financial strategies

7/29/2019 Financial Strategies

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BREAKTHROUGHFINANCINGSTRATEGIES

How to Dramatically

INCREASE YOUR CASH FLOW

An analysis of conventional and

Alternative techniques business owners can use

To strengthen their corporate cash position

FFIIRRSSTTCCAAPPIITTAALLFFUUNNDDIINNGGCCOORRPPOORRAATTIIOONN3175 Starbright Court, Suite D. Middleburg, FL 32068

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Internet: http://www.fcfcorp.com First Capital Funding Corporation-1995-2002


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Table of Contents

I. The Dilemma of Business Financing.............................................................4Financial ignorance is not a bliss .................................................................4

A host of funding variables...........................................................................4

In times Gone By .........................................................................................5Assess Your Assets .....................................................................................5

II. All the Way to the Bank...............................................................................7Conservative Institutions.............................................................................7Where Are They When You Need Them? ..................................................8What Banks Want from a Borrower ............................................................9The Bottom Line .......................................................................................10

III. Venture Capital .........................................................................................11High Risk, High Profits ..............................................................................11

Two Different Worlds ................................................................................11Financial Angels Venture Capital ..............................................................12In and Out Profits ......................................................................................12Shared Ownership ....................................................................................13Governments as Venture Capital Sources................................................14

IV. Real Estate Financing ..............................................................................15Money from Commercial Real Estate .......................................................15Customized Mortgages .............................................................................15Terms and Money Sources.......................................................................15Hard Money ..............................................................................................16

V. Go Public With Your Business...................................................................17Corporate Necessities...............................................................................17Costly Web of Securities Laws .................................................................17Public Sale of Stocks ................................................................................18Hope for Small Business that Can "SCOR................................................18

VI. Leasing For Dollars ..................................................................................19Equipment Financing ................................................................................19Reporting Under the UCC.........................................................................20Leasing Considerations ............................................................................20

VII. Government Financing ............................................................................21Tax, Spend and Help? .............................................................................21Red Tape Tangle ....................................................................................21Small Business Administration................................................................22SBA "Loans.............................................................................................22How To Find SBA ...................................................................................22

Farm Loans Aren't Just For Farmers .......................................................23


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Still More Federal Money .........................................................................23Think Local ..............................................................................................23

VIII. Factoring -- Assured Money for Business Success ................................24Deal Not to Be Refused ..........................................................................24

Constant Dollars for Businesses Large & Small .....................................25A Nation of Slow Payers .........................................................................26High Cost of Extending Credit.................................................................27Case Studies of Cash Flow Problems.....................................................27Natural Cash Disasters ...........................................................................28

A Big Order .............................................................................................28Keeping a Conveyer Company Moving...................................................29You Can't Always Bank on It...................................................................29Bottoms Up .............................................................................................29The Factoring Advantage........................................................................30What Does Factoring Cost?....................................................................31

A Case in Point .......................................................................................31Factoring Considerations ........................................................................33Recourse or Non-Recourse ....................................................................34Notification..............................................................................................34What Factors Do?...................................................................................35Credit and Collection Services ................................................................36In Summary ............................................................................................37


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I. The Dilemma of Business Financing

Neither a borrower nor a lender be;For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry.

William Shakespeare, Hamlet

Financial Ignorance Is Not Bliss

The United States is a nation built on and committedto the capitalist system of free market economics.Yet too many Americans do not truly understand howbusiness actually operates. In no area ofcommercial activity is this lack of knowledge more

evident -- and the need for information more critical --than business finance, which is the process by whicha company obtains sufficient money to assure thesuccessful creation of products, services, profits and

jobs.While much of the blame for this general

economic illiteracy can be placed on decades ofdeficient education concerning businessfundamentals, that does not explain the narrow ideasheld by many of those professionally active in theworld of finance -- bankers, loan officers, receivable

lenders, equipment and real estate financiers. Manyof these financing "experts" concern themselvesprincipally with their own areas of interest. They

ignore or even denigrate alternative money solutions. This constricted approach may stem inpart from the profit motive, since lenders naturally want to make money by promoting theirown methods. But for the entrepreneur in need of cash, financial tunnel vision can spelldisaster.

Unlike the established, historic use of mortgages to buy homes or commercial realestate probably the financing method most familiar to the general public -- other intricacies ofbusiness finance remain mysterious rituals conducted in a vague high stakes world moreimportant to others. Thus the casual reader of daily newspapers skips the business sectionin favor of the sports pages.

A Host of Funding Variables

That sort of detached popular attitude changes quickly when a person goes intobusiness and has a sudden confrontation with the practical need for start-up and operatingcapital.


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To have any chance of success, the new business owner must quickly master a host offinancing techniques. These methods include the customary commercial practices of theindustry; distinctive methods of borrowing and payment; credit; collateral; management andinternal fiscal policies -- and even an acquired ability to calculate the interest rate impact ofthe latest decisions imposed by the Board of Governors of the Federal Reserve System in

far-off Washington, D.C.Obviously, lenders and investors are major sources of initial or expansion businesscapital. When considering any business, these pragmatic people look for one thing -- value,meaning total assets minus liabilities. Oddly enough, what some lenders consider valuable,others think is worthless. For example, projected earnings, past profits and managementskins mean little to a traditional bank loan officer, who will insist on seeing a multi-year cashflow "track record" before even considering a loan. On the other hand, venture capitalinvestors usually appreciate the value of so-called business "intangibles" such as innovativeproducts, skilled management or accumulated experience and success in an establishedbusiness.

In Times Gone By

There was a time when American bankers freely accepted and granted businessapplications for a variety of loans that kept the wheels of commerce turning. Still today,themajority of business loan dollars come from traditional banks. But as we have seen, the"good old days" of bankers' easy money are unlikely to return.

In those days it was possible for a business to obtain inventory loans of a six- or ninemonth duration, based on inventory availability, with installment payments made as inventorywas sold.

Banks were willing to make accounts receivable loans, based on the standing of

business customers, a history of on-time collections and good credit ratings. While similartransactions are at the heart of the factoring business, traditional banks won't touch suchloans today. Like the late lamented dodo bird, they are very much extinct.

Once banks would even make fixed amount time loans togood business customers,with an agreed amount payable at the expiration of a set time period. While the lump sumpayment was a drawback, not having interim installment payments was a positive advantage.Try to obtain one of these loans today and a banker will look stunned just because youasked.

The most prevalent form of bank loan extended to business used to be the line ofcredit, a revolving maximum dollar amount to be used as the borrower saw fit, with regularinstallment payments based on the outstanding balance. This kept interest payments lower

and gave the business always-available funding. In the murky wake of the savings and loanscandals, new banking regulations make the line of credit a fast-disappearing oddity from thepast, for all but the best "blue chip" companies of the Fortune 500.

We have conducted this brief historic tour of past bank loan polices so youngerreaders will know what they missed. Older readers so inclined can shed a tear for nostalgia'ssake.

Assess Your Assets


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To formulate a business plan that will successfully attract financial support today, youmust compile a solid inventory of assets and liabilities which demonstrate a true net assetvalue -and these numbers must be verifiable and thoroughly convincing to a prospectivelender. Oddly, many business owners fail to fully evaluate all their assets -- one of the

important ones being Accounts receivable, a point we will explore more fully later.One very significant lesson a capital-seeking businessperson must learn is the propermatching of assets with lenders who can appreciate those assets. A rural bank specializingin seasonal agricultural crop loans may not know the first thing about financing wildcat oil wellexploration, so don't bother trying to fund your offshore drilling project there.

The next step is to understand whether a prospective lender or investor will see yourassets as secured or unsecured. Real estate lenders, usually banks or savings and loans,will only make secured loans; tangible real property gives them the collateral they want, andthat security gives the borrower the cash he needs.

