When lenders and borrowers become challenged with how to increase availability on working capital lines of credit, a deal structure can go sideways quickly. The lender has taken the stance that the traditional trading assets of accounts receivable and inventory are properly margined and priced, while the borrower feels that full value of these trading assets is not captured (e.g. excluded receivables, limitations on inventory, concentrations). Taking additional collateral or changing the company’s debt and equity players is the simplest path from a lender’s view, but often met with resistance from the borrower as these options many times are not even plausible, if even possible. When encountering this potential impasse on working capital loans, a lender should turn into the advisor role and look for additional ways leverage the value of these trading assets. Assuming that inventory valuation channels have been properly evaluated and then margined based on third-party vendors, this leaves only the accounts receivable in play. Without the lender moving outside their allowable credit-box parameters, an often overlooked solution is for the lender to partner with a non-recourse factor to extract more availability from the accounts receivables that can cure the borrower’s need for availability and also shift risk from the lender to the non-recourse factor.
Example: Consider the case of Company XYZ that is a supplier of furniture to various retailers. Company XYZ has a working capital facility that allows for 80% advances on eligible accounts receivable and up to 85% advance rate on inventory based on NOLV. At certain times in the year, the Company is required to put deposits down for orders which strains cash flow. Additionally, the company has business with some big-box retailers that push for longer terms and consistently use their clout to pay Company XYZ slow; further hurting cash flow and at times making these accounts receivable ineligible due to their dating. This has pushed Company XYZ into an over-advance position with their lender in the past which resulted in various penalties and costly time away from Company XYZ focusing on its core operations. Additionally, to conserve cash due to the limitations on the working capital facility, the Company has paid some of its vendors slow which has caused these relationships to deteriorate.
Solution: The lender has recognized that Company XYZ is consistently tight on its line. With no additional assets to pledge or any favorable changes to the Company’s balance sheet, the lender has already structured the facility under the most favorable terms given the credit profile. However, for Company XYX to grow and satisfy payments to their vendors, additional capacity is needed.
The most valuable assets on Company’s XYZ balance sheet are the accounts receivable. The lender and Company XYZ agree to partner with a non-recourse factor to manage all or a portion of the accounts receivables with an assignment of proceeds agreement between the lender and non-recourse factor. The non-recourse factor offers several benefits to Company XYZ and its lender that previously did not exist under the current facility structure.
- By the nature of non-recourse, the factor has now assumed the risk of the financial inability to pay of the Company’s debtors (customers), which reduces or in some cases eliminates the Company’s bad debt expense potential. Additionally, the lender has effectively exchanged a bundle of various Company XYZ receivables for guaranteed payment stream on these receivable from the non-recourse factor.
- Non-Recourse factors typically have multiple clients and trade history selling to the debtors of Company XYZ allowing for the non-recourse factor to set advance rates at higher levels than customary working capital lenders. If the non-recourse factor is comfortable with the debtor or pool of debtors, advance rates are typically set around 90% which directly transfers to the borrower as the lender should not take issue. In the above example, this would provide 10% more capacity on the AR level and potentially more if inventory advances are suppressed by the effective AR advance rate or ratio.
- Collections and slow-pay issues are handled by the non-recourse factor allowing more of the receivable base to remain eligible, where the lender might have excluded under standard borrowing base requirements. For example, the non-recourse factor might have $1.0 million of Company XYZ’s accounts receivable that are 60+ days past due on its books. If the lender had an eligible accounts definition of up to 60 days past due, at least $1.0 million would be excluded in availability under the initial facility. Through use of a non-recourse factor, the lender has no heartburn continuing the lending as non-recourse factor has a required payment under guaranty (PUG) provision requiring payment to the lender and subsequently Company XYZ on all accounts assigned. Typically, this is 120 days past invoice due date. Company XYZ is also alleviated from much of the collection aspects on outstanding invoices, which frees out employee time to be used elsewhere at Company XYZ as the non-recourse factor takes control of collections.
While other efficiencies and benefits exist, they can be more specific to various borrowers than others. For example, if a company is looking at expanding a relationship with an existing customer or entering a new sales territory, a non-recourse factor is a quasi-credit department that can help determine which customers a company would want to grow their revenues with and which companies might be struggling to make payroll and help prevent a purchase order going unfilled.
Some important considerations that both the lender and company need to consider prior to partnering together with a non-recourse factor the following:
- Credit worthiness of the non-recourse factor. As the lender is shifting its receivable risk to the non-recourse factor, consideration must be given to the strength of the factor and operational capabilities.
- Cost. Typically, non-recourse factors charge a commission percentage of the assigned receivables that are run through them. Rates depend on the Company’s customer base, volume/sales assigned to the factor and number and size of invoices. Industry and customer complexity also play a role. A company needs to consider if the cost can be offset by the combination of reduced bad debt and increased availability along with the more difficult to qualify benefits of an additional credit and collections team.
- Notification and collection procedures. Generally, non-recourse factors require funds to be directed to their lockboxes and then routed to the lender’s discretion. This requires one-time payment changes with customers. Additionally, customers are typically notified by the factor when payments are past due. While some companies welcome this as it alleviates tying up their internal resources on collection calls, others are concerned that it signals signs of distress to the customer. Programs are customizable with the ability of companies to inform non-recourse factors to refrain from any notification to their customers (non-notification) or limit collection calls.
Utilization of a non-recourse factor to augment a working capital facility can assist in keeping a deal in place as originally intended by the lender and keeping a borrower satisfied. Existing covenants, borrowing rates and other provisions are held in check, avoiding costly and lengthy debt refinancing that can take a company away from its core competency. Lastly, the lender is adding value and serving as strong advisor, which only further adds to maintaining and growing the relationship.
Brian Resutek has been with Branch Banking & Trust (BB&T) since 2007 and is an Account Executive in their Commercial Finance group. At BB&T, he has been involved in the factoring groups and the supply chain finance teams in Atlanta, GA. Additionally, he was also a regional corporate banker for BB&T’s Atlanta, GA region.
Prior to banking, he worked at Marsh and Aon Risk Services in the insurance brokerage fields earning his CPCU designation. Resutek received his BBA from the University of Michigan and earned his MBA from the University of Georgia.