Fred Dunayer: Welcome to the SCORE Small Business Success Podcast, Been There, Done That. To get free mentoring services as well as to see the wide variety of resources available for small businesses, visit our website www.score.org or call 1-800-634-0245 and now, here’s your host, Dennis Zink.
Dennis Zink: Episode four, Alternative Financing. Our guest today us Fred Dunayer. Fred got his accounting degree back in the days of 14-column ledger paper but spent his career designing and implementing computerized small-business financial systems. In October 2008, Fred became the principal of Interface Financial Group, a company which provides accounts receivable financing to small and medium-sized businesses. Through IFG, Fred has developed contacts throughout the alternative financing industry and provides cash flow consulting services.
Fred has been a SCORE mentor for three years and is currently serving as team leader for the administrative services team and the chapter’s technology coordinator. Fred is also normally our co-host and audio engineer and has Been There, Done That, but today, he wears his interviewee hat. Good morning, Fred.
Fred Dunayer: Good morning.
Dennis Zink: We are also joined today by Steve Lovinger. Steve is a SCORE mentor, CPA, serial entrepreneur and co-producer of Been There, Done That. Steve also has experience as a client receiving leasing and factoring services. Good morning, Steve.
Steve Lovinger: Good morning.
Dennis Zink: Fred, our topic today is alternative financing, interesting topic. What is alternative financing? Can you explain that please?
Fred Dunayer: It’s an interesting question just to answer that because alternative to what? I mean traditional financing is where you have bank loans, traditional bank loans, loans against real estate that sort of thing but a lot of people don’t realize that other assets that they have are also usable for financing. The textbook definitions of alternative financing, well, actually I’ll start with asset-based lending is a term you might hear, is where the lender provides funds secured by the borrower’s assets. Collateral could include accounts receivable, inventory, machinery, patents, trademarks or other assets where value can be determined.
Alternative financing which is a little bit different from lending is where the finance company actually purchases the collateral while continuing to provide the use of these assets to the clients.
Dennis Zink: Okay, great. Why would a company seek alternative financing?
Fred Dunayer: Well, there’s all kinds of reasons that companies needs funds, the obvious is for working capital, could be to buy equipment, funding for an acquisition, merger or a leverage buy out, perhaps debt consolidation, turnaround financing, hopefully not bankruptcy, re-organization financing, buying inventory. There could be financing needed for import-export trade or just plain growth.
Dennis Zink: What kinds of alternative financing is actually available?
Fred Dunayer: There’s a number of different resources. The ones I want to talk about today are basically four categories. There’s equipment leasing, purchase order financing, inventory financing and factoring.
Dennis Zink: What’s involved in equipment leasing?
Fred Dunayer: Basically, equipment leasing is like automobile leasing. It’s very similar in concept. There are few differences. In general, equipment leasing is where the lessor, that is the person doing the financing, purchases the equipment needed by the client for the duration of the term or even beyond. The equipment remains the property of the lessor until the borrowed funds plus interest have been repaid. Businesses will typically need to have established credit and had been in business a couple of years before a company will actually do that.
Some firms will purchase equipment that is already in place and the terms are typically up to six years. You would want to consider leasing when the client requires a lot of expensive equipment but wishes to avoid tying up large sums of money on the down payments required by purchasing. They might also consider it when they need to have their equipment changed frequently and want to avoid having capital tied up in obsolete equipment and they have the cash flow which can readily cover the monthly payments but don’t have the money to lay out for the purchase of equipment.
Steve Lovinger: What types of companies provides lease financing and how would I find one?
Fred Dunayer: There’s a couple of different ways to find the companies. One is you can go to the internet and just look up equipment leasing. There’s actually equipment leasing association that has a directory and you could look for equipment leasing companies. Obviously, if you can find a company that’s in your area, it can be beneficial because then you can sit down face to face and chat with them. Your bank also might do equipment leasing. After all, banks look for hard assets and the equipment is a hard asset. A third option is the manufacturer themselves. A lot of the times that if they’re selling expensive equipment, they see leasing the equipment as another source of income to themselves.
Steve Lovinger: Is it true that certain lenders specialize in certain industries when it comes to leasing?
Fred Dunayer: Yeah, particularly in transportation industries and manufacturing industries. If you’re a member of the trade association or can get involved with the trade association for your industry either in their publications or their websites, there could obviously be links to equipment leasing companies.
