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Should I Expand My Business?

Here, as promised, is the guest post from Domenic Rinaldi of www.bizbrokerjournal.com. Please see the last post on this blog for his contact information.

Despite today’s market, countless business owners are finding ways to weather the economic storm and keep their businesses profitable. The gut instinct for many is to look for ways to cut costs internally by trimming headcount, salary, employee hours, or seeking ways to reduce production costs or improve efficiency. Some business owners, though, could benefit from considering business expansion.

There are plenty of ways to expand a business. The most basic form of expansion is to focus on your current customer base and adapt your business’s offerings to fit their changing needs. This may involve purchasing new equipment or enhancing the inventory selection to provide more products or services applicable to a variety of demographics. Excellent customer service is also essential when today’s consumers have many options available to them. Providing additional support hours at the request of customers, for example, is a surefire way to maintain a more loyal following and possibly generate word-of-mouth recommendations.

You can also look to expand your business to new customers by introducing a new location, acquiring a competitor or moving into a related industry. Not only will these expansion opportunities help position your company for continued growth, they will also enhance your business’s selling power once it comes time to exit the business.

Here are some questions every business owner should ask themselves, however, before considering any type of expansion.

What Type of Expansion is Right for Me?

Not all types of expansion will work for every business or for every industry. Business owners need to be particularly diligent in researching what will work for them and what resources they have at their disposal. Before considering expansion, rule out the options you know are not plausible, or that you simply don’t have the time, money or desire to pursue.

You can make this decision by doing some initial research. If considering expansion that goes beyond internal activity or purchase, talk to local business brokers and ask for their input into what trends they are seeing in your industry.

You can also look at competitors that may be expanding to see what they did and where they had success or failure.

Will I Really Benefit From Expansion?

There are several benefits that could come with business expansion, but also a lot of assumed risk.

Some things to consider include:

Economies of scale -- Expansion may expose you to economies of scale, with cost advantages that result from having expanded. Consider if this might be the case for you.

Customer base -- Not only should you ask yourself if expansion will expose you to new customers, but also if your existing customers will remain loyal while you work out all the growing pains.

Yourself -- Will expansion bring unavoidable stress into your life that could potentially deter your ability to successfully operate the business under the new expansion?

Can I Afford Expanding the Business?

In today’s market, business loans are not easy to come by. With big lenders struggling to survive the market, receiving a loan for your business may be a bit more difficult than anticipated.

People who are getting loans are being forced to leverage large pieces of collateral, such as their homes. This adds a lot of risk to any type of business expansion because failure could mean the loss of not only your livelihood, but your home as well.

For buyers considering the purchase of another business – whether it’s a competitor or a business in a related industry – seller financing is proving to be one of the only ways to get a deal done. Seller financing is a loan provided by the seller of a business to cover an agreed percentage of the sale price.

Consider how you will fund your expansion before taking any drastic steps.

[Editor's note: Please see my interview with Domenic on using receivables finance as a component of your acquisition funding plan.]

Getting Started with Expansion

Once you have decided to take the initial steps toward expansion, consider how exactly you will make it happen. If it is only internal growth, put together a plan for how you will allocate resources and what you will do to make your current business bigger and better.

If your plan includes acquiring a new business, judge how well you feel you can take on that process yourself. There are several tools already in place, such as buyer acquisition programs that utilize the expertise of business brokers and intermediaries to set your goals, identify target businesses, screen the businesses, advise on offers and assist with negotiations and closing.. Business-for-sale online marketplaces like BizBuySell.com offer an alternative resource for those seeking to buy a business on their own.

While there are countless considerations to make before deciding to expand your business, these three standard questions can help facilitate your decision-making process. Taking advantage of the downturn -- with its lower business-for-sale asking prices -- by buying up your competition can put you in a great position for when the economy bounces back.