There are also unsecured sources of finance, backed by intangibles like patents,trademarks, new processes and products, or exciting, potentially profitable ideas and

management. Here's where venture capital investors will be interested.A business that formally incorporates can sell shares of stock as a means of finance,although incorporation means more lawyers, accountants and usually imposes strictcompliance with federal and state laws and regulations that can be onerous and costly.

Then there are life insurance companies and pension funds looking for goodinvestments, foreign investors, even public financing from federal and state direct lendingand loan guarantee agencies. You might consider forming a limited or general businesspartnership, although that arrangement guarantees shared management with possibleproblems, especially when one partner puts up much of the capital. Or you may sell propertyand lease it back for extended periods as a means to raise cash.

One form of business finance often overlooked by those unfamiliar with the spectrum of

lending possibilities is factoring -- the process of selling your company's accounts receivablefor cash. Factors (the funding source) can be especially helpful to new businesses juststarting up, or to an existing company in a cash bind for operating or expansion funding.Factors are unique because their willingness to provide funds is based not so much on thestatus of the client company, but rather on the economic strength of the customers who owemoney to that company.

In the following pages we will discuss various forms of currently available businessfinance, the pros and cons of each -- all with a constant eye on helping you find the bestcommercial financing suited to your business and your unique individual needs.


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II. All the Way to the Bank

Light purse, heavy heartBenjamin Franklin

Conservative Institutions

The English essayist, Charles Lamb (1775-1834) observed in one of his writings that"the human species ... is composed of two distinct races, the men who borrow, and the menwho lend." In the modem vernacular that would be the "haves" and the "have nots."Whatever you call that harsh division, it has always been far better historically to benumbered among those who have enough to avoid borrowing. Most of us are not sofortunate.

Money is a commodity like any other; its price is the rate of interest charged. As withany other desirable asset, the price of money rises in response to increased demand, or assupply falls. In other words, when farmers have a year of poor crops, produce prices

increase; when loan Money is tight, interest rates rise.As a commodity, however, money does have some unique characteristics. Whilethere may not be a direct connection between what happens to a California lettuce farmerand a Brazilian coffee grower, what happens to money impacts virtually every othercommodity.

Greatly increased money supply devalues the dollar in a process we all know painfullyas inflation, where more and more dollars buy less and less in the way of goods andservices. Unlike other commodities, money loaned is not meant to be permanentlyconsumed. When it is purchased, or borrowed, money must be paid back with interest on apre-determined schedule.

The single greatest source of business money, or "credit" as it is also called, is the

nation's banks. These financial institutions have a reputation for being very conservativewhen lending money.That is as it should be. After all, banks get their money from thousands of people who

demand a guarantee that their money will be safe and available when they need it The lastthing depositors want is a bank handing out cash in unsafe loans that may jeopardizeaccounts, and even the existence of the bank itself. That became abundantly clear duringthe savings and loan debacle in the 1980s -- a mess that is far from being cleaned up, andone that will be costing Americans well into the next century.

Centuries of experience with both human nature and banking have produced federaland state government regulation of the banking system. Official oversight requires periodicaudits and checks, demands certain minimum capital availability at all times, and hopefullykeeps bankers and balking honest.


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Where Are They When You Need Them?

Present operational policies imposed on American banking -- stronger protection fordepositors, tighter official regulatory standards due to vivid memories of disastrously laxlending by S&Ls now make it virtually impossible for even a mildly poor business credit risk to

obtain a bank's consideration, much less a loan.In the wake of several recent "tightening" increases in bank prime and discountlending rates imposed by the Federal Reserve, small businesses are asking: "When wascredit ever loose?"

While many businesses benefited from the U.S. and European economic recoverystarting in the second quarter of 1994, these same companies have had great difficultyfinding working capital to expand and meet new demand.

"There's supposedly billions of dollars out there, but not much of it is going the way ofsmall businesses that have sales of less than $2 million annually and a need for a $500,000loan," said Miles Spencer, a Connecticut investment banker specializing in small businessloans, in a November 1994 interview with the Wall Street Journal, And the sobering fact is

that 97 percent of America's 18 million businesses fit the definition of "small business."Typical is the predicament of Hydrokinetic Designs, Inc. of Coral Gables, Florida, aproducer of popular twin nozzle showerheads. Although the company's sales have followedthe home building upsurge and more than doubled in 1994, Hydrokinetic was turned downtwice in 24 months for bank loans. Banks would not lend against the company's $450,000 ininventory, demanding instead fixed assets as collateral. Unfortunately, the company lackssuch assets because they subcontract most of their work to other manufacturers and don'tneed real estate and machinery. This lack of capital has severely limited growth, forcingHydrokinetic in one case to decline the order of a large retail chain because they could notfinance production of a rush order of 10,000 additional units.

The Journal reported that banks uniformly were declining loans requested bycompanies without fixed assets, as well as newer businesses with little operating history, andolder turns that had suffered economic setbacks.

Charles Freeman is the chief executive officer of Commercial Capital Corporation,Inc., a New York financial services company for small businesses. He says many of thebusinesses rejected lately would easily have qualified for loans in the easier-money 1980s.Freeman's view: "Banks are expanding credit, but mostly to existing borrowers who alreadyhave lines of credit, not new ones."

Meanwhile, "Themes that has, gets," as the old saying goes. The biggest companiesare finding much easier access now to banks, equity capital and institutional lenders such asinsurance and pension funds. But potential small business borrowers are left out in the cold.In response to an August 1994 Federal Reserve survey, senior loan officers of only 6 out of57 banks contacted said they had eased credit standards for small business borrowers. Atthe same time a year earlier, only 7 out of 60 banks said they had eased small businesscredit.

In spite of a special push by the federal government to increase small business loansin 1994, only 10 percent of banks contacted said they agreed. On August 30, 1994, the U.S.Small Business Administration launched a new program guaranteeing 75 percent ofqualifying small firms' revolving credit lines up to $750,000. SBA predicted the program


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would generate over $1 billion in new loans in the first year, but in the first four months onlyfive loans totaling $1.5 million were made. An SBA official admitted most bankers are highlyreluctant to make loans secured by inventory and receivables, rather than plants andequipment.

None of these sad statistics surprised Alfred Heyer, president and founder of Ecco

Products, Inc. in Freehold, New Jersey, a maker of environmentally safe household andindustrial cleaning products. Two loan applications were rejected within the last year, eventhough Ecco is nearly three years old and expects revenues in the fiscal year ending June1995 tojump to $3 million from $300,000 the prior fiscal year. Heyer said, "We have goodproducts and a good future, but we are not 'bankable' according to the banks' standards."

What Banks Want from a Borrower

In spite of this gloomy banking outlook, banks are making loans, and your businessmay be the one that successfully connects with the right banker at the right time. When youapproach a bank, always keep in mind that bankers don't really care too much about what

your intended use for borrowed funds might be. What they want to know is whether or notyou can demonstrate a realistic ability to repay the loan, and what type of tangible collateralis available as security for the loan -- preferably hard ' foreclosable assets like real estate,buildings and machinery.

Loan length does relate to the proposed use, however. Short-term loans, whenavailable, are generally restricted to seasonal inventory needs, receivables or workingcapital. Long-term loans are used to fund plant expansions and improvements, majorequipment purchases and real estate. Most standard bank loan agreements allow the bankto "call" the loan at their option at any time, and most require a personal guarantee from thebusiness owner as well.Here are the major points a banker looks for when reviewing a business loan application:

V. Cash flow. A consistent record (a minimum of three years or more) ofavailable cash flow; net profit is not nearly as important as receivables that are consistentlypaid on time.

2. Strong collateral. Even with a good cash flow, bankers won't take receivablesand inventory as security for a long-term loan, but they might -- just might -- consider them asbacking for a line of credit; but you will have to pay it off within a year or less in order toqualify for a renewal. The collateral must be the kind that retains its value over the life of theloan, because banks want something of value to be there if they must foreclose.

3. An established history of increasing profits and retained earnings.Bankers want to lend to profitable, going concerns that can produce plenty of proof ofrepayment ability; and they don't want profits syphoned off to unreachable places like anowner's personal income.

