By now most you have already heard about Facebook’s purchase of WhatsApp for 19 billion in stock, cash and incentives. Before this record purchase it was Instagram, YouTube and so forth down the line. Just a few months ago, another company called Snapchat turned down a three billion all cash offer from Facebook saying they feel their company deserves a higher valuation based on interest from other parties. Wow, have times changed from when I was a young accountant a few years ago. Back then valuations were based on multiples of earning ratios, revenues, and operating margins. What’s funny now is that many of these companies have never generated a profit or been in business for more than a few years before they were acquired. These are the kind of rags to riches headlines we all love to read about since the majority of these companies are startups typically founded by a few guys under the age of thirty. I guess the old saying holds true that your company is worth as much as someone is willing to pay. Unfortunately, for those of us in the factoring industry there are no quick shortcuts to success. I can’t remember the last time I heard about a factoring app going viral or a new asset based startup being purchased for billions. In our industry, it’s kind of the opposite of these quick hit startups.
First, unlike most new businesses, an invoice factor’s goal is to decrease cash. Factors make money by purchasing invoices and getting their funds “out on the street”. The objective is to earn a high enough rate of return on purchased invoices to offset borrowing costs and general administrative expenses. Therefore, an adverse position for a typical factoring company is to have large amounts of idle capital not earning a return. It’s kind of ironic that factoring companies in too strong of a cash position sometimes get themselves in trouble by funding less than perfect applicants in order to cash out the door.
Secondly, most factors do not want to fund every transaction. I know that may sound crazy but you need to look at this from a risk reward perspective. Unlike typical businesses whose goal is to sell as many of their products and services as possible, factors know that every deal has a certain amount of risk whether it be with the client, customer or both. One of the biggest misconceptions about this industry is that factoring companies will fund almost anyone as long as their customers have good credit. Our position has always been a strong account debtor is a great starting point but not enough to close the deal on its own. So often I see new factors getting in this business and do not take the time to really understand the entire picture of the factoring deal. This business is so much more than just checking boxes off on an underwriting list. Understand what your client does, the relationship they have with their customer and why they are utilizing factoring for their business. Our closing ratio hovers somewhere between ten and twenty percent depending upon the industry. We advise our sales staff and brokers of what is important when looking for new prospects. However, at the end of the day it all comes down to proper due diligence, a thorough understanding of the client’s business model and a feel of what the client is trying to accomplish by using invoice factoring.
Finally and most importantly, understand the business. It’s ironic that although our industry is very easy to understand so few take the time to really understand it well. All too often we come across deals that others have passed on because there was an issue that was rubber stamped as a deal breaker. For example, if the company is in a growth phase where they need additional cash flow to keep up with orders then it’s probably a good reason to move forward. However, temper this by looking at the company’s profit and operating margins. We have come across several companies that are growing but not making a profit because they have either expanded too quickly or agreed to produce a higher volume at too low a margin. Conversely, if a company is scaling back then you should know why they are taking this course of action. Is it because sales are declining or are they just tightening their belt as a result of being bloated from accelerated growth? We have found that no two deals are exactly alike even if they are producing goods or services within the same industry. In one example we have funded two clients in the apparel industry with the same customer. It was clear that the one client, who was labeled a “preferred vendor” received preferential treatment through shorter payment terms and greater flexibility in getting the purchase order fulfilled. It’s almost equivalent to a person with a higher credit score getting a better rate on a mortgage loan than someone with less than perfect credit.
At the end of the day factoring takes time. It takes time to find out where the deals are and more importantly, the kind of deals you want to fund. Factoring takes patience. So often you come across great companies with great customers but the pieces of the puzzle do not connect. The account debtor may not want to work with a factoring company or the client may have a loan and the bank refuses to subordinate their position. These are just a few of the reasons why factoring business requires planning, understanding and most important, patience. If you follow the correct path, it can be a rewarding business and career.
This article was written by our President, Don D’Ambrosio and was originally published in the March/April 2014 issue of The Commercial Factor.
Don D’Ambrosio is the president of Oxygen Funding, Inc., an invoice factoring company located in Lake Forest, California. Don has over 25 years experience working in the commercial and residential finance industries. He previously served as Controller of a commercial insurance agency and as Chief Financial Officer of a publicly traded mortgage company. He can be reached at 949-305-9300 or firstname.lastname@example.org.