The principle of borrowing money secured on a business’ assets, particularly invoices, arrived in the UK nearly 50 years ago but has only really taken off in the last decade – in which time the market has swelled by 460%.
The number of businesses using such facilities jumped from 40,000 to 43,000 in 2005 alone, and in the same year £11bn of funds were advanced to companies.
Today, a growing number of banks and specialist lenders give you the option of borrowing money against outstanding invoices, your premises, equipment, machinery, fleet and even your brand.
Borrowing money against your sales ledger will be ideal for some of you, helping grow your business because the cash available increases with your customer list and charges are not payable on demand, unlike standard loans. But where do you start?
FACTORING
Probably not for you. Factoring is generally thought of as a development facility for small businesses with turnovers of less than £1m. Like invoice discounting (see right), it only works for b2b businesses that raise invoices, so retailers need not apply. Popular sectors for invoice finance include recruitment, manufacturing, wholesalers, courier companies, haulage, franchises and family businesses.
For an agreed administration charge and a small percentage of your invoice, a factoring company will take control of your debtor book and pay you for invoices up front and on the day that you raise them if need be. When your customer’s credit period is up – generally between 30 and 60 days later – the factor will call in the debt.
Factoring has the dual benefit of ploughing cash into your company while also acting as a credit and quality control service. Factors can root out late payers and act as a clear channel for customer complaints.
Steve Netherton, commercial director at Eurofactor, says a handful of owner-managed companies with turnovers of more than £10m use factoring because of these additional benefits, but they are the exception and not the rule.
INVOICE DISCOUNTING
Commonly perceived as a ‘grown-up’ version of factoring, invoice discounting gives you the same cashflow advantages but allows you to maintain control of your sales ledger, so the onus is on you to collect payments and forward them to the discounter.
If you are precious about your customer relationship then not allowing third parties access probably suits, although lenders are not debt collection agencies and it’s in their interests to keep your customers happy and not harass.
It is also cheaper than factoring because your financier does less work for you, so the admin fees are proportionally lower. On the flip side, because the discounter is kept at arm’s length, you’ll have to work harder to show them you’re a low-risk investment.
Because of its comparative value and light bureaucratic requirements, discounting has become a viable alternative for funding acquisitions, management buy-outs and buy-ins. In simple terms, you can use the assets of the business you hope to acquire to self-fund the deal.
Of course, the company must have a steady stream of sales, and you may need to arrange a complementary package of funding to support your invoice discounting facility, but at the very least it will reduce the burden of loan repayments and could delay the need for venture capital involvement.
“It’s a fantastic route for acquisitions and buy-outs,” says Netherton. “The last five years have seen a big increase in deals funded by discounting companies because it takes away the need for private funders who’ll demand 20% or 30% of your business and a place on your board.”
Like all your suppliers, financial or otherwise, a discounting company has a vested interest in your success and will want assurances that your infrastructure, client book and products work well. But that shouldn’t translate into a lot of work on your part.
In a nutshell, the effort involved sits between the light touch of an overdraft facility or loan and a due diligence-heavy relationship with a private equity investor.
“On an operational level, your business shouldn’t change too much when you sign up to invoice discounting,” says Diane Blinkhorn, a director at Bibby Financial Services. “We verify invoices each time they are raised and ask that communication channels are kept open, but there’s very little admin involved after the initial checks.”
ASSET BASED LENDING
Confusingly, the term ‘asset finance’ is used to describe myriad services. It’s sometimes an umbrella phrase for borrowing against any asset, including invoices, and sometimes excludes the debtor book.
It can refer to hire purchase agreements, whereby a financial company buys equipment on behalf of a customer then leases it to them over an agreed period of time, usually handing ownership to the customer at a pre-arranged date.
But for the purposes of this article, it means borrowing money secured on a business’ assets other than the sales ledger; in other words, your property, equipment, stock, vehicles and brand.
It’s a small point, but there’s plenty of financial jargon in this market and it’s worth making sure you and your financier understand each other. They are bound to throw in a few esoteric references without realising it, so be prepared to trouble them for an explanation when they do.
How much money you get will depend on the value of the asset you wish to use as collateral and the expected depreciation of its value as the loan is amortised – see what we mean about the jargon involved?
