The Growing Factoring Factor: An Option for the Cash-Hungry

By SHARON R. KING

WITH credit tight and the market for initial public offerings bone-dry for all but the biggest deals, cash-starved small and midsize companies are hunting for alternative sources of money. Galloping into the breach are firms called factors, which buy companies' accounts receivable or lend against them.

Factors see an opportunity to break out of the niche markets they have traditionally served, mainly garment and textile makers, and venture into industries like health care, construction and technology.

In a growing number of instances, factors are gaining customers and working in business partnerships with an unlikely ally: banks, their main competitors.

''We're going to see that more and more,'' said Leonard Machlis, executive director of the Commercial Finance Association, a trade group for factors and other asset-backed lenders. ''When things start to tighten up, as banks lose money in emerging markets and hedge funds, some businessmen will not be able to get refinanced'' by banks and will turn to factors, he said. Some association members, he added, have already seen an increase in such business.

Floor Concepts, a commercial flooring company in Saddle Brook, N.J., offers a case in point. When Len Gleeson and Fred Renshaw, partners in the company, needed money to keep their business running, they knew better than to turn to a bank.

A year ago, a local branch of First Union Bank turned them down for a loan, Mr. Gleeson said, because the company did not have the collateral the bank required, such as ownership of its headquarters building. With the climate change in the financial markets since then, the odds of getting a loan this time were probably even worse.

But without more money, Floor Concepts could not afford to increase staff and buy supplies for jobs already under way or about to start.

So the company sold the right to collect $220,000 it was owed by customers to Quantum Corporate Funding, a factor in New York. Quantum advanced Floor Concepts about 60 cents on the dollar up front, and took over responsibility for collecting from the customers. Quantum gets its money back as the customers pay what they owe, and keeps a further 3 percent, called a discount, for its profit; after that, Floor Concepts gets the balance.

''We had plenty of business, but what we really lacked was cash to fund our business,'' Mr. Gleeson said.

Although it cost Floor Concepts considerably more to get cash from Quantum than the company might have paid in interest on a short-term bank loan, Quantum was prepared to advance money without insisting on collateral that banks usually demand. With its coffers refilled, Floor Concepts was able to bid on and win more new contracts, and the profits from the new work should more than offset the cost of factor financing, Mr. Gleeson said.

Banks base lending decisions on the borrower's creditworthiness. But to a factor, the creditworthiness of the borrower's customers is what counts. In Floor Concepts' case, Quantum sized up the likelihood that clients like Barnes & Noble or Hackensack University Hospital would pay their bills.

The cost of money for the client -- akin to the interest rate charged on a bank loan -- is the discount, which can vary from 2 to 4 percent on current invoices due within 30 days, to 15 percent or more if payments are overdue or are not payable for several months, or there is much doubt about the customers' ability to pay. Discounts are also affected by whether a client promises the factor a minimum amount of future business or just wants one deal, and by how much effort the factor expects to expend to collect what is owed.

How expensive is such financing? A 3 percent discount on 30-day receivables is equivalent to an annual interest rate of about 42.5 percent, assuming invoices are paid on time.

In its current form, factoring has been around since the 1960's, but it has been growing rapidly lately. According to a survey of its members by the Commercial Finance Association, factors had $205 billion in outstanding advances at the end of 1997, a 21 percent increase from 1996.

Though garment industry-related business still accounts for 80 percent of all factoring in the country, factoring is spreading to new industries, Mr. Machlis said, partly because of new cooperation between banks and factors. Instead of just saying no to applicants who cannot meet their lending requirements, some banks now steer customers toward factors.

Craig Sheinker, Quantum's president, says that every week he receives marketing calls and visits from bank officials who are looking to line up factors for client referrals.

Quantum's bank, Sterling National, a unit of Sterling Bancorp, also sends clients Quantum's way, said Michael N. Gallina, a senior vice president for corporate lending at Sterling. ''If a company doesn't have the ability to generate a profit, we probably wouldn't do business with them'' right now, Mr. Gallina said, but the company may grow into a profitable future customer. ''If I'm not able to help them directly, I can refer them to somebody who can help them. And who knows the benefits of that down the road?''

Factors can also be useful to banks by monitoring the creditworthiness of receivables for bank clients, or by helping the bank keep track of collateral. ''It gives banks some comfort in lending to companies that are having some difficulty in troubled times,'' said Richard V. Romer, executive vice president of CIT Group Commercial Services, a factor in Livingston, N.J.

Four of the country's largest factors are owned at least in part by banks. Dai-Ichi Kangyo Bank has a stake in CIT; Fuji Bank is an owner of Heller Financial of Chicago, and Nationsbanc and the Bank of New York each have big in-house factoring operations. Banks have gotten into factoring because they like its high profit margins compared with traditional lending, said Stewart M. Long, president of Nationsbanc Commercial, the bank's factoring arm. Bank factors tend to offer easier terms than independents but stick to the least risky customers.