Interview with Domenic Rinaldi (CBI) of www.bizbrokerjournal.com

I recently had the pleasure of being interviewed by Domenic for his business brokering blog www.bizbrokerjournal.com. Domenic brings more than 24 years of proven experience in merger/acquisition, sales, service, marketing and operations to the business brokerage arena. He is also part of the Sunbelt Business Network, the world’s largest business brokerage firm with approximately 300 licensed offices located throughout the world, works out of Chicago, and is an expert in his field. Expect to see a guest post from him here in the not too distant future on growing through acquisitions.

Thanks to Domenic for allowing me to introduce his readers to the possibilities of using receivables finance as a means to assist in acquisitions.

The full text of the post is below. For more information on what Domenic does, or if you have an interest in buying or selling a business in Chicago or the greater Midwest, feel free to contact him: Domenic Rinaldi, CBI.

Tuesday, September 8, 2009

Factoring to Finance a Business Acquisition

Financing has been a common theme for most of our blog posts this year. The lack of bank funds for business acquisitions has left the marketplace to scramble for alternatives. One such option is to 'factor' a company's receivables to secure a transaction. Factoring is simply the ability to obtain upfront cash against a company's accounts receivables.

As with most financing options, factoring has its pros and cons, and I recently had the opportunity to interview Sean Lelchuk of Bibby Financial Services to learn more about this service. Below is a recap of my interview with Sean and some insights into how this may apply to your business acquisition plans.

First, a little background on Sean and Bibby Financial. Bibby Financial Services is an independent, family owned business that operates in 27 countries. Bibby provides receivables funding services for domestic and export receivables, and purchase order financing. Sean is a Business Development Officer in their Florida office and is responsible for assisting clients with their factoring needs. Sean is a former small business owner and understands the importance of having access to capital for business growth and maintenance.

Interview with Sean Lelchuk from Bibby Financial Services:

Q: Please explain factoring?
A: Factoring is where an advance of cash is made to a Client against the purchase of an accounts receivable by a financing company (aka Factor). The Factor then proceeds to collect the receivable. The balance of the receivable less any fees due to the Factor is then payable to the Client on collection of the receivable by the Factor. Factoring is an effective way for a business to finance growth or to assist in the restructuring of a business. It is also a means by which an acquiring company may leverage existing assets of a target company as collateral for secured financing to help close a deal. It also does not lead to any loss in equity of your business nor does it involve taking specific security over personal assets.

Q: How can factoring be used to help buyers and sellers in a business sale transaction?
A: For the buyer, there are two main ways to use receivables finance to creatively finance an acquisition transaction.
1. Funding your receivables: In this scenario, you establish a factoring facility on your own receivables to extract cash out of your business to bring to the closing table. Usually, this can be done on a relatively short term basis allowing for the purchase of the target company with the conversion of a current asset.
2. Funding the target company's receivables: This approach is a little bit more complicated, but can work to even greater advantage. Assuming it is an asset sale, you can work with a factoring company to finance the existing receivables of the target allowing for the seller to essentially help finance the sale of their business. At the closing table, the factoring company will provide an advance on the outstanding receivables of the seller's company to contribute to the cost of acquisition.

For the seller, the advantages of this approach are that the seller usually does not need to offer direct financing to the buyer, can "take home" some of the money they have earned through delivering their product or service, and can, in some instances, offer this method as a way to finalize a deal.

Q: What are the Pros's of Factoring?
A: The biggest pro in working with a factoring company is that the main determinant in whether or not the funding will come through is the credit of the business's customers - not the credit of the buyer or seller or their companies. To obtain traditional debt financing everyone knows that it can be a challenge to close on a facility, especially for an acquisition, and more challenging in these times. The other pros are that you will also acquire a built in credit team to monitor the business's customer quality and aid in decisions to sell to new customers, a collections team to help make sure payments are received in good order, and access to other types of secured financing as most factoring companies have a long list of colleagues that finance other assets (i.e. equipment, inventory, property, etc.) that may prove to be helpful in the event additional funding is needed. Also, factoring companies do not require the submission of a regular borrowing base certificate and all the time necessary to compile one, and in the event additional availability on the facility is needed it is much easier to obtain an increase from a factor than it would be with a bank - if the invoices are there and the debtor credit is good, these companies make money by putting money out the door.