4. A major interest in the business by the owner. Banks want clearevidence the owner: a) has good credit, business-wise and personally; b) plows profits backinto the firm; c) Has a large personal equity investment in the firm; d) has a high personal


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net-worth exclusive of the firms status; e) has not stripped the firm by taking profits thatshould remain in the company. Income tax returns for the last two to three years willnormally be required.

5. Financial projections. Show why this is a loan good for your business, and that

you have thought through what the consequences of failure win be. You want to give thebanker all of the information necessary to increase his or her comfort level; you want thebanker to be able to approach the lending committee and confidently recommend approvingyour loan application.

The Bottom Line

What banks want are good character, good credit, good capital investment, goodcapacity to repay, and good collateral. And you may well be muttering to yourself, "If I had allthose things, I wouldn't need a bank loan."

Even if your business (and you) fail to meet all these stringent loan standards, you maystill be able to find a hungry, aggressive bank somewhere looking for loans and depositors,one willing to lower requirements a little. The unusual lending institution fitting thisdescription will be a smaller local bank anxious for growth, but certainly it won't be the branchof a massive banking conglomerate with an unyielding policy against potential loanheadaches, however slight.

If your business balance sheet is stained with any financial problems, it won't take anastrologer to predict your bank loan chances correctly. Money may be "tight" in general, butyour chances would be even tighter.

While you should always try, be prepared for the reality that bank loans are not likely tobe the answer to your financial prayers.


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III. Venture Capital

Give and it shall be given unto you.

The Bible

High Risk, High Profits

Venture capital is high risk capital.Another important distinction: people with available venture capital are investors first, notlenders. They want more than repayment with interest and they may want "a piece of theaction."

The driving force behind this type of investor is not so much interest in your tangibleassets as security, but rather an openness to innovative ideas and formulas, dazzlingmanagement techniques, imaginative products that could sell big and produce big profitsfast.

Where banks and institutional lenders want hard security to back up loans, the venturecapitalist uses your debt and his acquired loan equity in your business as his investmentvehicle that is why this form of available business money is appropriately called "risk capital."In this sometimes chancy arrangement, your ultimate business success is the investor's onlyreal guarantee of a return on investment.

Two Different Worlds

As further evidence of public misperceptions about business, most people tend to think ofventure capital as the traditional, formal sources of such money. These are usually solidfinancial partnerships backed by high dollar funding from big institutions -- insurancecompanies, business and labor union pension funds, foundations or even the state andfederal government, in cases such as Small Business Investment Companies (SBICS) orMinority Enterprise Small Business Investment Companies (MESBICs).

There are fewer than 1,000 of these venture capital firms nationwide, and many aresubsidiaries of banks or major corporations. These operations are run very carefully, for themost part, by professional money managers with strict fiduciary responsibilities to theirfunding sources, groups that demand capital preservation, prudent investment and bigreturns.

Of the $30 billion of private venture capital invested in American business each year,only about 10 percent, or $3 billion, comes from these traditional established venture capitalsources. There are approximately 18 million businesses in the U.S., but only about 2,000 ofthem succeed each year in obtaining venture capital from such institutional investors. Thatmeans fewer than 1,400 businesses get help each year, and of those, only about 250 arenew start-up businesses.

And yet this is the "venture capital" segment that gets all the media attention whenthe business news is reported.


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What these cautious institutional investors are looking for are "sure things," not risk. Bytheir cautious policies they have long since taken the "adventure" out of venture capital,searching instead for investments averaging 100 percent return or more every year over thelife of their investment. They know that half of business loan applicants will fail, and the otherhalf will be lucky if they produce 20 or 25 percent returns. That is why less than one percent

of all applicants to these traditional "venture" capital sources ever get any of this institutionalmoney.

Financial Angels

The true unsung heroes and heroines of venture capital -- the "financial angels" as theyare endearingly called -- are the individual private investors who put up the other 90 percentof that $30 billion of capital available to businesses annually.

Without them, American small business would have little chance of collective orindividual success. They are usually professional people with extra cash, on the lookout for

good moneymaking investments -- doctors, lawyers, dentists, accountants, managers, retiredpeople of wealth, relatives and friends.More than half of the $27 billion annually invested by these truly adventuresome people

goes directly to new start-up businesses, almost all of it to small businesses. While onlyabout 31 percent of traditional venture capital goes into financings under $1 million, and only13 percent under $500,000 -- the informal private venture capital community invests 90percent in loans under $1 million and 82 percent under $500,000.

The term "angel" comes from Broadway, where it was first used in the early part of thiscentury to describe high risk investors willing to put up money in order to launch newBroadway plays and musicals. Now an angel is any investor willing to take a chance on anentrepreneurial business venture. Together this host of more than a million angels is the

largest single source of risk capital in the nation. Sometimes these angels are truly blessed;in 1903 five of them invested $40,000 each in a company started by a fellow named HenryFord, and over the next 16 years it earned them $145 million.

In and Out Profits

Either institutional or private, venture capital investors tend to look for similar things inany supplicant business.

First and foremost, they want to make a lot of money in a very short time -- ten years orless, usually.

They want a company that has absolute, exclusive control over a unique proprietaryproduct or service protected by patents, copyrights, trade secrets or private formulas no oneelse has or is likely to get anytime soon. They want to see proof of a potential growth marketof $50 to $ 100 million in gross revenues within five to ten years, and only then will theyagree to pick up the tab.

They want -- at a minimum -- an annual average return on their investment of at least 20or 25 percent, and some demand as much as 30 or 40 percent return.


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They want a good management team and structure -- people with ideas and abilityand a proven record of personal success. To the venture capital lender, exceptional,seasoned management is often the most important single factor. They look for honest high-achievers with competence, experience, good character, and lots of energy, realism andcommitment.

They want products that are innovative, but not necessarily revolutionary. The nextgeneration of an established product is more attractive than something no one has everheard of before, however useful it may eventually become.

Shared Ownership

Few venture capital investors require hard security as collateral in exchange formaking money available to a business. What they do want is a profit and an unfettered rightto receive that profit. As a practical matter, this usually means the money comes with ademand for part ownership, or equity, in the proposed enterprise, often in the form of a

partnership.The possibility of such an outside intrusion into the management of your existingbusiness might -- and should -- give you serious concern. You must decide whether or notyou are willing to surrender absolute control of your business in exchange for needed capital.

It is entirely possible that an experienced venture capitalist could well turn out to bethe best partner you could have. The advice and experience injected could be far morevaluable than even the total dollars invested. It could mean new business contacts andcustomers or other financing sources allowing expansion and growth. On the other hand, itcould mean irritating interference and the possibility of losing the company you worked sohard to create.

However, if you are sophisticated enough to seek venture capital investment, you

should have little trouble dealing with a partnership arrangement should it be required. Thekey is to make sure everything is clearly spelled out in writing before the agreement isfinalized.

In what the law calls a "general partnership" there is an association of two or morepersons (or other legal entities) formed to conduct a business for mutual profit. More than 90percent of all partnerships in the United States are general partnerships in which eachpartner is a co-owner, jointly running the business, each acting as agents for, and having afiduciary relationship with one another. As a result, each partner is personally liable for thebusiness acts of the others, including partnership debts and liabilities.

General partners, by common agreement, may have the same or differing capitalinvestments, and may share profits and losses in the same or varying proportions, usuallycorresponding to each one's investment. A partnership is recognized in law for mostpurposes including contracts, credit, bankruptcy, debt, and acquiring and transferringproperty. A partnership, as such, does not pay tax -- its partners do as individuals owingincome tax on their partnership income.

What is known as a "limited partnership" has at least one general partner who usuallyis the managing partner, and one or more "limited partners," usually investors in thebusiness, a likely role for a venture capitalist. The limited partner, whose status by lawforbids any role in day-to-day management, has no personal liability beyond the amount of


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their capital investment, but does have a right to receive agreed amounts of income whendistributed. This arrangement is created by a partnership agreement, a basic governingdocument to which all partners are parties.

