Gerald C Watson is a Financial Intermediary specializing in arranging Contract and Working Capital Financing for growing firms throughout the country, for over the past 20 years.
Gerald has spoken on numerous panels and conducted seminars on Contract Financing within the public and private sector, written numerous articles and published a workbook on Contract Financing, and provided testimony on the subject of Contract Financing before the United States Commission on Minority Business in Washington, DC.
He has served on numerous Board of Directors, including the Commercial Finance Association (CFA), the St John's River Community College, and has also been a recipient of the SBA Business Advocate of the Year Award, and is a member of the International Factoring Association (IFA).
Gerald holds a Bachelor of Science in Business Administration from Babson College in Wellesley, Massachusetts, and a Master of Science in Business from the Management Education Institute in Cambridge, Massachusetts, where he graduated third in his class with Honors. Connect with him on LinkedIn or email him here
Articles by Gerald Watson
You just received a call from one of your favorite merchants saying they had “good news” and “bad news.” When you asked what the “good news” was, they said they had just filed for their ERC refund claim and were getting back $550,000. When you asked what the “bad news” was, they said they wouldn’t be getting the check from the IRS for 6 to 12 months, and needed $120,000 to cover their payroll in 5 days. WHAT WOULD YOU DO?
If all you simply said was “no problem- send me a few banks and we’ll take a look at getting you a position,” that would be WRONG! Why? Because you’d be LEAVING $$MONEY ON THE TABLE! Here’s why:
After you have helped Mr. Merchant solve his payroll problem by getting him a position, he’ll keep asking around until he finds “someone else” who can help solve his “other” problem which is HOW TO “monetize” his ERC refund claim and convert it to CASH!
Let’s take a quick look and see how much money you’d be “leaving on the table”- at minimum!
But before we do, let’s look at what you SHOULD HAVE said to Mr. Merchant. Something along the lines of, “thanks for reaching out because we ACTUALLY have a “two-part SOLUTION” for you. The first thing we’re going to do is look at a position to help cover your payroll.
Then, we’re going to bring in our ERC Funding Specialist to identify options for converting your ERC refund claim to CASH, instead of you having to wait 6 to 12 months for the check from the IRS. We only charge a nominal 2% PS fee which we don’t collect until AFTER you’ve been funded. Fair enough?
Plus, we’re ALSO going to arrange an early pay discount on your position in case you elect to use some of the proceeds from the ERC to pay it off early. The savings alone will help reduce your financing costs.
Now let’s take a look and see how much money you’re leaving on the table. First of all, assuming you make 10 points on the position, on $120,000 you’d make $12,000.
Now let’s look at ERC financing. Your PS Fee of 2% on $550,000 would equal $11,000, almost as much as you’d make on the position, and BEFORE adding any referral commission on the ERC side!
In other words, if you simply took “LESS THAN 5 MINUTES” to tell Mr. Merchant you have a 2-Part Solution versus one, you could potentially DOUBLE your money on the deal, right? RIGHT!
But here’s the question: how do you know what ERC funder is the “best fit” for Mr. Merchant? And what questions do you need to ask to make that determination? (Topic of one of my future articles)
The bottom line is, just like with MCAs where one size “doesn’t fit all” – which is why you typically work with more than one funder – ERC funding works the same. Why not apply the same rule?
But here’s the real dilemma: you have a stack of deals on your desk right now and simply don’t have time to identify ERC funders, and even if you did, you don’t have time to become an “instant expert” and know what questions to ask! So now, WHAT DO YOU DO?
One option is to work with a “trusted” ERC Funding Specialist. These are professionals who not only have the ERC funding relationships but know how to pre-qualify Mr. Merchant to determine which ERC funder is the best fit. In addition, they work with all parties “in the weeds” through underwriting, due diligence, final approval, and funding. In a nutshell, while obviously, they can’t guarantee ERC funding no more than you can guarantee MCA approval, the odds of getting the deal across the finish line are typically greater, particularly when there are issues with approval.
And all YOU have to do is two things; (1) TAKE 5 MINUTES OR LESS to tell Mr. Merchant about your two-part solution and can GET PAID when they get funded and (2) ask EVERY OTHER lead, prospect, and client the SAME QUESTION- “By the way, have you already applied for your ERC refund?” and if so, ask “would you like to get your refund now versus 6 to 12 months later?”