Dennis Zink: What happens typically when the lease is up, what are the options?
Fred Dunayer: That’s interesting because there’s a lot of different options, there’s a lot of things to consider with equipment leasing. For one thing, you can have the purchase option where you can buy the equipment from the leasing company, it can be something like they write into the lease, it’s dollar or it could be fair market value. You purchase it for that point or it could be anywhere from 10 to 50 percent of the original value of the equipment. That’s all negotiable with the company. When you negotiate, you want to consider some possible issues.
Number one is that you might have financing issues in terms of the early buy out. If you want to buy out early, you’ll typically have to pay a penalty because they based their risk-exposure base on the duration of the term. You also need to remember, if you’re going to do equipment leasing that you can’t use your leased asset as collateral for a future loan. It’s already tied up. Interest rates can be pretty high on equipment leasing again and sometimes difficult to calculate because it’s built into the cost and businesses don’t have the credit protection in terms of disclosures that consumers do.
Dennis Zink: From my experience, they used to call it a lease factor. They wouldn’t tell you the percentage interest rate. You have to back into it to figure it out.
Fred Dunayer: Yeah, you really have to consider that. Also, you need to consider that one missed payment can trigger a re-possession. Of course, if this is essential equipment to your business which why else would you be leasing it, that could put you out of business. As I mentioned, the leases do tend to be long term. It can be hard to get out of. You need to be prepared for a thorough examination of your credit history, it could require that you pledge additional collateral to secure the equipment and a requirement for copies of your personal tax returns.
The reason is pretty understandable for everything from all those requirements, to high rates is because the lenders or person who’s buying that equipment and leasing it back to you is taking a pretty significant risk. There’s the obsolescence issue, you can buy a piece of equipment and lease it to somebody and technological changes can happen where that equipment is almost valueless during the term of the lease to where the lessee can get rid of the equipment, buy a new, more efficient equipment and still save money.
There’s also, the equipment can be damaged. There’s usually some maintenance provisions that are written in there that have to be dealt with. There’s a lot of reasons for the complexity of equipment leasing.
Dennis Zink: What if the equipment is stolen and or disappears? Do you typically have insurance? Are you forced to get insurance on that equipment?
Fred Dunayer: Yeah. Again, it’s similar to a car, a vehicle.
Steve Lovinger: I’ve heard the term sale lease back, what does that mean exactly?
Fred Dunayer: Well, what happens in that situation is if you’ve already got equipment in place and really need to raise capital, you can actually sell your equipment to the leasing company and then the leasing company leases it back to you. Unlike a car lease where it’s always a new car and you’re making payments to the leasing company, it would be as if you sell your own car to a leasing company and they lease it back to you for a period of time.
Steve Lovinger: That sounds like fun.
Fred Dunayer: Good luck trying that. You can give it a shot.
Steve Lovinger: What is inventory financing?
Fred Dunayer: Inventory financing is where business have large amounts of capital tied up in warehouses or behind the counter that the typical, classical example is automobile dealers or appliance dealers. There’s no way your local auto dealer can afford to keep 200 brand-new vehicles on his lot. You might think he does but he doesn’t. What he has is he has the inventory and it’s basically financed by the auto company.
Dennis Zink: That’s floor planning, they call it?
Fred Dunayer: That’s right. Now, there is other kinds of inventory financing where if you just have a traditional amount of warehouse and you want to get a company to help you with the rotation of that inventory to keep the value at a certain point, they will do that. That’s not very common anymore. It’s hard to find inventory financing. I’ve had a couple of clients recently that were asking about it and I was not able to find any sources of that kind of inventory financing. Usually, right now, what I’m seeing is large companies, I guess that auto dealers, things with the companies with large expensive inventories that are working with their own manufacturers to provide that kind of financing.
Steve Lovinger: Is one of the drawbacks the ease of reselling the inventory? Is that why it’s difficult to find inventory financing?
Fred Dunayer: Again, you’ve got a situation where a generalized finance company might find themselves with a whole lot of inventory of something, they don’t know how to sell. That’s the biggest thing it is, if you’re a finance company and you’re going to be dealing with some particular industry’s products, you probably have to value at scrap value because you’re not going to have the time or the energy or the expertise to go out there and market it the way that the original company would have marketed it. If you got it, probably the original company didn’t market it very well.
Steve Lovinger: If my inventory was gold bullion, I might get decent financing terms?
