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Business Debt that is Worse than Credit Cards

Ever get a call from a friendly guy offering you attractive non-debt financing? “Accelerate your accounts receivable!” “Turn AR into cash!” “No credit check required!” Sounds good, right?

Remember this maxim: good capital is never easy.

The Hidden Factoring Expense

Financing AR is, in fact, an alternative to debt available to manufacturers with poor credit. Instead of borrowing against assets, you’re selling an asset at a discount. It’s like getting a payday loan from Moneygram – 80% of the cash now, and some portion (say 16%) on payday. Easy, simple, very little paperwork, no bankers, no credit scores.

However, while it is technically not debt, AR factoring could be replaced by a traditional bank line of credit. Lines of credit are typically collateralized by AR and/or inventory. I’ve seen lines of credit as high as 80% of AR – an advance as big as factoring!

Lines of credit typically cost 5-8% APR. What does factoring cost?

The human brain says 80% advance + 16% on payment = 96% paid, so 4% expense. But that’s not the same as APR. You lost 4% on a “loan” to your customer that would have otherwise taken 30-60 days to pay. We can quickly annualize a 30 day AR loan by multiplying x 12. 4% x 12 = 48% APR

48% APR?!?

Yes. It’s true. You’d be better off borrowing from a credit card. (By the way, this example is not unusual.)

Desperate Capital v. Opportunistic Capital

Whats the difference between jumping a good opportunity and desperately grasping at life preservers? Planning. Smart business owners develop resources before they need them. Do you start selling the same month you want the revenue? No! You begin developing leads months in advance of your sales goals. Capital planning is no different-plant seeds in anticipation for a rainy day.

Here’s a good capital planning process:

  1. Gather senior management and build a business/growth plan
  2. Create budgets/pro formas that reflect your plan
  3. Identify risks and develop contingencies
  4. Share this plan with your:
    1. Bank
    2. Debt partners
    3. Investors
    4. Friends/family
    5. Employees
  5. Ask stakeholders for their support executing your plan

This plan bears fruit in two ways:

  • Anticipating risks raises your antenna and avoid pitfalls
  • When opportunities arise, your stakeholders will think to present them to you

Bankers around the world are nodding in agreement with point #2. They want to know how to help you. They want to give you money! But bankers are slow. They are conservative. They don’t move as fast as manufacturers. So act early, and touch base often. Stay top-of-mind so they think of you the next time their interest rates are cut.

I’ll be talking more about avoiding desperate capital, including AR factoring, at a panel discussion July 13th at the Commons on Champa. It’s free and full of useful information about planning and debt strategy. Stop by for a great conversation and networking!

Click here to RSVP for the panel

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