And if they haven’t applied yet or have questions about the ERC, tell them you can arrange a 15-minute call to determine their eligibility.
BOTTOM LINE- If you don’t “ask for the order you’ll never get it,” and it only takes “5 MINUTES OR LESS to do so.”
CONGRATULATIONS!!! You have finally made the decision to quit “stepping over” those hundred-dollar bills and establish a factoring brokerage business!
But here’s the problem. With literally THOUSANDS of hundred-dollar bills spread all over, WHERE and HOW do you start picking them up?
To be sure, you need a GAME PLAN for doing so, right? Well, today’s your lucky day because that’s exactly what Part 3 of our series is about; “HOW TO establish a GAME PLAN for establishing your factoring brokerage business”.
But first, a couple things to keep in mind. The first is that the closing and funding cycle for factoring is much longer than an MCA, and typically takes from a few days to a couple weeks. However, once your merchant is set up, they will typically fund invoices EVERY MONTH.
What that means to YOU it’s like getting an automatic renewal every month, because you’re GETTING PAID for the life of the factoring relationship. And that automatic monthly paycheck will keep getting bigger and bigger with every new factoring merchant! True “residual income”.
The second thing to consider is that you will need to identify the “mix” of factoring funders to do business with and get set up with as a broker.
While we touched on the topic of finding factoring funders in Part 2, we could actually do a series on this subject alone. Keep in mind that funders specialize by industry, i.e. construction, medical, trucking, etc., while others are generalists, and fund a broad range of industries both domestically and internationally.
OK. So, let’s get started. It’s basically a 2 step process. (Don’t worry. We’ll teach you how to dance.)
STEP 1: Take A Look in The Mirror
3 things you want to look at:
- The first is the size and structure of your existing ISO organization. What size is it? Are you a one-man shop? How many ISOs do you have in-house? How many in the field? Do ISOs in the field work under your umbrella or do they work under their own? Who makes the decision on which MCA funder to use?
This is important because the size and structure of your ISO organization will help you in determining which GAME PLAN OPTION is the BEST FIT. More on that later…
- The second thing you want to look at is how your existing merchant database is organized. This could range from a box of index cards to a computerized database where you can pull up contact info for every prospect, merchants funded, funding date, funded amount, commission, renewal date, and maybe even blood type. (Don’t laugh. Some guys are anal like that).
This is important because, regardless of how or where you keep this info, your existing files are where you’re going to find “low hanging fruit”.
More specifically, these are YOUR merchants who sell B2B with receivables RIGHT NOW! Plus, most are generating new invoices every month, and are PERPETUALLY WAITING to get paid. But let’s face it, you can’t sell the guy a new position every month (even though you might like to) because they obviously can’t sustain it. But now you have a solution that will.
- The last thing you want to look at is how you do your marketing; i.e., telemarketing, lead purchase, direct mail, email marketing, door to door, media advertising, etc. This is important because to be successful with integrating factoring into your existing business, you will need to integrate it into your existing marketing medium and message as well.
There are several ways to do this, but it essentially boils down to 3 simple questions:
- Do you sell B2B? Even restaurants who offer commercial catering could do more business if they didn’t have to wait 30 days or more to get paid.
- Roughly how much do you have outstanding in receivables?
- Would you be interested in looking at how to convert your invoices into cash with no payments?
Why Do We Need to Look in The Mirror?
REGARDLESS of how you operate your business, the purpose of this exercise is NOT for you to be judgmental (it is what it is), but simply to help you determine which GAME PLAN OPTION you feel is the BEST FIT for you. But to do so you have to be honest with what you see. That’s what “LOOKING IN THE MIRROR” is all about.
In starting a new year, we ALL would like to do better. And as much as we might consider making radical changes to our business model and even our personal lives, (i.e. losing 200 lbs. in 3 weeks), the changes that have a better chance of sticking are those we gradually integrate into our lives and business over time.
In other words, establish realistic goals for your new factoring brokerage business, establish a GAME PLAN for doing so, and over time you will gradually, and consistently generate positive results. Now, where’s that pie?
2. Select Your GAME PLAN Option
Once you’ve taken stock of where you are, the next step is to look at options for integrating factoring into your day-to-day operations.
