any
finance company generally will fund every invoice youpossible course of action.
submit, but will require a refund plus their fees forFINANCIAL MYTH: No. 8
invoices that are not paid within a specific period ofSBA business loans are similar at every bank.
time, usually 90 days.FINANCIAL FACT:
Non-recourse factoring may free your company ofSome banks originate SBA business loans with
any responsibility for non-paying accounts, if, and onlydelegated authority. This allows additional financing for
if, it is truly “non-recourse” withoutpurchase order, accounts receivable and inventory
conditions.from third party lenders creating more capital for
The commercial finance company with agrowth.
non-recourse contract will have more stringent“Put all your eggs in one basket”
policies for the invoices they will accept. In aIf you put all your eggs in one basket, you risk
non-recourse contract the commercial financeeverything on a single opportunity, which, like eggs
company agrees to purchase the invoice from youbreaking, could go wrong.
and takes some or full responsibility for its payment.FINANCIAL MYTH: No. 9
It depends on the contract terms. Credit insuranceAll finance company contracts, terms, and conditions
may be required. This is an additional expense.are similar.
Non-recourse factoring generally is defined inFINANCIAL FACT:
commercial finance contracts to mean: if theTerms range from fair to onerous. When you factor
customer does not pay in limited situations,invoices you entrust all your cash flow to a
it’s not your problem. For example, shouldcommercial finance company.
the customer declare bankruptcy or go out of“Comfort Zone”
business you are not responsible to pay back theIt is the temperature range in which the body does
commercial finance company for the advance onnot shiver or sweat, but has an idiomatic sense of a
certain invoices. But, if there is a warranty issue, ifplace where people feel comfortable, where they can
anything at all is wrong with your product or service,avoid the worries of the world. It can be physical or
you may be held responsible for the advance youmental.
received. And the commercial finance company canFINANCIAL MYTH: No. 10
assert a breach of the many warranties andAll finance companies require that your customers be
representations in your contract as a defense tonotified that you are working with them. This is called
accepting responsibility for a loss due to non-paymentnotification and verification.
in a non-recourse agreement.Financial Fact:
There are also commercial finance companies that willSome finance companies allow non-notification
provide a mix of the two. These companies willfactoring. This makes the financing transparent to
promise to assume the risk of your invoices butyour customer.
require you to swap in a replacement of equal or“Take the plunge”
greater value for slow-paying or defaulted accounts.If you take the plunge, you decide to do something
This is not a true “non-recourse”or commit yourself even though you know there is
contract in the literal sense of the idea because youan element of risk involved.
are required to substitute non-performing invoices