Q: What are the Cons of Factoring:
A: Most often the biggest concern is cost. It is true that factoring rates are higher than a traditional line of credit, but the flexibility with a factor, the ease with which a factoring facility may be obtained, and the opportunities that can be realized usually outweigh the additional cost. There is documentation that is required on a regular basis, but this is usually related to the transactions conducted by the business (i.e. PO's, invoices, and proofs of delivery) and is typically readily available. Customer notification and invoice verification can be worrisome for those who are guarded with their customers, but I have found that this is usually managed very well by the better factoring companies.

Q: Can you give a recent example of how you used factoring in a sale transaction?
A: Recently, a venture fund wanted to acquire a company that manufactures flooring and sells to distributors. The fund had allocated a set aside amount for the acquisition, and expected, based upon purchase and sale negotiations that it would be sufficient to close the deal. At the last minute, the seller decided to raise the selling price due to an uptick in backlog orders and argued that the price increase was justified by the addition of the pending business. The fund went back to management, but was denied an increase in allocation for the purchase. The lead agent contacted one of our brokers who directed him to us. We discussed the opportunity, reviewed the supporting documentation (i.e.transactional paperwork for the target company's typical sale, financials, receivables and payables, legal entity documentation, etc.) and the revised draft of the purchase agreement. We proposed on the transaction where we would finance the receivables of the target company for 12 months at the specified discount, advance on the eligible receivables outstanding at the time of purchase to contribute the shortfall created by the revised selling price for the business, and the fund was pleased that they did not have to come up with additional cash to finalize the deal. The target company did not have any secured financing, so we were able to secure the assets and close on the transaction.

Q: Where are the pitfalls in this type of acquisition financing?
A: The biggest thing you want to watch out for using receivables financing as collateral for secured funding in an acquisition transaction is that you do not want to strip the target company of operating capital. This may happen by taking too large an advance on the receivables to support the purchase - make sure the company will have sufficient working capital to operate when the transaction closes and those funds are removed from the business. Another thing you want to watch out for using receivables (or any other asset) as collateral for secured financing in an acquisition transaction is that you do not pay too dearly for the asset as a line item in the purchase agreement. If the seller wants to sell at a price over book value of the asset try to structure the purchase such that you pay for the book value at closing and any amounts over that (i.e. goodwill) on a schedule out of future profits from the accounts sold or as some kind of royalty. Make sure that any receivables collected by the seller during the negotiation stage are either removed from the asset listings or credited against the purchase price. You may want to include a provision in the purchase agreement that allows for a credit or repayment for any accounts uncollected (bad debt) after 90 days from closing. As an alternative to the above, you may consider setting an allowance for bad debt/uncollectable accounts and discount that from the purchase price.

One other item to look into is whether the assets are currently secured.
In this case, you must make sure that the receivables you intend to use as collateral are unencumbered since almost all factoring companies require a UCC-1 filing in the first position on at least the receivables themselves. The best way to avoid these issues is to do your due diligence and speak directly to a factoring company that is capable of handling these types of transactions during the purchase and sale negotiations.