Fred Dunayer: I think that’s probably your best bet for getting inventory financing from the third party. There are some ways of getting approved. I’ll just go through a quick list here. Number one is to demonstrate to the lenders that there’s proper inventory management systems in place that would provide accurate and timely information on to the size of the inventory and the cost. You have to make sure that the inventory is protected from damage and shrinkage by either the elements or from people. You have to make sure that the assets are maintained in good shape and the lender may require inspection from time to time.
You need to be able to demonstrate to the lenders that the inventory is actually selling by showing sales orders and you have to show that the inventory is managed as efficiently as possible by keeping the bare minimum on hand while maximizing the turnover rate. Again, you have to demonstrate good business practices. Again, that’s in situations where you can actually get inventory financing. As I’ve mentioned, that seems to be challenging right now. If it’s something you need, go out on the internet, go look up inventory financing. There you will see companies that are advertising, whether you can get them to match your particular situation or not and if they can do it cost effectively is the question.
Steve Lovinger: I had some experience with traditional financing where they’re giving me a working capital loan and they would look at receivables and inventory very differently. For instance, they may lend 70% of your receivables and maybe only 30% of them in inventory, is that because of the reasons you mentioned?
Fred Dunayer: Exactly. If you don’t know how to market a particular asset and you have to, and you might find yourself owning that asset, how are you going to value it? You’re going to value it very low and hope to do better but originally price it at what you would have to scrap it for.
Dennis Zink: Let’s talk about factoring. What is factoring?
Fred Dunayer: Factoring is, it’s an unfortunate word because nobody knows what the hell that means unless they’re in the business. Basically, it’s account receivables financing. People don’t realize it but when you sell on terms, that is you sell business to business and you ship goods and you send a bill along with it, it’s maybe you’re going to be paid in 30 days, that piece of paper that represents the amount owed is actually valued. That paper is worth the number that’s printed on it. That is an asset to the company which can be sold.
Factoring is basically a third-party company coming in and purchasing that invoice, giving a certain amount of cash to the company that did the selling and then collecting from the company that did the buying. An easy way to look at it is if you take credit card transactions, if you’re a merchant that takes credit cards, you’re doing factoring because what’s happening is when you sell something to somebody with a credit card, you’re going to get the money in your bank account the next day. The credit card company gets paid by the consumer 15, 30, 45 days out and the credit card company is going to charge you two and a half percent, three percent for the process and the financing.
That’s actually factoring but in the business to business sense, it’s a third-party companies buying those invoices. There are a couple of different versions of factoring. There’s traditional or standard factoring, in that situation, we’ll call the company a factor, that’s the term for it. They actually will buy or loan against the receivable and they’ll assume the risk of credit loss. They undertake collections and they manage the bookkeeping functions. They basically become your accounts receivable department. That can be either recourse or non-recourse.
Recourse means that if the company goes bankrupt, the finance company can go back to the client. Non-recourse means they’re stuck with the credit loss. Florida is a non-recourse state which means that factoring companies do get stuck if the client customer goes bankrupt and that does result is some higher rates down here in Florida. The other kind of factoring is spot factoring. That’s just the purchase of individual invoices. It doesn’t require long-term relationship, the spot factor doesn’t manage the receivables, they don’t set credit limits. They just buy an invoice and provide the cash up front and then collect on the backside from the customer.
Dennis Zink: As a business, if I had someone calling my accounts to collect receivables, I’d be concerned about how heavy handed they were with those clients because I still want them as clients.
Fred Dunayer: That is one of the issues with full factoring, with traditional standard factoring. The factors want a long-term relationship. They will get involved in making those collection calls. That’s one of the reasons people sometimes turn into spot factoring. The difference is with full factoring, you can get a higher percentage of your accounts receivable portfolio because they’re doing collections. With spot factoring, where they’re only buying individual invoices, you usually have to have more invoices available because the factoring company will turn a bad invoice back to their client and have the client replace it with another invoice.
If you don’t want the factoring company involved in your client relationship, then traditional factoring could be problematic. Of course, everything is negotiable too. The factoring company is not going to go first beating down the doors of your customer. They’re going to come to you and involve you in the call and try to work it out in a way that’s beneficial to everybody but if push comes to shove, the finance company is looking at their own money out there and they’re going to do what they need to do to get their money back.
Steve Lovinger: If I did a factoring agreement, do my customers know the receivables are factored or is there a way to not alert them to that fact?