Below are 3 GAME PLAN OPTIONS to consider;
OPTION 1: “Limited Service” Broker/Referral Agent
This option which might appeal to small ISO organizations or one-man shops. Once you have identified a factoring prospect and they have expressed interest in moving forward, make the introduction to your selected factoring funder, and for the most part, step back from the process.
HOW you do the introduction is totally up to you and can range from a three-way call, email, or even text in some cases. Regardless of how you do it, you want to make sure your Factoring Funder knows the referral came from you in order to get paid.
The funder will typically keep you posted as your merchant moves through the process. However, don’t forget. It’s YOUR merchant and YOUR money. So, don’t hesitate to follow-up with both.
This is essentially what I refer to as a “low touch” approach, designed for ISOs who want to start picking up one hundred-dollar bills, but have limited time or resources for doing so. At a minimum, it gets them in the game and launches a “new profit center”.
OPTION 2: “Full Service” Broker/Referral Agent
The full-service referral broker operates much like a traditional ISO does for MCAs. You work with the merchant to compile their factoring app package and submit it to the funder. In addition, as questions arise during underwriting, the funder may reach out and in some instances seek your help in addressing them.
Depending on the size and structure of your ISO organization, you might want to consider establishing an in-house Factoring Desk. This would be an individual designated as the point of contact between the referring ISO, the merchant, and the factoring funder.
There are multiple benefits for taking this approach. For one, you centralize the decision-making on the factoring funder best suited for the merchant. In so doing, your Factoring Desk should be familiar with each funder, their doc requirements, approval criteria, rates, terms, timing, etc.
Second, establishing an in-house Factoring Desk will limit the number of ISOs reaching out directly to your factoring funder. This is important because you don’t want an ISO to suggest, demand, or work outside the scope of your broker relationship and agreement with the funder.
Finally, establishing a Factoring Desk will facilitate a rapid response to getting your factoring deals done. The last thing you need is for a deal to be “stuck on someone’s desk,” simply because they shifted attention to work on something else.
OPTION 3: Broker/ Referral Partner Relationship
This option involves establishing a broker/referral relationship with an established entity which specializes in factoring and other forms of asset-based lending. This relationship can also be blended with Option 1 or 2.
For this arrangement to make sense, the broker/ referral partner should be well established and bring several things to the table including;
- Extensive and detail knowledge of the underwriting, due diligence, documentation, closing and funding process.
- Established relationships and history with a diverse mix of funders.
- Experience in addressing one of the fastest growing issues factoring funders are facing, which is resolving UCC filing issues, particularly within the MCA industry.
- Relationships with factoring funders who fund in “second position” behind other secured parties, including traditional bank financing.
- Knowledge and experience of other forms of financing including purchase order financing, material supply financing, etc.
To be sure, the right relationship will enable you to accelerate the funding process for your merchants while learning from their experience as well.
By the way, in Part 2 of the series, I mentioned a client who needed funding for 63 purchase orders to 63 different locations, of which half were expired. Well, I am pleased to announce they were funded!
In Part 2, we’re going to focus on 3 major areas:
(1) What is Factoring and How Does it Work?
(2) What Are the Costs?
(3) How Do You Qualify?
We’re also going to touch on HOW TO find factoring funders.
What is Factoring and How Does it Work?
Factoring actually dates back to 2000 BC but got going in the US during the 1600s when colonists sought “advance payments” on tobacco, cotton, etc., shipped across the Atlantic to England. Today, it’s a TRILLION DOLLAR INDUSTRY worldwide, involving commercial banks, asset-based lenders, Fintech companies, and private hedge funds all over the world. And a million years later the purpose of factoring is the same; speed up cash flow by leveraging receivables, while waiting to get paid.
In a nutshell, much like an MCA, factoring is an advance against “future invoice proceeds.”
However, unlike an MCA where the advance is largely based on bank statements, with factoring, advances are based on the number of confirmed invoices the merchant has outstanding with their approved B2B customers. The invoice(s), which is the asset, serves as COLLATERAL.
So, while an MCA funder “looks backwards” at bank statements to help determine eligible amount, the factoring funder “looks forward” to determine eligible amount based on approved invoices.