Q: What are the costs of Factoring and typical terms?
A: Some factoring companies will provide you a rate sheet showing you what discount they will take for x number of days an invoice is unpaid. I find this to be misleading and counterproductive since each business is unique and you cannot put a generic formula to task for businesses in various industries, operating a differing volumes, and, most importantly, with very different customers. Most factoring contracts are structured on a 12 month commitment with minimum monthly factoring volumes. They are typically full-turn which means that all invoicing must be submitted to the factor regardless of whether or not you want an advance on the sale. Advances, once product or service is delivered and verified (directly by the factoring company), range from 70 - 95% of eligible receivables. Accounts that will be excluded from eligibility are those that are over 90 days old, are cross-aged (meaning that even though there may be outstanding invoices under 90 days, there are some, usually a percentage of total outstandings, that are over 90 days for the same account), and those for which a credit limit decision was unfavorable. Pricing can range widely and is dependent upon two main
criteria: 1. Debtor (customer) credit, and 2. Monthly volume. These items are inversely related to pricing - the better the quality of the customer and the higher the committed volumes, the better the rate. Rates typically range from 12 - 24% on an annualized basis.

Summary
In these uncertain times, finding creative ways to finance an acquisition is a given. You need to be aware that the cost of money derived from factoring receivables is usually higher than if you were to take out a traditional loan or line of credit, but the flexibility and ease of obtaining increased limits often allow for more business to be transacted or supplier discounts to be realized, thus offsetting (an in some cases eliminating) the effective costs.

Choosing the Right Financial Partner

One of the most difficult questions to answer is: Which company should I work with?

If you are at the point where factoring and/or PO funding is being considered, I highly recommend that you arm yourself with a basic understanding of the process and a series of questions for any funding company representative you talk with.

Below is a list of basic questions you should get answers to prior to making a decision to enter into a relationship with a financing institution. If the representative is unwilling to talk with you about any of the items below, or makes you uncomfortable when asking questions you have to think about what that says regarding his or her company.

The decision to work with a factoring / PO funding company should be made with care since they will be in communication with your customers. Make sure you are comfortable with whomever you choose to do business and that they have your company's interests in mind.