There are fewer players in this market than in factoring or discounting, and some companies will offer you asset finance only as part of a wider package, which may include a loan, overdraft, factoring or discounting.
Mike Harrison, regional sales director of Enterprise Finance Europe, estimates that there are between 60 and 70 companies in the UK offering factoring, but only 20 to 25 that do asset finance.
Low volumes of asset finance specialists mean the market is less competitive than related funding options, while the complicated process of assessing your assets’ value could also push up administration fees.
“It is suitable for larger companies with turnovers of at least £2-£3m and with plenty of high-value assets,” asserts Harrison. “Even then, your assets won’t be worth as much as when you bought them, so the costs might outweigh the benefi ts.”
According to Harrison, property and vehicles are relatively easy to evaluate because they are bought and sold regularly. But niche assets – for example, a printing press bought four years ago for £300,000 – are harder to put a fi gure on. If the lending company has to bring in a specialist to price an asset, the fee will go up proportionally.
THE COSTS
There are no hard and fast rules about how much you should pay for factoring or invoice discounting. You will be charged twice: one service fee – which will be greater for factoring because more administration is involved – and a percentage of each invoice raised.
A big business with lots of big money clients will pay more in terms of admin charges, but a lower rate for each invoice. Kate Sharp, chief executive of the Factors & Discounters Association (FDA), believes the charge on your invoices should range from 2.5% over the Bank of England base rate for small businesses to 1% for bigger ones.
According to Mike Horner, chief executive of the Institute of Business Advisers, it’s a good idea to total up the annual cost to your business of the operations you plan to outsource. A full-time credit controller, for example, costs between £18,000 and £20,000. The percentage taken off your invoices should, in money terms, total no more than the interest on an equivalent bank loan or overdraft, he adds.
Asked to put a number on the costs involved, Harrison states that a business with a £5m turnover should expect to pay around £12,000 for invoice discounting and around £3,000 for borrowing against a major asset.
THE PROS & CONS
With factoring and discounting, not having hard and fast deadlines to pay fees is a big plus for a growing business like yours. It means you don’t have to physically take money out of the business periodically, and the risk of being charged for late returns or breaching your borrowing limit is reduced.
However, the overall charges will be greater than a standard loan, so be sure that invoice fi nance is the right solution for your particular set of circumstances.
Factoring is great for credit control purposes, but the factor will have a say in who you sell to and can refuse to underwrite invoices from your less reputable customers, even if you are insured against bad debts.
Factoring could also have negative repercussions for your business’ reputation, as it will be clear that you don’t have in-house credit control systems and may have cashfl ow problems. On top of this, your customers might simply prefer to deal with you directly and not through a factor.
Your reputation is safe with invoice discounting, although it only works if you have steady sales. Seasonal businesses might not see the benefit in lean months when contracts dry up. Temporary sales blips can be smoothed over, but longer draughts may necessitate additional funding.
Asset-based lending works if you have a major one-off cash requirement, say to part-fund an acquisition, but it is only suitable for companies with major assets. Lots of little assets don’t add up to one big one because your lender will spend time and money adding values together, a process that you will end up paying for.
THE PROCESS
In an ideal world, you’d leave several months to weigh up your funding options, find the right provider, conduct due diligence and get the money in. We all know that cashflow crises rarely afford you that luxury, but if at all possible, take time to learn about the asset finance industry and its major players before you act.
Once you feel comfortable with the range of facilities on offer, contact your bank manager and any other company you borrow money from. Your current banking arrangements, and in particular any overdrafts and loans taken out, could tie your hands when it comes to looking for alternative funding.
Stephen Haskew, managing director of Manta Finance, quotes the example of a hot tub-importing company that used factoring to help with short-term cashflow deficits. When the owner tried to get separate funding to cover six-week import delays, he discovered that the business was bound by an all-asset debenture taken out by the factor. Companies vying for the trade finance contract had to apply to the factor to waive the debenture; a complicated and normally fruitless process.
Depending on the small print in your contract, your bank has the power to call in a loan or reduce your overdraft if you take up a funding contract with another financial house. Go straight to your solicitor for advice if you find yourself in this situation.