Factoring advance rates typically range from 70% to 90% of the invoice face value, and are based on volume, industry type, etc.
There are two major elements required for factoring to work. The first is the merchant must be doing business with a credit-worthy B2B customer. Approval isn’t based on the financial strength of the merchant, but on their customer, i.e. the company paying the bill.
The second major element is that, in addition to being credit-worthy, the customer must agree to send invoice payments DIRECTLY to the funder. This provides the funder with an assurance of payment and substantially reduces the risk of re-payment or default.
So, unlike an MCA where payment is on a daily or weekly basis, the factoring advance has NO PAYMENTS, and actually pays itself off once the invoice has been paid. The funder then deducts the advance along with their fee and wires the balance to the merchant.
With no payments and invoice proceeds automatically paying off the advance, I refer to this as a “SELF LIQUIDATING LOAN”. It’s also “ELASTIC”, which means the more confirmed invoices the merchant has outstanding, the more funding they are eligible to draw. It’s like having a revolving LOC with no payments………of course unless the customer doesn’t pay, right? Good question!
So, here’s the answer: There’s actually two types of factoring; (1) RECOURSE FACTORING, which means if a customer doesn’t pay the invoice, the Merchant is financially responsible for the advance, and (2) NON-RECOURSE FACTORING, which means they’re not.
Here’s the process in a nutshell: Merchant submits app and doc checklist for preliminary underwriting approval. Funder issues term sheet, and if accepted by Merchant, underwriting and due diligence is completed. A closing and funding docs package are submitted to the merchant, and upon execution, the funder is prepared to start confirming and funding invoices.
How long does it take from start to finish? Depends on how much hair there is on the file. A clean file can take as little as 5 to 7 business days. A file with a lot of hair can take much longer. We actually had a $13 million file funded in 48 hours! That guy was pretty happy and so was I. It was an acquisition with a deadline. So, here’s what to tell your merchants with regards to timing: “funding is not calendar-related, but event related”. In other words, once the required events are completed then funding can occur.”
What Are the Costs?
There are several major factors that determine cost, rate, terms. volume, invoice size and funding frequency, industry type, risk, etc. Every funder has their own respective rate and fee schedule. Some charge application/due diligence fees while others don’t. Some charge origination and/or admin fees, while others don’t.
Some funders base their pricing on APR, with rates as low as Prime + 3 to 5%, while others have all-in rates typically ranging from 1.5% to 3% per month. After the first 30 days, monthly rates are typically broken down in 10 or 15 day increments (pro-rating). As a result, the ACTUAL COST of factoring in dollars and cents, is based on the amount of time the advance is outstanding, from the funding date to the date the invoice payment is received by the funder.
Here’s an alternative perspective on cost: Factoring is like “renting money on a daily basis,” where the funder essentially takes “equity in the transaction” versus equity in the business. Comparing the bottom-line cost with the bottom-line benefits is the key. But at the end of the day, “the highest price you pay for money is the price you pay for the LACK of it”.
Just like with MCAs, make sure you understand the rate structure, terms, and fees charged by your factoring funder, and how to calculate the cost in dollars and cents as well.
How Do You Qualify?
Factoring approvals have 3 components: The first is the merchant. Again, every funder has their own approval criteria and document checklist. Some require minimal info, while others ask for EVERYTHING including a pint of blood. While most only require one month bank, approval is not based on deposits, or how well they manage their account. Remember their primary focus is on assessing the quality of the receivables, determining if they have sufficient gross profit margins, ensure they are in good standing, and address any “deal killers”, i.e. tax liens, judgments, or UCC filings in first position, which is where they need to be, in most cases. (We actually have funding partners who will factor in second and third positions)
The second factoring approval is the merchant’s customer(s), typically referred to as the debtor. This is determined by the funder who looks at things like D&B, PAYDEX Scores, and other proprietary industry databases. In some instances, a lack of secondary financial/credit information on the customer can be offset through their payment history with the merchant. In other instances, the funder may require bank and trade references if no history exists. Candidly speaking, best practices by the merchant says they should already be doing the same thing; i.e. credit qualifying their customers, whether they need funding or not, unless it’s a large, well established company or government agency. The fact is, extending terms to someone you don’t know can be risky because ‘all businesses may not be good businesses.’ Let’s face it, it’s all about getting paid, right?