While this may sound complicated, venture capital comes with a price tag and oftenthat reads "shared control" of the business.

One last word about shared control by venture capital investors: the central purpose ofsuch an investor is to invest at low cost in the stock of a young company with a bright future,stay with the company for as short a time as possible, then sell out at a "killing" -- meaning abig, fast profit followed by an equally fast exit. Most investors will want a prior agreement asto how this. exit will occur, and there are two main possibilities: a) going public by the sale ofshares on the open market; or b) a private sale of the investor's shares to management or toothers. In order to retain control, most business owners will want the right to buy out theinvestor when the time comes, but this exit strategy should definitely be in writing, along withthe partnership agreement and the original capital transfer from the investor to the company.

Governments as Venture Capital Sources

There are numerous government sponsored venture capital firms. On the federal levelthey are bankrolled by the taxpayers through the U.S. Small Business Administration and areknown as SBICS. Those directed toward helping with lending to minority groups are calledMESBICS. The only major difference with these venture capital sources is that they areforbidden by law from taking over management or control of a company.

There are also a host of state government-sponsored small business capitalprograms, usually providing government guarantees as backing for conventional bank orother business loans. Your local economic development agency should be able to direct youto these programs.


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IV. Real Estate Financing

Property has its duties as well as it rights.

Thomas Drummond (1797-1840)

Money from Commercial Real Estate

The "good news-bad news" business enterprise is one that finds itself in a cashcrunch, but already owns unencumbered commercial real estate that can be mortgaged.

When we speak of commercial real estate, we mean land and buildings that areowned by or used by a business rather than for personal use.

Compared to financing business operations, obtaining financing for real estatepurchase or improvement is a borrower's "piece of cake." And of course, a business thatowns real property can always use it as collateral for a cash equity loan. Oddly enough,many businesses that have been around for a while, buying land and buildings at their

inception, find in a few years the real property has increased in value far more than thebusiness operation itself.Therein lies the cash.The reasons a lender is almost always willing to loan money, even to a shaky

business enterprise, with real estate as collateral, are all very reasonable: land isn't goinganywhere, it will always be marketable, it retains value, and it can easily be appraised as toexact value.

Customized Mortgages

Although home mortgages can almost always be written by filling in theblanks on aprinted form, commercial real estate financing deals each have to be customized. That isbecause there are so many more variables involved in these deals, including zoning,occupancy, the proposed business use, licensing of occupants, degree of risk and the creditof theland owner. Some types of commercial real estate used for rapid turnover businesseslike restaurants or gas stations are unattractive to lenders. Others, like apartment houses,are better bets for financing.

Financiers are also wary of land that may have been used in the past for purpose thatproduced environmental damage or toxic wastes. Under federal law subsequent owners aremade responsible for clean up costs once land is found to have such problems. Needless tosay, a surprise like that instantly diminishes land value.

Terms and Money Sources

Most conventional commercial real estate lenders will finance from 65 to 70 percent ofappraised value, including improvements. For purchases, lenders determine down paymentsbased on a formula taking into account cash flow to cover all costs of the purchase includingoccupancy, taxes, interest, insurance, maintenance, and management. A similar formula will


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determine the amount of equity that can be borrowed against already owned real estate. 'MeSBA requires only a 10 percent down payment for business real estate. Sometimes a lenderwin defer payments until cash flow increases, but that is rare. More likely is a balloonpayment plan, a few years of lower monthly payments, then the balance all comes due atonce, requiring refinancing.

Banks, savings and loans, commercial mortgage brokers, venture capital are all goodsources for real estate financing because they all like hard assets as collateral.

Hard Money

There are also so-called "hard money" brokers and direct lenders who get their namefrom the type of bargain they drive. They rarely lend more than 65 percent of the property'svalue and they may charge from 3 to 15 points on top of the deal. They usually lend only forthe short term - three to five years at most.

But hard money people rarely ask many questions about credit, confining themselves

to the real property in question. They move fast, settle in days, and are often available fortemporary "bridge" loans or to avoid foreclosure in a pinch. Of course this often meansrefinancing within a short time, but it does produce cash in a hurry.


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V. Go Public With Your Business

Is it not lawful for me to do what I will with mine own?

The Bible

Corporate Necessities

A major reason for incorporating a business is to protect its owners and managersfrom personal liability for company activities and debts. For purposes of examining variouscapital sources, we have assumed that your business is incorporated under the laws of oneof the fifty states, the District of Columbia or a U.S. territory; however, being a corporation isnot essentialto the ability to borrow money or attract investors.

In order to benefit from the form of capital procurement now about to be explained --the sale of shares of stock in a business corporation -- your business must be incorporated

and able to issue shares of stock.A stock corporation is an incorporated business with legal authority to issue capitalstock, ownership of which is vested in individual shareholders who by purchase of theshares become owners of the corporation. The company is also authorized to pay its profitsto theseshareholders in the form of dividends.

Common stocks are issued to shareholders who have the right to elect members ofthe board of directors, share in profits, and in a final distribution of assets if the company isdissolved. Preferred stocks are held by investors who may have superior rights to dividendsand assets upon dissolution, but usually have no voting powers. In a small corporation, statelaw will require a minimum number of shares of stock to be issued and they may be held by a

single owner, or by a small number of owners.Corporations raise huge amounts of capital through the public sale of shares of theirstock, the value of which depends on what an investor is willing to pay for each share. All thefactors we have discussed that are of concern to any lender also apply to investors -- cashflow, profits, management, future prospects and the potential return on investment, in thiscase in the form of dividends paid on the stock owned.

A Costly Web of Securities Laws

Unfortunately for the small business person, federal and state laws governing the

issuance and sale of corporate stocks require a costly and complicated ritual of paperworkand procedures, even before outside capital investment can be solicited. Ibis complex legalprocess has to be followed even before you can call a friend or relative to offer them sharesin your business. Failure to comply with such laws can result in heavy personal civil finesand criminal penalties.

Generally, corporations, shares of which are not listed or traded on a public stockexchange, are called "close" or "privately owned" companies. Close corporations privately


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offering shares to a small number of people may be exempt in limited ways from somefederal and state laws controlling stock issues, but expert advice should be obtained to findout if your company might qualify. Usually issuance of shares to the original incorporators ofthe company are exempt from registration. The Securities Act of 1933 (Rule 504) givesstates the power to regulate most offerings of stock valued under $500,000 in a twelve-

month period, so state laws should be carefully checked.

Public Sale of Stocks

The right to solicit funds from the public by the issuance and sale of stock comes withcertain minimum requirements, which include the state and federal filing of a registrationstatement concerning the securities to be sold, along with lengthy disclosure documentsabout the company with detailed information for potential investors, as well as currentfinancial statements. AU of this information must be made public. Issuing a public offering ofstock also requires advice and assistance from attorneys and stock underwriters, and a

possible audit by accountants, which can be very expensive. In addition, there must becompliance with state laws governing persons associated with stock sales includingstockbrokers and dealers, investment firms and individual investment advisors.

If you can get beyond the technical complexities of stock sales, selling shares in abusiness may be an excellent way to raise capital -- if certain factors are present. Obviouslythe company must have investor appeal, so all the requirements any lender or investor wouldwant to see must be present -- good management, appealing products, a record of earnings,profit, cash flow and a good future.

Hope for Small Business that Can "SCOR"

In recent years there have been state legislative attempts to simplify securities lawsfor small businesses wanting to sell stock to the public. While this still means the expense oflawyers, accountants and paperwork, it has eased the situation somewhat.

Called "SCOR" - Small Company Offering Registration (also known as ULOR, for"Uniform Limited Offering Registration") - this legal method is now available in over 30 states,and the rest are likely to have the legislation soon.

Once a company registers in one of the named states, stock sales can also be madein Delaware, the District of Columbia, and New York. For a current list of eligible states,contact the North American Securities Administrators Association at (202) 737-0900. Even ifyour business is not based in one of these states, you may still register and sell yoursecurities in the states, which have adopted SCOR.