Fred Dunayer: Usually, it requires full disclosure and the reason is that the companies have to make the check out to the factoring company. If they make it out to the client and the client cashes the check, it becomes very problematic. Although it is fraud for them to do that, it can be problematic. There are arrangements that I’ve seen where they do lock boxes and that sort of thing but typically, it’s full disclosure.
Dennis Zink: If a company is in trouble, don’t you think they might be less likely to pay the bills of someone they don’t know versus the company that they’ve been dealing with the years? If they’re having trouble they might say, well, it’s this factor now I don’t have to pay them, or use that as an excuse?
Fred Dunayer: Typically, there will be an agreement in advance and that’s again part of the reason for the full disclosure is that the customer will sign a document that says that the product or services were received in good order and they will in fact pay the Factor and then if they don’t do it, they’re liable to be sued. That’s part of the reason that factors make more money than banks is because there is additional risks for all sorts of psychological and other reasons that the financing company might not get paid.
Dennis Zink: Let’s take a client who doesn’t have accounts receivable, but may be a new customer in a new business, but they have an order that can’t be filled because they don’t have the funds, is there a way to finance that?
Fred Dunayer: Yeah. I think what you’re looking at is purchase order financing. The challenge there is that the companies are pretty restrictive and it’s pretty expensive. I also want to differentiate between contract financing and purchase order financing. Let’s say you as a company gets a contract that you can’t fill not because you can’t get the supplies but you don’t have the money to buy the supplies. A contract in it of itself can be cancelled. A company’s not going to want to provide you with funds and then have the contract get cancelled and who knows where the money went.
When you actually have a purchase order from that customer, that then is again a document with value because it should not be cancellable so the company then will provide those goods and services for the price defined. A lot of purchase order finance companies have certain limits and a lot of restrictions because, again, they are depending on their client to perform to the contract. A number of them won’t deal with work in process type stuff. Let’s say, part of your job is to buy a bunch of parts, put them together and then sell them to the client. A lot of financing companies, purchase order financing companies won’t do that. They’ll only purchase finished goods for resale, again because if they have a situation where they have to liquidate, they’ve got finished goods that they can sell. It’s not a bunch of resistors in a box.
Steve Lovinger: I had heard there are certain industries like the rag fabric industry that’s predominantly financed by factoring. Is it true that certain industry’s banks don’t lend too much and they go to factoring more?
Fred Dunayer: Yeah, in New York and Chicago, particularly the shmatah business, as they call it, the clothing business, does a lot of factoring. I’m not sure what the reason for that is. A lot of sweetheart deals have been going on since the 1920’s or something but the thing is with factoring, we go back from purchase order financing for a minute, it’s not something. In fact that’s true of purchase order financing as well. It’s not something you want to use on a continuing basis. It’s too expensive. When it’s used judiciously to solve a particular problem, it makes a lot of sense but as a standard way of financing your business, it’s just a little bit pricey and a little bit complicated.
Typically what I do with my clients is I’ll provide them with some sort of whatever kind of a bump they need. They might need to get over particular payroll problem. Maybe they got surprised by a tax bill that they weren’t anticipating. I had a situation where a company came into a merger where they had the opportunity to buy another company that would have increased their profits. It was a vertical situation where they would have gotten both their vendors profits as well as their own by providing a certain amount of capital to this other company.
Doing things like that make a lot of sense because the amount that it cost you is basically irrelevant to the benefits that you would get by doing the transaction. In those kinds of situations, these kinds of alternative financing programs work really well but as soon as you get past that hump, I will walk my client into a bank and say, okay, this guy, not only is this guy ready but he’s been a good client of mine, he always pays his bills, his clients, his customers are good. Now, give him his three to four percent loan because what I’m charging at is just not good from a sustainable financial practice. I don’t want him working for me. I want him working for himself.
Steve Lovinger: Is there a range of a percent of receivables that generally can be factored? Let’s say I have a $100,000 receivables, can I borrow 50%, 70%?
Fred Dunayer: It actually depends on the type of factoring we’re talking about. In traditional factoring, you can get up to 80 or 90 percent of the receivables financed. By the way, I want to explain, people think that if I say 80% that means the finance company gets the other 20%. It doesn’t work like that. What happens is if they advance you 80%, they’re holding on to the 20%. It’s like an Escrow. When the customer pays, the factoring company then calculates the amount due, subtracts it from that remaining 20% and sends a second check back to the client for the balance.