Ever heard this horror story; “I need an MCA because I got burned by one of my customers who strung me out and never paid me!” Too bad. They should have picked up that $100 bill off the street! Just kidding!
The third factoring approval is on the deal itself, i.e. the purchase order or contract the merchant has with the debtor. There are over 15 different things the funder will look at to identify existing or potential funding issues. Here’s an example. I recently got a referral for a client who had 63 different purchase orders going to 63 different locations for the same large customer, but BEFORE he started shipping, half the orders had already passed the CANCELLATION DATE! What do you think the chances are of the deal being approved for funding? Don’t know yet. Will let you know when I get to part 3 of the series. Keep your fingers crossed and so will I.
Typical things the funder looks at are payment terms, default clauses, customer signature, offset clauses, just to name a few. If you’d like a complete list, just shoot me over an email.
How to Find Funders
Finding factoring funders is easy. Just google FACTORING and you’ll get a whole bunch. What’s NOT so easy is determining the “best fit” for YOUR merchant because one size does not fit all. Over the years, some of the biggest horror stories I’ve heard from both funders and clients was a relationship that went bad because it was not the best fit. But remember this; “just because you picked the wrong spouse doesn’t mean getting married is a bad idea.” Determining the best fit is one of the key functions for your factoring brokerage business.
Some funders you will find specialize by industry, i.e. transportation, medical, staffing, construction, while others don’t. Some can move quickly while others take two weeks. Some are more flexible than others. Some focus on A-credit Merchants and have the lower rates, while others work with start-ups. Always find out UPFRONT their approval criteria and constraints. Shoot over an email and I’ll send our list of the Top 10 Questions to Ask Before Selecting a Factoring Funder.
Let me ask you a question; If you were walking down the street and saw a $100 bill on the sidewalk, would you stop and pick it up? Of course you would, unless you didn’t see it. Or would you say, “I’m in a hurry and it’s ONLY $100. I’ll make a lot more money on that big MCA deal I’m heading into the office to work on, so I’ll just leave it on the sidewalk.” Really?!
Well, Here’s a rude awakening. For any of you who haven’t added Factoring to your financing product mix, that’s EXACTLY what you’re doing RIGHT NOW! And get this, you’re doing it with some of the SAME merchants you’re doing deals with RIGHT NOW! Here’s why; A percentage of your merchants sell Business-To Business (B2B), and get paid in 30 to 45 days, and in some cases, even longer.
Many of these are the SAME merchants who come to YOU for an advance to help cash-flow due to delayed invoice payments, so you provide an MCA, right? Right! That’s what we do. But here’s the problem: Next month they come back again, and then again, and then sometimes they get wise, secure another position somewhere else, and before long, well, we all know the story. After all that, while the last advance may have solved their immediate problem, they will ALWAYS have a continuing and on-going need for cash because they’re ALWAYS waiting to get paid. And the FASTER they grow, the BIGGER the problem! Sound familiar?
So, what does that tell us? In most cases, while an MCA may help stop the bleeding, it’s not designed to heal the wound. More specifically, the “wound” that needs to be healed is the un-predictable timing of customer payments on outstanding invoices. So while an MCA provides immediate relief, factoring solves the timing problem. Here’s how it works: The factoring funder provides an advance against approved invoices, typically 70% to 90%. Once the invoice is paid, the funder deducts the advance, along with their fee, and wires the balance to the merchant. So the advance essentially pays itself off, working much like a revolving Line of Credit (LOC). In other words, no payments! The term I use to describe this is called Self-Liquidating.
Here’s how I see it: when structured properly, factoring and MCAs can often complement each other and work well together. Factoring provides predictable cash flow because advances are based on predictable billings to their customers, whether it be monthly, weekly, or even daily. The predictable cash-flow from factoring advances is what the merchant can rely on to cover their continuing and on-going business expenses, i.e. payroll, materials, etc. MCAs can also be used to provide a lump sum injection to cover interim cash needs on a short-term basis, while factoring is being put in place.