Many small companies have successfully used SCOR to sell stock without using asecurities underwriting firm. This works particularly well with an established customer baseor other supportive source of investors. One of the success stories of SCOR is Real GoodsTrading Co., an Ukiah, California, mail order retailer, which made an 11 -state, $1 millionoffering to its 15,000 customers. Within less than a year the firm sold $800,000 in stock tomore than 600 investors.


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Check with your lawyer to see if SCOR might be the way for your company to raiseneeded capital.

VI. Leasing For Dollars

Equipment Financing

Equipment financing is using the equipment you already own or intend to acquire ascollateral for borrowing money. 'Ibis is especially attractive to new equipment-hungrybusinesses just starting up. Because equipment is tangible personal property, it, like realestate, is attractive to certain lenders who want hard collateral as security for their loans.

At the heart of this type of finance is an agreement known as a lease, in which oneparty, the lessor, offers to rent a piece of equipment from another party, the lessee. When

the deal is struck, the latter retains ownership but makes money from rent payments, theformer gets to use the property and avoids the full cash cost of immediate purchase.

The traditional way of producing cash from equipment is buying it on an installmentpayment plan. The seller retains title until the buyer pays the full amount owed over a periodof time, and if he fails to pay, the seller can repossess the equipment. In effect, the buyertakes possession and uses the equipment as collateral for the purchase money loan. For abusiness the equipment is an asset; the loan is a liability.

The second method of lease financing is to transfer title to equipment a businessalready owns to a lender, who rents it back to the selling company. (Sale-leaseback) Thisallows a cash-short business to convert equipment into available money, and still retain useof that equipment. While the business continues to enjoy use of the equipment, it cannot be

counted as an asset.There are many questions to be answered before you can make an intelligent decisionregarding equipment leasing as a proper method of finance for your business, including taxconsiderations, the type of equipment involved, customary industry practices, and degree ofcash need.

One of the most useful aspects of leasing equipment is that a business can borrow allof the cost of needed equipment, which releases capital for other business needs. Often thelease can be written to cover all incidental costs such as insurance, installation, or licensingfees -- and the lease will extend for the useful fife of the equipment. A lease can also allowyou to upgrade equipment as technical innovations appear.

There are two major types of leases. The first is known as closed-end, in which thelessor retains ownership, providing all maintenance, repairs and replacements. The secondis open-end, allowing the lessor to purchase the equipment at the end of the lease, usuallyby paying off the balance owed after deducting rental payments.

There are numerous lenders willing to finance equipment leasing. They usuallyspecialize by the type of equipment involved -- autos, trucks, aircraft, agricultural machinery,heavy industrial, and the like. Before Amtrak and Conrail put the government into thebusiness, much of American railroad rolling stock was financed in this manner by major


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banks. You may have seen a metal plate affixed to a sleeping or dining car announcing itsowner as the Chase Manhattan Bank.

Reporting Under the UCC

When secured financing is obtained, the applicable law governing the transaction isthe Uniform Commercial Code (UCC), in effect with variations in all 50 states and the Districtof Columbia.

The UCC requires the filing of certain reports that act as public notice of the lender'ssecured interest in the property. These reports cover a period of five years (UCC- 1), longerthan five years (UCC-3) or agreements where the borrower obtains title to the property at theend of the lease. Depending on the state and the type of collateral involved, reports areusually filed in the local courthouse where the debtor resides, where the equipment islocated, or at the debtor's principal place of business.

Leasing Considerations

Obviously lease financing is best suited to equipment purchases, not to raising majoramounts of capital for other business purposes. However, leasing may allow somereallocation of internal business funds to other purposes.

Since the money available under leasing arrangements is tied to the equipment itfinances, there are several considerations about that equipment that will best determine yourcourse of action; the reasonable length of time before obsolescence occurs; projected repairand maintenance costs; the equipment's likely residual value at the end of a lease; thepossibility of using accelerated depreciation tax breaks; whether the equipment will really

perform as you wish.Answer these questions realistically and you can determine whether leasing is one ofthe ways to finance your business needs.


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VII. Government Financing

Government, even in its best state, is but a necessaryevil; in its worst state, an intolerable one.

Thomas Paine (1737-1809), Common Sense

Tax, Spend and Help?

Long before President Calvin Coolidge offered his succinct opinion in 1924 that Thebusiness of America is business," government at every level theoretically has been offeringto help business. That government has not always been successful in this effort is adiscussion best left for another time and place. Even so, government agencies -- federal,state and local -- may well be the single largest source of funding available to smallbusinesses. By one estimate there are over 1,100 small business assistance programs runby at least 60 different federal agencies. There are literally billions of dollars available every

year, far more than are actually loaned.

Understand that government financing programs for small business are often nottotally government funded and controlled. Like the SBICs and MESBICs mentioned inour examination of venture capital, many programs guarantee funding by privatesources that otherwise might be reluctant to extend credit without government as arecourse guarantor.

There are many volumes available in any public library listing page after page ofgovernment agencies offering monetary help for small business, so you can start there as aninformation source. A bit of advice: if you find yourself dealing with a federal agency, you

might want to visit the local office of your U.S. Senator or Congressional representative, andenlist them in support of your efforts. These legislative offices have staff aides whospecialize in assistance to business people. They know that federal bureaucrats jump whena congressional inquiry arrives by mail or phone concerning the status of a constituent'sbusiness loan application.

Red Tape Tangle

A century ago, in an age before microfilm and floppy disks, government clerks usedto tie bundles of papers to be filed with red cloth string. This is the basis for the term "redtape" meaning to get tangled up or lost in the maze of bureaucracy.

Technology may have changed, but unfortunately government has not. Anygovernment program you approach for financial assistance for your business is going toinvolve you in forms, applications, information requests, delays and referrals -- sometimes toa maddening degree. This means persistence is a major virtue in dealing with anygovernment program, and that means never taking "no" for an answer. Be courteous, butnever be reluctant to go over any civil servant's head to the next level of supervisors, all theway to the top if necessary. Remember, these people are paid by your taxes and they workfor you.


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The Small Business Administration

This agency has been around for many decades and SBA is what most people think ofwhen a government business loan is mentioned. The truth is that available SBA loanguarantees and funding are only drops in the bucket when compared with the total number of

government programs at all levels. You might want to start your finance inquires close tohome at local and state agencies, usually listed in the blue government pages of yourtelephone directory.

Although SBA has certain qualifying guidelines that vary with the individual type ofbusiness, generally any firm with less than $1 million in annual gross income will be eligiblefor some help. Some businesses have higher qualifying thresholds, but probably 95 percentof all existing businesses in America qualify for some kind of SBA help.

SBA "Loans"

SBA loans come in two basic types.

1. SBA can guarantee up to 90 percent of a private loan in amounts up to $500,000made through a bank or other private lender, once an applicant has been turned downby that lender. By far the vast majority of "SBA loans" you hear about are of this type-- government loan guarantees, not direct loans.

2. Very rarely SBA will make direct government loans to small business, usually inamounts of $15,000 or less, but there are all sorts of requirements that must be met.These loans tend to be specialized: disaster relief, energy conservation, pollutioncontrol, businesses displaced by government actions like military contractcancellations and base closings, veterans loans. If you think you might qualify, goafter it. In addition to the usual factors any lender looks at when making a decision

about a requested loan, SBA (and other government agencies) have a strong interestin job creation and retention -- the greater number of jobs you can show to be involvedin your request, the better for your loan prospects. The drawbacks associated withSBA loans and guarantees are the mountains of paperwork and the time delays.There are also all kinds of policy restrictions on how you manage your business onceyou get the money, since government money always comes with strings attached.

How To Find SBA

There are SBA offices all over the country, so check the phone book. Or you can call(800) U ASK SBA, or write to:U.S. Small Business Administration1441 L Street N.W.Washington, D.C. 20416Phones: (800) 368-5855 or (202) 653-6570.