It’s not just the initial transaction. There’s a second check that comes back to the client based on the amount of time that it took to collect the amount from the customer.
Dennis Zink: As a follow up to Steve’s question, what kind of percentage does the factoring company actually net out?
Fred Dunayer: It really varies by the amount and the time frame. A lot of companies charge something along the lines of one percent for every 10 days, that’s in the traditional world. In the spot factoring world where I typically operate, we charge on a per day rate. We don’t actually require the invoice to be factored on the day it’s cut. If the client can sit on that invoice and age it themselves for so many days before they actually need the money, they only have to pay for the number of days from the day they get the money until it come backs in. It could be five or six days, as little as that and then of course, then it’s much smaller then.
Steve Lovinger: Are there other fees, charge in addition to the interest rate?
Fred Dunayer: Traditional factors will typically charge for an application, processing fee maybe a per transaction fee, I’m not trying to sell my service but we don’t do that. We only charge out of the transaction.
Dennis Zink: Where do you look for sources of alternative financing? How do I find them?
Fred Dunayer: Well, there are several different ways. Number one, you might go ahead and take a look, Google is your friend. You have to be very careful there though because finance companies are pretty notorious for putting up teaser rates that are unattainable. I’ll give you a quick example with factoring. The rates you’ll see for factoring are typically quoted against the face value of the invoice not against the amount that is actually lent. If you only need, let’s say you’ve got a million-dollar receivable out there and you only need $10,000. The rate is going to be incredibly low because you’re not taking a whole lot of that invoice.
Whereas if you’re getting $900,000 out of that million-dollar invoice, the rates you’re going to see are much higher. You have to be careful and you might pick them off the internet but just don’t pay any attention to any rates that are quoted in the search engine. You have to get down to the details and talk about that. Some banks provide alternative financing. They may or may not be competitive. A lot of them, it’s under the bank’s name but it’s actually a third-party company doing it because banks don’t typically have the staff or the resources to do all the follow up that’s necessary for these kinds of transactions.
There’s also brokers, there’s financing brokers, cash flow brokers out there. If you go that route, you want to make sure to talk to a couple of them because they all have their own structures. They all have different connections and you probably want to find out some level of detail about their backgrounds and their connections before you choose one.
Dennis Zink: What concerns should our listeners have when they’re choosing a financing company?
Fred Dunayer: The main thing is obviously, everybody wants to know the rate but you also want to check out the integrity of the company. If they’ve been doing it for a long time, if they can share some customer information with you, typically these companies are a little bit reluctant to share customer information because there is a perceptions that if a company is using these services, why? Are they in trouble etc. Obviously, most of our companies are using our services because they’re trying to grow. We won’t lend to companies that buy invoices from companies that are circling and drain to just prolong their agony and put ourselves at risks. Nevertheless, there are some perceived issues with using a non-traditional financing that some people take on.
Steve Lovinger: My experience has been that certain banks, leasing or factoring companies specialized by industry. A good example is I think the reason fabric industry is dominated by factoring is they understand how to liquidate the inventory and they have the infrastructures in place better than banks. Would you agree with that?
Fred Dunayer: That makes a lot of sense that there’s a lot of outlets for clothing and if these companies are prepared to liquidate it and they have that industry expertise. They can then offer more competitive rates and they can actually take burdens off the manufacturer’s hands for overstocks and things like that.
Dennis Zink: Thank you for enlightening us today about alternative financing. One question how would our listeners contact you if they wanted to use your services?
Fred Dunayer: I appreciate that. My company has called the Interface Financial Group. We’re here in Sarasota. My number is 941-400-0977941-400-0977 or fdunayer, spell that out, F-D-U-N-A-Y-E-R @interfacefinancial.com.
Steve Lovinger: Is that only for Florida-based companies that you provide the service?
Fred Dunayer: My company actually has something like 150 offices in seven different countries. I can hook anybody up, anywhere.
Fred Dunayer: You’ve been listening to Been There Done That in our new studio. Thank you all for listening and have a great day.
Fred Dunayer: You’ve been listening to the SCORE small-business success podcast, Been There, Done That. The opinions of the hosts and guests are theirs and do not necessarily reflect those of SCORE. If you would like to hear more podcasts, get a free mentor, view a transcript of this podcast or would like more information about the services we provide, you can call SCORE at 800-634-0245 or visit our website at www.score.org. Again, that’s 800-634-0245 or visit the website at www.score.org.