1. Is your company financial stable and how long have you been in business? This should be the first question you ask. If they are not willing to talk about their finances and history, why should you talk to them about yours? Ask for their most recently available financial statements (they will probably ask you the same), and if they are unwilling to provide them, walk away.
2. How does your funding process work and do you offer both AR and PO funding? If so, do you do both in-house, or do you partner with another company? Generally, this is pretty standard in the industry, but some companies charge their fees out of the advance they give you and others take the fees out of the reserve portion once your customer makes payment. Have them explain to you in detail how the actual operation of the relationship will develop. What documentation do I need to provide for funding, when will I receive the advance, do you make calls to my customers, when do you release the reserves? All good questions to ask. Most factoring companies only offer receivables financing and use a third party company for PO funding even though they may market that they offer both. There are a couple of companies that offer both in-house and are usually more cost effective.
3. Can I factor if I have a loan, line of credit, or back taxes outstanding? Some financing companies will consider funding even with your business assets secured by another institution. Most commonly, factoring companies will require a 1st position security interest (lien) against, at minimum, your accounts receivable. If you have an existing lender (or government lien) in place it doesn't mean that you cannot factor, just that you will need to work with your existing lender and the factor to either takeout/payoff the existing lender or get a subordination from them. In some instances, you can work out a paydown schedule or installment plan that will allow you to move forward with the factoring company.
4. How does your application process work, how long will it take, and are there any application fees? Your time is valuable and you don't want to waste it on companies that charge application fees. If the company you are talking with charges an application fee and/or files a UCC-1 financing statement on your company (a blanket lien against your company's assets) at the time of application, walk away. Find out what kind of documentation you need to provide to get a decision from them. Usually, all that is required to get a proposal is: signed application, accounts receivable aging detail, your customer list, and an invoice trail showing all paperwork from a recent transaction (i.e., PO from customer, invoice to customer, and proof of delivery; PO funding requires some additional paperwork related to the front-end/supplier side of the transaction). Depending on how much financing you need, you may also have to provide recent financial statements, accounts payable, and additional transaction histories. You should expect to pay a due diligence fee to any company you want to consider working with, but you should not pay it until you have a proposal in hand. Most companies should be able to give you a proposal within 48 hours of you giving them all the documentation they need to make an informed decision.
5. Do you require monthly minimum invoicing or a minimum contract term? Most factoring companies do require a 12 month committment with minimum invoicing expectations and charge penalties for not meeting them. Find out ahead of time what programs are available to you from any financing company you talk with since many have different product offerings. Do not be afraid of making a committment to a company so long as you are comfortable with the expectations. Find out what happens if you want to exit the contract prior to the end of the term. Most companies will penalize you for early termination. This is not a bad thing, just make sure you are committing to what you are comfortable. If you are a startup company this can be worrisome and potentially dangerous. Find out if they have any products the will allow you to waive minimums for a period of time, or if they have any products designed specifically for startup companies. The good ones do.
6. How is your pricing determined and what should I expect regarding fees? There are a number of different ways to set price in a factoring relationship. You can have a flat fee, a percentage fee on the gross receivable for different periods of time, administration charges, fees on the actual funds advanced, facility fees, lockbox fees, wire fees, credit check fees, lien/UCC search fees...the list can go on and on. There are two main ways funding companies price their services: discount and availability pricing. Discount pricing is where you get charged a percentage of the gross invoice. Typical discount pricing is structured so that you get assessed one discount rate for the first 30 or 45 days, then a smaller rate for each additional 15 days thereafter. This can be sliced and diced any number of ways: one discount rate each 10 days, or one discount rate to cover that administration and a much smaller one on a daily basis. Typical availability pricing is structured so that you get assessed a small discount rate on the gross invoice and an indexed rate plus (i.e. Prime or LIBOR + 3.5%) on the net funds employed (actual funds advanced). Make sure you help the representative understand what terms you offer your customers and what their payment trends look like so the both of you can come up with the best pricing model for your business.
7. Have you worked with businesses in my industry before and are we the right size for you? This can be critical. Some factoring companies specialize in specific industries such as apparel, staffing, or trucking. If you are a manufacturer of technical electronic equipment and are talking to a factoring company that specializes in trucking, this may be a disaster waiting to happen. Find out if they understand your industry. This can be done most easily by paying attention to what kind of questions the representative is asking you. If they are really trying to understand how you do business and how your invoicing process works, then you probably have a company that should be considered. But, if they don't seem to get it, it might be time to look elsewhere. Also, some factoring companies only work with small to medium sized businesses, others just the really big ones. Find out if there is a fit here before going through the application process so you know they either have enough funds to work with you or too much so you would be lost in the shuffle.
8. How will I know what's going on with my customers and their payments? Major question. If payments are now being made to the factoring company or a lockbox, how will you know when those payments are received? If the company does not have available to you internet account access you may be left in the dark about what is happening with your customers. Find out if they have the technology in place for you to be able to log into an online account to see payment history, account aging, and copies of cleared checks. It is in your best interest to have direct access to this information. If they don't, consider talking to other companies.

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Purchase Order Finance

The days of easy credit are gone and we probably won't see them again for a number of years. Markets have tightened across the board, banks are hoarding cash, and you are unable to finance orders you have on hand (or could have on hand). If you could only find a way to get your suppliers to release goods, you would be able to pay them because you know your customers are good for the money.

Sound like something you've experienced?

Well, my friend, you are not alone. Many business owners find themselves in similar situations: They have the opportunity to take on a potentially valuable order, but do not have the means to pay their suppliers due to cash flow issues, maxed out credit lines, or a lack of terms with their supplier.

There are usually a couple of reasons a business needs this kind of financing. Large orders, seasonal sales and business expansion are most common. Sometimes a company may have funds available to finance an order, but has opportunity elsewhere and just needs to find additional sources of funding.

Fortunately, there is a way to make this work without having to fork over 100% of the cost of goods to your supplier. It's called purchase order (PO) finance, and there are a couple of ways it can be done.