Farm Loans Aren't Just For Farmers


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Businessmen or prospective business owners who are unable to get an SBA loanoften do not realize that there are other federal agencies which make business loans.

The Farmers Home Achninistration has a program of business and industrial loans forprojects located in towns of under 50,000 population; although preference is given to those intowns of under 25,000 population, rural communities, and open country.

Still More Federal Money

The Economic Development Administration has a program of loans in areas whichhave been designated as econon-Acafly depressed, and this actually covers a very largepercentage of the country. Preference goes to fmm which will have an effect on increasingemployment in the area, and these loans may be combined with SBA loans. 'Me interestrates are very low. Full information may be obtained from the Economic Development

Administration, Washington, D.C. 20230.

Think Local

In your search for cash, don't forget there are many other federal loan agencies, andstate and local agencies. State agencies also offer tax breaks and incentives, industrialdevelopment bonds, even direct grants if you meet their qualifications.


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VIII. Factoring Assured Money for Business Success

When all is done, the help of good counselis that which setteth business straight.

Francis Bacon, 1st Baron Verulam,1561-1626

A Deal Not to Be Refused

No matter how busy one might be, a sensible business person most certainly wouldfind time to consider a professional service that offers:

1. Increased cash flow immediately2. Available capital without regard to your credit rating3. Expanded growth and enlarged capacity to grow

4. Greater equity and reduced business debt5. Funding without new debt6. Early payment, thus discounts on your bills7. Instant credit reports on prospective customers8. Constant monitoring of customers' credit status9. Appealing credit terms to attract new customers10. Complete professional collection services11. An end to the hassle of customers' bad debts12. Bookkeeping, invoices, and financial statements13. Generation of analysis on sales tracking and history14. Handling of all receivables accounting and data entry

15. A constant check on customer service problems16. No encumbrance on other assets17. Absolute control maintained18. Ownership not compromised

Do these guarantees sound too good to be true? That may be a first impression, butin truth these are just some of the direct benefits flowing to a business that uses factoring toturn accounts receivable into immediate cash.

Factoring is a well-established form of business financing that produces inmediatecash payments to a company at the time of shipment, delivery and invoicing a customer. Inits basic form, factoring has been used by American business at least since Colonial times,and its origins go back even further, literally thousands of years to the early days ofcommerce.

With factoring, quick payment in cash (usually within 24 hours) comes not fromthe customer, but from the factor, a funding source that has a formal agreement withyour business to purchase your receivables on a continuing basis. By its most simpledefinition, a factor is an investor who actually buys your accounts receivable. As part of the


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process, the factor assumes responsibility for all the costs, difficult work and potentialheadaches that traditionally go with customer debt collection.

Perhaps the most attractive aspect of factoring is a continuous level of cash flow into amanager's hands, allowing business planning and operation in a timely and efficient manner.The factoring system also means available financing automatically adjusts to your unique

rate of business growth because increased cash is triggered by new invoices. Factoring isthe only finance mechanism directly linked to a company's sales. And with bookkeeping,accounting and collection off your employees' backs -- the factor will do all this for you --expanded capital inflow is guaranteed with much more time to devote to efficient production,better service and expanded sales promotion.

Constant Dollars for Businesses Large and Small

You may be wondering why, if factoring is such a good deal, you haven't heard moreabout it before now.

The answer to that depends on what sources for business advice you have available.Oddly enough, the majority of people involved in financial circles are probably just asunaware as the general public that factoring is used more than all other types of businessfinancing combined. Many of America's major companies and thousands of smaller firms notonly know all about factoring, they are enthusiastic present users of this finance system andhave been for years.

Here's a current representative list of companies with revolving maximum amounts ofreceivables for which they routinely use factoring arrangements:

Georgia Pacific $850 million

POI-IR Industries Inc. $120 millionScott Paper Company $100 millionHoneywell $ 75 millionIMC Fertilizer $50 millionWestern Digital Corp. $ 42 millionPittston Company $ 25 million

Perhaps these commercial and industrial giants know something about businessfinance you may have missed. In fact, you may not realize factoring comes a lot closer toyou personally than just big name businesses whose products you know.

American consumers take part in a common form of factoring every time they use a

credit card. There are 1.15 billion credit cards in circulation, 10 each for every Americancardholders In 1970 the average balance on individual cards was $649, increasing in 1986 to$1,472, and today it is $2,800. Millions of times a day every business that offers customerscharge privileges using credit cards is the direct beneficiary of factoring. American retailbusiness depends on the factoring system, and without it the national economy would beseriously handicapped.

In this familiar transaction, the issuing bank or card company is the factor -- using theVisa, Mastercard or other system -- advancing the seller of merchandise or service cash


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immediately after your purchase, long before you actually pay. The business owner is alsoprotected against bad debt since the cardholder's subsequent non-payment has no impacton the business because the seller gets cash up front without having to wait for yourpayment, his money is not tied up in receivables. For the double privilege of making creditavailable to customers and getting immediate payment, the business is willing to pay a

discount to the issuing bank or credit card company -- typically two to four percent of thepurchase price. Thus for every $100 of merchandise you buy with a credit card, the sellergets $96 or $98 in immediate cash. Factoring accomplishes the same for commercial -- orbusiness-to-business -- transactions.

According to the New York Times, in 1994 Americans charged about $700 billion to theircredit cards, running up $325 billion in debt on them. Consider these billions of dollarsfinanced annually and you can easily understand why, added to commercial factoring, this isthe single major dollar source for business finance in America.

A Nation of Slow Payers

A good businessperson understands that extending direct credit to a customermakes them that customer's part-time banker. For the period credit is extended to CustomerSmith -- 30 or 60 days -- you become his lender, and he your borrower. For the length oftime credit is extended you lose the value of that tied-up money because you can onlyanticipate payment. If Mr. Smith had paid cash, you could have invested that moneyimmediately, earning interest on it rather than having to wait. When Smith pays late, yourcost increases still further.

Since there is no "free lunch" in business, someone has to pay the costs of yourextension of credit; either you pay by reduced profits, or your other customers are forced topay higher prices. The business person who ignores this not-so-hidden cost of credit does

so at his or her own economic peril. In a marginal company, excessive credit extension andlate customer receivables can spell disaster.In mid-1994, the Wall Street Journal reported a significant increase in late bill

payments behind as much as 45 to 60 days by many big businesses (500+ employees),especially to their small suppliers. Dun and Bradstreet, with four years experience trackingbill payment data, said this was the slowest payment rate it had seen so far, but noted binpaying performance has been declining since 1992. The D&B survey canvassed smallsuppliers; generally firms that can least afford payment delays that endanger cash flow.

In a first quarter 1994 survey, nearly two-thirds of the 35,000 National Association ofCredit Management members said slow-paying customers were a moderate to severeproblem. One Pennsylvania family-owned steel distributor said most of his billing fell into the45-60 day late category, and as a consequence he was forced to indefinitely delayconstruction of much needed warehouse expansion.

The Chicago telecommunications giant, Ameritech Corp., simply told its suppliers inApril 1994 that henceforth it would stretch out 30-day payments to 45 days in an effort "tocontrol costs and optimize cash flow." Their spokesman did not comment on what this mi htdo to the 9 cash flow situations of the company's 70,000 suppliers.

A D&B official said large companies were routinely paying 30-day invoices as much as90 days late, many without warning their creditors. He noted small suppliers typically accept


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such terms "out of desperation to get business," adding, "They don't realize the implication ofthe decision until it hits them." A credit manager observed, "Many entrepreneurs forget a saleis not a sale until you collect the money."

He cited the case of a home-based New Jersey floral gifts business that got a majornew order from a national home-shopping company, only to find payment delayed for months

while cash flow dried up for this supplier. As a result, they had to fold. Other smallbusinesses ended discounts for early payment, demanding cash if any question arose aboutextended payment.

