Capital Markets

Lien on Me

CFOs eager to fill financing and liquidity gaps are turning to receivables for leverage.
Vincent RyanApril 1, 2010

When Belgium-based InBev bought U.S. beer king Anheuser-Busch in July 2008, payment flows to its suppliers dried up. One such supplier, Performance Cos., which prints point-of-purchase displays, received a notice from the beermaker saying that invoices would now be paid on a net-120 basis.

That kind of hit to cash flow can cripple companies, but Performance CEO John White took the news in stride. That’s because Performance has an asset-backed line of credit secured by its receivables from lender First Capital. While Anheuser-Busch InBev’s new payable policy might cause Performance to raise its prices, the company could still get 85% to 90% of the cash owed by Anheuser-Busch InBev within a week after invoice. “Assuming you have a good relationship with the asset-based lender, and the customer is creditworthy, it works,” White says.

Stretched by customers, rejected by banks, and pressured to grow sales again, finance chiefs are finding receivables-based financing a stable source of fast funds. Factors provided $140 billion in financing in 2009, showing slight growth over 2008. Asset-based lending (ABL) volume is typically three to four times larger, and in the fourth quarter of 2009 total outstanding loans increased 1.25%, says the Commercial Finance Association.

“An asset-based [instrument] generally has more reliability than a discretionary line of credit,” says John Kiefer, president of First Capital. “And if a company has a favorable uptick in activity during the year, or needs more cash because of an unanticipated problem, asset-based lenders will review [the facility] more often.”

That said, receivables-based financing, which encompasses asset-based loans, factoring (in which a company actually sells its invoices), and related credit mechanisms, is no panacea. Pledging receivables and getting advances against them can cost 30% to 40% more than an unsecured bank line, for example. In addition, “the CFO enters a different world,” one that often entails more-rigorous reporting on accounts receivable and collections while providing less flexibility in negotiating terms with customers, explains Guy Guinn, a partner at Squire Sanders Dempsey. And, in some cases, the lender comes to have an iron grip on the company’s cash flows. “It can [result in] a big loss of self-esteem and independence,” Guinn says.

Are You Eligible?

In general, companies turn to receivables financing when a bank won’t grant them unsecured credit. But that doesn’t mean this approach is the province only of distressed firms. Performance’s White, for example, says bankers get nervous when they see the debt on his books, which he incurs to buy expensive printing equipment. Other firms may require a larger credit line than banks are offering postrecession, or they may not want bank covenants hanging over their heads. Credit-loss protection is another motivation.

Of the various forms of receivables-based financing, asset-based loans are the toughest to qualify for and maintain, because the lender still underwrites the borrower and sets covenants like minimum tangible net worth. “We sit just below the banks when it comes to effacement of credit risk, and we are turning down a lot of deals,” says Laurence Kaplan, executive vice president of Gerber Finance, an asset-based lender.

Asset-based loans are usually written on receivables and inventory, and lenders screen the books extensively to decide which receivables are eligible for the “borrowing base,” says Kaplan. Concentration (more than 20% of sales with one customer), dilution (a high percentage of returns and chargebacks), and aging can all lower the dollar amount the lender is willing to advance. Government and foreign receivables often won’t qualify at all. The lender will also demand that borrowers provide robust weekly reporting on portfolio trends. While the pure cost of money is relatively low, there is also a facility fee, a collateral monitoring fee, and costs for field examinations by the lender.

But many companies like the discipline an asset-based loan brings to receivables management and collections, and the certainty of timely cash flows. “Our lender sets credit limits on every customer and ensures we have proper documentation in the invoicing process,” says Jim Castille, president of New Century Fabricators, a manufacturer serving oil and gas companies. Castille has grown his business from $8 million to $30 million in four years by using an asset-based loan to fund the company’s large, project-based payroll obligations.

The company’s engagements, such as building living quarters for offshore-drilling platforms, extend over long periods, and during the long march toward completion Castille needs cash to pay his workers. “If not for the loan, I would have to find more-expensive means of raising capital — like bringing in equity,” he says.

Mix and Match

Factoring is more expensive than asset-based lending, but for companies with only a few large customers and either a lot of debt or little to no capacity to manage complex receivables, it can be invaluable. Start-ups in particular use factoring because factors evaluate clients on the strength and solvency of their customers, which are often more creditworthy than the borrowing company. The borrower sells the receivables to the factor without recourse, and the factor performs credit investigations on customers, collects the cash, and takes the loss if a customer can’t pay. “They do all the things that go into running a credit department,” says First Capital’s Kiefer. So, although the cost of factoring is higher, the borrower also reduces the overhead that comes with a credit operation.

It is now possible to combine elements of an asset-based loan and a factor. Pure Earth, a recycling and waste-management company, terminated its shrinking line of credit with a big bank this past February and secured a $5 million hybrid asset-based/factor facility.

The lender buys Pure Earth’s receivables and puts a line of credit equal to 85% of the receivables at the company’s disposal. There are no financial covenants or onerous reporting requirements and fewer “ineligible” categories for receivables, says Brent Kopenhaver, Pure Earth’s CFO. But the lender does have recourse — it can kick back an invoice to Pure Earth if it’s not paid within 90 days. The lender/factor also has the right to accept or reject new customers. And, unlike in an ABL, the lender fully discloses the relationship to Pure Earth’s customers.

Going Once, Going Twice

For companies that want fast cash and maximum flexibility, auctioning off receivables in an electronic marketplace is another solution. The Receivables Exchange is an online bidding platform that offers faster remittances and access to pools of cash, such as hedge funds and other private money. The seller of the receivables posts invoices or groups of invoices online and describes the terms it wants — the advance rate as well as a cost of funds. Anonymous buyers then bid on them, and the seller receives its money within 24 hours of the invoice being bought.

Joe Reini, president of integrated-controls and IT-services firm Mason-Grey, posts about $25,000 of outstanding invoices per week on The Receivables Exchange. Invoices can be sold in minutes, and in the eight months Reini has used the exchange he has lowered the financing cost from 2% of the invoice to 1.5% (based on a 30-day term) and pushed the advance rate from 85% to 88%.

“The payment history of our customers gives confidence to buyers, and receivables of Fortune 500 companies are very well received,” Reini says. “New employees go to work on Day 1 and by Day 5 we have our first invoice printed. In a typical situation, we wouldn’t get paid for another 45 days. With the Exchange, I can load an invoice Monday morning and have the cash by Tuesday. “

Of course, the seller on The Receivables Exchange is not building a relationship with capital providers, which is a drawback if a portfolio’s quality goes south. And the cost of the funds may be fairly high when considered on an annual basis, although Reini says that for his firm the cost is small as a percentage of gross margin.

All forms of receivables financing come with headaches — lenders wanting to send verifications of transactions to customers, negotiations about the lender having “full dominion” over cash flows, and the inability, for the most part, of the borrower to independently grant customers looser terms. But for companies snubbed by traditional banks, it’s filling a crucial financing gap. “It has worked masterfully,” Reini says. “We’re growing when banks aren’t trying to do a thing on our behalf.”

Vincent Ryan is senior editor for capital markets at CFO.