• Making Direct Payments to your Supplier

A PO funding company can advance up to 100% of the confirmed purchase cost to your supplier by paying them directly and taking ownership of the goods. The funding company then collects the invoice payment from your customer and pays you the balance between the order value and the amount paid to your supplier, minus fees, once payment has been received.

• Issuing a Letter of Credit

This is a commitment to pay the supplier on their fulfillment of certain conditions backed by either a Bank or the PO funding company. The conditions are normally related to the provision of correct documentation. These Letters of Credit are governed by the regulations of the International Chamber of Commerce. Terms are negotiated directly between your supplier and the funding company, and the Letter may be opened prior to production or just prior to shipping, whichever works better for the transaction. Funds are typically released once the goods are delivered to the buyer, but may be released "against docs" while in transit.

• Supplier Guarantee

This is a commitment to pay the supplier by the funding company from the availability (funds) generated on the funding of the receivable created once you invoice on delivery of the goods related to the purchase transaction.

As you can see, there are a couple of ways to keep your business moving even if you don't have the ability to fund these opportunities yourself.

The Basics of Factoring

What is receivables funding?

Factoring is where an advance of cash is made to a Client against the purchase of an accounts receivable by a financing company (aka Factor). The Factor then proceeds to collect the receivable. The balance of the receivable less any fees due to the Factor is then payable to the Client on collection of the receivable by the Factor. Factoring is an effective way for a business to finance growth or to assist in the restructuring of a business. It also does not lead to any loss in equity of your business nor does it involve taking specific security over personal assets.

For instance, you sell your good or service to your customer in the normal course of business. Once your side of the transaction is complete and your service has been provided or your product delivered you generate an invoice for your customer that states they owe you X dollars within 30 days for what you have given them.

At this point you would normally have to wait those 30 days (payment is always right at that 30 day mark, isn't it?...) prior to receiving the cash you are owed. Factoring changes that.

When you factor your invoices the factoring company will advance you a percentage of the invoiced amount shortly after the invoice is created. This percentage is usually between 80 - 90% of the gross invoice amount. So instead of having to wait those 30 days for your cash, you are able to receive the majority of it almost immediately after you deliver your good or service.

The difference (that 10 - 20%) is held by the factoring company until your customer makes their payment through a lockbox. Once the payment is made, you get all of that back minus the fees for the service.

Fees range quite a bit between different companies and are structured based upon your customers' credit and the amount of invoicing you do and the factoring company's cost of funds (what their money costs them), but are generally small compared to what can be done with the available cash. There are some instances I have seen where companies actually come out ahead of the game and are effectively PAID to factor their invoices. This can happen when a company is able to take advantage of early pay or bulk discounts from their suppliers (sometimes enough by itself to cover the cost of factoring) and is able to put the free cash to use. It is truly an amazing concept! I believe Warren Buffett calls it negative float for his insurance businesses.

Welcome!

What I have found in the world of receivables finance is that most small to medium size business owners (outside of trucking and apparel businesses) are mostly unfamiliar with the mechanics of how this type of financing works.

Statistics have been presented that show over 70% of small business owners in the United States do not even know that there is a way to accelerate the conversion of your accounts receivables to cash.

I know in these challenging economic times that a majority of those people could benefit from learning about the concepts behind factoring their invoices and, in some instances, using their purchase orders as a means to obtain the support of a funding company.

The most frequently asked question I get is: How does this work?

It is really pretty simple. If you sell to creditworthy business customers on terms of say, Net 30 days, there are companies that will provide cash against that invoice.

How many situations have you experienced where your customers are taking longer and longer to pay and if they would just pay you a bit faster you would have been able to take on more business.

What about being able to meet payroll, taxes, and other operating costs?

I know plenty of people who just don't want to wait 30, 45, even 60 or 70 days to get paid: Are you one of them?

This blog will attempt to explain different aspects of how this kind of financing works, provide examples of how it has helped other business owners, and the various specialized products available.

If you have any suggestions for topics, or just have questions, please do not hesitate to contact me and share your thoughts.