The Journal article concluded that "small companies are generally less sophisticatedin managing cash flow, and thus more likely to find themselves struggling to collect overduebills." The D&B official recommended establishing a financed line of credit to fund possiblebill payment shortfalls.

The High Cost of Extending Credit

What these sad stories underscore is that once a business extends credit, whateverthe terms, it places itself in a cash deficit posture.This is so because the company already has expended its available cash for

production and service before billing for the delivered finished product. WidgetManufacturing Inc. undoubtedly had to produce a large quantity of widgets months beforereceiving a customer's order to satisfy fulfillment. Widget Inc.'s suppliers have alreadysubmitted their due bills, and now Widget has to wait for its customers to pay up. Dependingon production costs, volume and total sales, extended credit can rapidly sink a marginaloperation like the New Jersey floral supplier, unless tight internal controls are exercisedconstantly.

The chief financial officer of a California raisin packing company told the Wall Street

Journal it had stopped offering early payment discounts when it discovered several largecustomers had been cutting checks before the due date, but not mailing them until 30 daysor more passed. The late payers caused a cash crunch, but fortunately the company had allits income and disbursements computerized and quickly realized what was happening. Thisallowed management to obtain an exact fix at any moment on their own cash float, andavoided disaster. For small businesses with less technical expertise, news of a cash crunchcan come as a sudden and nasty surprise, and often too late for survival unless emergencyfinancial help is available.

Case Studies of Cash Flow Problems

Not all business operation cash shortages are produced by late bill payments.Consider these case histories:


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Natural Cash Disasters

In the last few years destructive natural disasters have plagued the United States,from the devastation of Hurricane Andrew in Florida and Louisiana, to wild fires andearthquakes in California, and floods of the century inundating the entire Midwest, Georgia -

and several other southeastern states.When natural disasters like these happen, many companies are unable to survive theresulting loss of property and interruption of revenues, but other businesses can prospergreatly. For companies in the latter category, cash flow management is a critical element insuccessful business response.

Obviously a business cannot anticipate and plan for a major catastrophe of nature, butwhen it strikes a company must be able to respond quickly to the unexpected demand. Aswork orders pile up, there is a dramatic increase in the need for cash to pay for supplies andlabor. Insurance claims usually mean delayed customer payments. Businesses that want toplay a part in post-disaster cleanup and reconstruction need cash to move quickly.

This was the situation faced by numerous temporary personnel agencies in South

Florida after Hurricane Andrew. They were swamped with requests for workers, and manyhad to turn down new business because they did not have the necessary cash to meet theimmediate demand for greatly increased payrolls.

One agency was able to avoid the cash scramble and instead focus on providing jobsand workers to help the recovery process. The company had been considering factoring andalready understood the process. A factoring agreement was quickly finalized and the resultwas a greatly increased number of clients and profitability. The agency not only survived, itgrew and prospered while others in the temp business did not fare so well. Factoring madethe difference.

A Big Order

Consider the pleasant recent dilemna of Next Generation, Inc. of Coral Gables, Floridaa single order for 2,000 product units totaling $11 million -- but not enough available capital tofinance a sudden twelve-fold production increase.

Mickey Moore, company president, found himself in this predicament when Sam'sClub, a division of Wal-Mart Stores, Inc., placed an order for Next Generation's popular trap-house sporting clays, a patented system that can simulate any hunting shot. Skeet shootingenthusiasts all over the country embraced the popular product and demand was sky high.Wal-Mart wanted 2,000 two-level trap house trailers at $5,500 per unit. To meet the order

the company immediately had to increase production from one to twelve units per week.Next Generation turned to factoring to provide immediate cash for supplies and labor."I would not have been able to deliver on the order without factoring," Moore said.


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Keeping a Conveyer Company Moving

Emergency need for cash is certainly not the best reason to compel a business toconsider factoring.

Most astute managers use factoring as a long-term planning tool to avoid both

foreseeable and unexpected problems. A good example is Tim Gabhart, president of MidcoCorporation of Louisville, Kentucky. Midco fabricates and assembles its own brand ofspecialized conveyer belt equipment used in coal mines across the U.S. and Canada, aproduct sold directly by a commissioned sales force to many Fortune 500 companies.

Gabhart was frustrated because half his time was occupied by details of businessoperation that had little to do with marketing and sales: buying raw materials, collectingaccounts, canning nervous lenders. He began to factor, and in a few months cash flowimproved markedly. Gabhart was able to focus on building sales volume and productdevelopment. He says the cost of factoring was more than offset by its direct benefits andincreased sales.

As Midco expands its Canadian operations and is beginning exports to South America

and Europe, Gabhart says he wishes he had discovered factoring in the early days of hisbusiness. "When I think of all the comers I had to cut because my money was tied up inreceivables, I'm convinced we could have been a multimillion-dollar company a long timeago," he says. "With factoring, we are well on our way."

You Can't Always Bank on It

Consider the Hunter Group, Inc., a Baltimore consulting firm specializing in financialaccounting and human resources information systems. On the rebound, the established 13-year company's robust growth was a decided plus in their comeback from a slump, which

started in 1991 when a commercial bank cancelled an existing line of credit. The companyre-established its profitability by mid-1993 with 16 months in the black, but a bank loanapplication in late 1994 was rejected because the lender wanted 24 months of "positiveoperating results." The turndown occurred even though Hunter expects revenues of over $11million in 1994 with assured comparable profits.

Mary Weaver, Hunter's senior vice president and chief financial officer, told the WallStreet Journal the company would turn to factoring its receivables. "Banks are there for youin the good times," she says, "but never in the bad."

Bottoms Up

In 1990, the founders of American Enviro Products, Inc. in Placentia, California, cameup with a unique product: the only biodegradable baby diapers on the market. They targeteda consumer market worth $3.5 billion annually, dominated by giants Kimberly-Clark (Huggiesand Kleenex) and Procter and Gamble (Pampers and Luvs).

Surveys showed there were definitely enough environmentally concerned parents tosupport Enviro's diapers (known as Bunnies), which would capture two or three percent of


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the market -- $100 million plus annually in potential sales. But as a new firm with no creditstanding, cash was no where to be found at major banks and traditional lenders.

The Heller Financial Group of Los Angeles put together a typical factoring operationfor American Enviro. That included pre-approval of prospective customers (most weregrocery chains, drug stores and discount retailers like Wal-Mart and Kmart), advances of 75

percent of invoices after delivery against a bank-like line of credit, non-recourse, and allcredit administration and collection handled by the factor.Mike Zullo, president of Enviro, said he could not have made all those parents and

babies happy without factoring. The deal allowed him to concentrate on production, salesand distribution while factoring paid the bills. In the first year sales topped $40 million andincreased further in the second. The company has now branched out into otherbiodegradable products. Zullo says, "Factoring is part of a sound financial environment."

The Factoring Advantage

As you may have noticed from these real-life business stories, inherent in the factoringprocess is the factor's ability to take greater risks than almost any other sort of financier.Factors are not as closely regulated as banks and other lending institutions; while this allowsflexibility, it also means a potential business client should check out a prospective factorcarefully, including capital assets and satisfaction levels of current or past clients.

Factors are not lenders of last resort for businesses in deep trouble. It is not unusualfor a careful factor to reject two out of three business applicants. Factors are in business forprofits like any one else, and they take care to check out the credit and financial standing ofprospective business clients -- even more than banks do because the risk is greater. Thisincludes examination of the age of existing accounts receivable, the diversity of the customerbase, and a preference that no single customer represents more than 25 percent of total

company income. They may also look at financial statements, bank and trade references,and personal financial statements of owners and principal stockholders. The approvalprocess often includes a visit by the factor's representative with the prospective client inorder to "get a feel" for the business operation.

A factor is one of the only sources of business money willing to lend money to a new,untried company, or an existing business struggling with a poor credit rating. It is not unusualfor an open-minded factor to take on a business corporation operating in formal Chapter 11bankruptcy if the situation is right, although this requires Court approval.