Here’s an actual example of a real client situation we recently funded using this approach. Client is a large importer of Spanish wines selling to one of the largest spirits distributors in the country. They typically get paid in 45 to 60 days, so we established a factoring facility, which would take about a week. However, they had a container from Spain that needed to be paid for and shipped IMMEDIATELY to help fill holiday orders. We secured an MCA to pay for the container and negotiated an aggressive early pay-off discount. Once the factoring LOC was in place, the MCA was satisfied using a portion of the proceeds from the first factoring advance. We are now putting a purchase order funding facility in place to cover the upfront costs on all future container shipments from overseas.
This combined approach, enables YOU to provide FUNDING SOLUTIONS for your merchants, much like Ed McKinley described in the September/October, 2019 issue of deBanked Magazine where he talks about Consultative Selling. A true professional focuses on solving financing problems and building a relationship with their merchants, versus simply funding a transaction. You then have the opportunity of becoming a “trusted financing resource” versus a broker simply interested in what I call “hit and run” selling. In addition, this approach can have a multiplier effect on your income, enabling you to get paid on a continuing and on-going basis.
Speaking of getting paid, you may ask, “So how much money can I make with factoring?”
I’m so glad you asked that question. Maybe now is a good time to introduce myself. For over the past 25 years, I have specialized in arranging factoring/PO and contract financing for hundreds of growing business owners all over the country, providing millions of dollars in financing. Over the years I have earned in excess of a seven-figure income, primarily as a broker. I’m sharing this information with you to make a point; there’s a LOT of money which YOU can make too with factoring, IN ADDITION TO what you’re already making with MCAs.
So, then you say, “Well that’s great for you Watson, but how much money can I make?” Good question. Let’s take a look at how it’s structured. With factoring, you’re paid by the funder, just like an MCA. Two major differences. The first is that broker commissions for factoring typically range between 10% to 15% of the fee income earned by the funder per month. Fee income is earned once the outstanding funded invoices have been paid by the merchant’s customers. Broker commissions are then paid by the funder the following month. As an example, if the fee income earned by the funder was, say, $10,000 per merchant, per month, you would be paid $1,000 to $1,500 per merchant, per month. Ten merchants would pay you $10,000 to $15,000 per month and so on. Broker commissions will continue to be paid for the life of the factoring relationship and provide you with residual income, or what many refer to as, mail-box money, because it’s actually like getting a renewal every month from the same merchants, and you don’t even have to get out of bed!
A second source of income which is OPTIONAL, is to establish a fee agreement with the client to pay a success fee or origination fee based on the size of the facility. It is a one-time fee paid at closing and funding, either from the first factoring advance or over several advances based on what you work out with your merchant. Success fees are much like points in a closing on a real estate loan and typically range from 1% to 5% of the facility size. The fee is paid to you directly by your merchant once they have been funded. It is designed to provide you with IMMEDIATE INCOME. As an example, a $250,000 facility at 2% will pay you $5,000 or $10,000 at 4%. And that’s just for one merchant. How many could you do per month? For large contracts, we’ve established factoring facilities up to $5 million. I’ll let you do the math to see the potential.
Combining these two income streams can potentially provide a significant increase to your existing MCA income base, and in some cases from your EXISTING book of merchants. These are what we refer to as the low hanging fruit. They include your construction contractors, service and supply companies, transportation, manufacturing, medical and professional services firms, or anyone else who invoices B2B. Some retail merchants also sell B2B, while others, like restaurants, may have catering contracts. Take a look through your files. For many of these merchants you are already asking for A/R Aging Schedules as a stip, right? Now that aging schedule takes on a whole new meaning! And if they’re not factoring now, my friends, THAT’s the $100 bill you “didn’t see” laying on the street, and potentially THOUSANDS more you are leaving on the table! To be sure, close the MCA they need right now, make the money, and set them up with Phase II by establishing a factoring facility on their behalf. Then continue to provide MCAs as needed to cover unexpected problems or take advantage of opportunities. Make sense?
The next article will be what I call Factoring 101 and will focus on 4 major areas: (1) What is Factoring? (2) How does it work? (3) What are the costs? and (4) How do you qualify? We will also talk about identifying and selecting potential factoring funders, HOW TO deal with UCC filing issues, Subordination Agreements, and Fee Agreements with your merchants. We will also touch on Purchase Order Funding as well.
The last article will be designed to bring it all together and talk about HOW TO establish a game plan and options for getting started with your factoring brokerage business and a few key tips on maximizing success in the business.