Upon hearing that your business requires a cash injection, at the very least your bank will try to tempt you with its own refinancing offers, but don’t accept one of these until you’ve got at least two more quotes from rival organisations.
Once you pair up with a lender, it will want to make sure your business is as good an investment as you claim it is and will conduct some checks. The due diligence is not as thorough as in private equity deals, but invoice discounters, in particular, will want to see your client list, sales ledger, credit terms, business plan and products.
In factoring deals, the searches are gentler still, because the financier has complete access to your client list and sales data. Meanwhile the work involved in asset-based lending arrangements depends on the type of asset you want to borrow against.
In general terms, all three facilities can be set up quickly. According to Harrison: “Facilities take around three weeks to set up on average, but it can be done faster if the business requires it. In the case of an MBO or acquisition, lawyers and accountants will need to be involved, so the process will be more drawn out.”
GETTING THE BEST DEAL
Once you’ve cleared the air with your bank, your next port of call is the FDA, an umbrella organisation for the asset-backed lending industry. The organisation’s members are vetted for size of funds available and industry reputation, and its website, www.factors.org.uk, has a search facility to help you to sift through finance houses that match your business’ requirements.
If in doubt, contact a broker. Most recover their fees from the financier, so you don’t get charged for their legwork. They know the difference between reputable companies and the sharks and on past experience will be able to point you in the direction of a handful of would-be suitors.
Their industry contacts should help to secure you a hefty discount on what you’d be offered on your own. When Adam Starky, managing director of food business Green Gourmet, needed £500,000 in funding to buy out his business partner, he went straight to advisory group The FD Centre on the recommendation of a friend.
For just over £3,000, the company brought together six potential financiers, orchestrated the due diligence and checked all the legal documentation was in order. Starky believes he saved around £7,500 by going through a specialist.
One word of warning: it is in your broker’s interest to tie you into a lengthy contract because they command a higher fee from the financier for doing so.
Even if you don’t use a broker, contact at least two or three companies and meet them face-to-face. The process of pitching your company to them and hearing what they have to say will give you a better idea of your own needs, as well as a picture of the type of institution that’s right for you.
This is a two-way process, however, and your chosen partner could decide that you are too small or high risk to work with, or might push you towards factoring when you want invoice discounting; so communicate your business proposition, growth plans and funding requirements clearly in your pitch.
Remember that everything is negotiable. Financiers are incredibly risk averse, so settle their nerves by reassuring them about the longevity of your business and watch your costs come down.
As with any big financial decision, make sure all your choices are informed ones. Learn about the industry and its peculiarities, check out alternatives and move only when you are sure you’re doing the right thing.
The key to getting the best deal is knowing how much you want, what you need it for and how you’re going to get it. Enter into the process without answering these basic questions and you’ll end up either with the wrong package or paying too much for the right one.
Case study: Combining invoice and asset-based finance to grow
Company: Livingston
Owner: Alan Halsall
Livingston, a pan-European technology-leasing business headquartered in Scotland, used asset finance to fund growth following a management buy-out in March 2004. The investment bank that backed the MBO would not provide an additional €21m (£14m) required by Livingston to invest in new equipment, such as laptops and telecommunications testing machines, so Livingston’s fi nancial director, Tom Flynn, looked to refi nance the business.
“We presented to lenders such as GMAC, GE and Lombard, and were looking to secure a deal within six months,” Flynn remembers.
The process was complicated by Livingston’s international outlook, its high-tech, quick-burn stock and the company’s size, which positioned it between small- and big-business lenders.
After some toing and froing between prospective lenders, Hilton Baird, a broker, approached Livingston offering to source a financier.
“They put us in touch with Landsbanki, who were like a breath of fresh air,” says Flynn. “They understood our business immediately and asked a lot of very pertinent questions, which put us at ease.”
With a debtor book worth €14m and rental assets priced at €25m, Livingston opted for a combined invoice discounting and asset-backed borrowing facility. Landsbanki used specialists to value Livingston’s assets and post-deal regularly recalculates their worth.
Meanwhile, Livingston brought in the same trusted law fi rm that dealt with the MBO to oversee the drawing up of contracts.
“All in all, it was a positive experience. We provide detailed information on a regular basis, but you’d expect that from a complex arrangement,” says Flynn.