The reason is simple: factors are not as concerned about the credit status of thecompany seeking help -- although that is important -- as they are about the credit status ofthe customers who owe that company money. If cash-starved Smithtronics Co. is owed$250,000 by Bell Atlantic or NYNEX, any factor will be willing to provide cash based not somuch on the financial standing of Stnithtronics, but on the far more secure status of a major"Baby Bell." As Lily Tomlin says in her famous comedy routine, "You, sir, are dealing with thephone company!

With that major underlying principle understood -- in factoring, your business status isless important than who owes you money -- let's discuss in practical detail what factoring isall about.


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What Does Factoring Cost?

It may appear that a very important consideration when making the decision whether

or not to factor is the exact profit margin of a business. If your business operates on verynarrow margins, the immediate cost of factoring may seem too much for you to handle. Oryou may believe a high profit margin allows for the luxury of letting a factor collect from slow-payingaccounts.

The fact is current high or low profit margins are not particularly relevant to thefactoring decision. The real question is, what is the true potential increase in net profitsfactoring can offer your business? Can you afford not to adopt factoring, once you know thenumbers?

In figuring your profit margin, remember once the factor takes over he absorbs all yourlabor and other costs for debt collection and credit administration, leaving your employees

free for other tasks -- or allowing you to cut staff and costs. Think a moment about thediscounts your suppliers offer for quick payment and what those discounts would amount toin a year. What does it cost to pay your staff to send out invoices, deposit checks, logpayments, produce reports and handle collections? How many personnel hours does all thisrequire? And how much bad debt did you have to write off last year? Working with a non-recourse factor eliminates all or most of these costs and produces savings instead.

But in addition to these savings, there is a far more important impact factoringcan have on business profit -- it easily can increase production, total sales, and as adirect consequence, net profits.

A Case in Point

A leading professional factor tells an illustrative story of a prospective client whoowned a solid business caught in a continuing cash crunch, doing annual sales of $1 millionand growing rapidly. The businessman was aghast when offered a fairly typical agreement inwhich the factor offered to provide 70 percent of the value of receivables in advance, norecourse, for 4 percent discount for the first 30 days, the balance less discount uponpayment of the bill by the customer.

What upset the businessman, who said he was operating in a very competitivemarket, was the 4 percent discount cost. "If I raise my prices by 4 percent, I'll have to goout of business,"he said heatedly. The experienced factor carefully explained the facts offactoring to his potential client -- that in all likelihood he would not have to raise his prices atall, much less 4 percent.

Questioning the businessmen, the factor discovered he was operating on a grossprofit margin of 15 percent with an annual overhead of $60,000 -- in other words, making aprofit of $90,000 a year on sales of $1 million.

The factor asked a simple question: "How much business could you do if you hadunlimited funds available?"Without hesitation the reply was: "I could easily make $2million in sales within a matter of days, but I don't have the cash to handle that kind ofproduction."


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The factor pointed out that if sales were doubled to $2 million that would not likelydouble business overhead. The businessman estimated overhead would increase as little as$20,000. Suddenly the traditional cartoon light bulb appeared above the businessman'shead -the true realization of what factoring and its available cash could do for his overallbusiness situation had finally gotten through.

The key issue, he now realized, was not the 4 percent cost for factoring, but howmuch profit his company would net after hiring the factor.Here's the arithmetic: the business was making a profit of $90,000 a year on the first

$1 million in sales. If all accounts receivable were factored, the annual cost for theinmediately available cash would be $40,000. But that greatly increased cash flow would.allow sales to zoom to $2 million a year.

That means that if the company nets more than $90,000 a year after paying the factor,it made sense to go to factoring. The 15 percent gross profit would stay the same (or morelikely increase because of the ability to pay suppliers early and take advantage of discounts),so the gross profit on $2 million in sales would be at least $300,000. The increase inoverhead, by the owner's calculation, would be from $60,000 to $80,000.

That produces a new and much higher annual net profit of $180,000 -- double what hewas making, without incurring any debt and without having to put any more of his own moneyinto expansion of his business.

Confronted with the hard facts of this cost-benefit ratio, the businessman admittedsheepishly he had focused only on the 4 percent cost of factoring, missing the much biggerpicture. He said, "A price increase makes no sense -- but factoring surely does." Factoringwould give him the cash he needed to expand his business dramatically, take advantage ofsales opportunities he was now missing, and double his bottom line of profit.

Profit Comparison

Present FactoringAnnual Sales $1,000,000 $2,000,00015% Gross Profit $150,000 $300,000Overhead Cost $60,000 $80,000Factoring Cost N/A $40,000

Net Profit $90,000 $ 180,000

The key to this typical example of what increased available cash from factoring canmean is understanding that as a small business's sales increase, the percentage of salesattributable to overhead decreases. In this example, the company's overhead was 6 percent

at $1 million in sales, but only 4 percent at $2 million. Even though sales double, there is noneed to double office space, utilities, or even labor (though staff may increase somewhat).This increased efficiency known as economy of scale is what allows for such impressiveboosts in net profit.

Even ff a company's overhead does increase proportionally with its sales -- a fairly rarecase -- it still makes good business sense to use factoring if net profits exceed the cost offactoring.


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Every business manager should weigh increased costs carefully, but he also mustconsider the extent of any accompanying tangible benefits. As clearly demonstrated in thiscase, factoring receivables can multiply benefits many times over the actual cost of factoringconsidered in isolation.

Factoring Considerations

The major scale-tipping ingredient in the hiring of a factor -- at whatever cost -- maybe a business's immediate need for cash. Of all possible funding sources, factors aregenerally the most available.

Factors also provide a wide range of services traditional lenders do not. We oftenhear America referred to as a "service economy" -- and experience teaches us that trulygood service rarely comes cheap.

When a factor speaks of the advance rate, he is referring to the initial percentage of

receivables a business gets immediately in cash, after invoice approval, of its receivables. Agood factor will pay an owner an advance rate of from 70 to 80 percent of the face value ofreceivables. The balance is paid, less the factor's fee, after the invoice is paid. The discountrate is the percentage of the invoice the factor will keep as his fee and will depend on certainimportant conditions that exist in each individual business, including volume of sales andcustomer credit standing.

The first and foremost essential item the factor must consider is the financialstrength of your customers. If your sales list is loaded with major companies withexcellent credit or government contracts, your factoring costs will be far less than if allyour sales go to small stores with questionable credit standing which are scattered all

over the nation.The type of industry in which the client company and its customers is engagedis often important. Certain types of commercial enterprises have reputations for veryslow payment -- and that will boost factoring cost. So will existing overdue accounts,and therefore most factors will not purchase accounts older than 60 days.

If your business situation dictates that you must have a "with recourse" clausein your factoring agreement (see below), your own business financial status win have amajor bearing on the factoring cost. A factor operating with recourse wants to bereasonably sure that if he is forced to turn to you for payment of a bad account, therewill be enough financial strength to meet such obligations.

If your company has a record of high returns of merchandise or weak creditenforcement policies, this also may increase the factoring cost because the factor willbe forced to spend more time, effort and money to collect the full amounts owed.

Recourse or Non-Recourse

Factors can buy your receivables either "with recourse" or "without recourse" --both legal terms pregnant with meaning.


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If the sale of receivables is with recourse, it means that even though you havesold your accounts to the factor, your business still remains liable for any deficiency inan account the factor is ultimately unable to collect. This potential problem can becovered by the purchase of a blanket credit insurance/non-recourse insurance policythat will indemnify your business against bad debts. Some factors include such

insurance in their service at additional cost.A factor who buys your accounts without recourse relieves you and yourbusiness of any legal liability to make up collection shortfalls on those receivables.The bad debt is no longer your problem and the factor takes the loss. A non-recoursefactor assumes the credit risk for you.

The one major exception to a non-recourse sale of receivables occurs when adispute arises as to the work or service your business has performed -- your customeris unhappy with the product or has some other concern sufficient to make him refusepayment. Usually in that case the account is returned by the factor to you forcollection and adjustment.

Often the business owner seeking to sel

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