By Nic Perkin
In business it takes money to make money. That is a plain and simple truth. Unfortunately, maintaining the reliable cash flow needed to invest in growth while keeping up with day-to-day financial obligations is a perennial problem for small and medium-sized businesses (SMBs), even in a strong economy.The current lending environment has made it tougher than ever for SMBs to raise the cash needed to fund day-to-day operations or capitalize on upcoming growth opportunities. Commercial bankers—especially the regional and community banks that do most of the small-business lending—haven’t fully loosened the tight lending restrictions they began imposing in 2007. Minority-owned businesses are disproportionately affected. According to the U.S. Department of Commerce, “inadequate access to financial capital continues to be a particularly important constraint limiting the growth of minority-owned businesses. The latest nationally representative data on the financing of minority firms indicates large disparities in access to financial capital. Minority-owned businesses are found to pay higher interest rates on loans. They are also more likely to be denied credit, and are less likely to apply for loans because they fear their applications will be denied.”
A lack of capital can be a major challenge to a minority business, but owners and executives who seek alternatives to traditional lending may be better suited to overcome these challenges, and better positioned for success. Take Eddie Ortega and Erik Espinosa, founders of United Tobacco Inc. in Sunrise, FL. The two friends built their business into one of the most reputable and rapidly growing manufacturers and sellers of unique hand-made cigars. Like many small companies, the early stages were mostly self-funded with support from a small bank line of credit. As they started to blaze their trail in the industry, they also started to experience the difficulties of effectively managing their working capital to grow with them. The business had an established relationship with a local bank, so it never occurred to the owners that it would be difficult to increase the line of credit.
“Maintaining a stable business for the long term means having sufficient liquidity—even when you don’t have an immediate need,” said Mr. Ortega. “We hit a growth pattern that required us to enhance our cash flow position, but the bank was unwilling to increase our line at a reasonable rate despite our track record of profitability, our clear potential for growth and ability to repay the debt.” Without a reasonable means to access affordable capital it could have become difficult to maintain the current pace.
One potential source of financing is the working capital that small businesses have tied up in their outstanding receivables. What businesses have lacked is an efficient, economical way to access that resource. The Receivables Exchange, the world’s first electronic marketplace for online receivables financing, allows businesses like United Tobacco to monetize their accounts receivable in a real-time, online auction. Unlike other forms of receivables-based financing, The Receivables Exchange allows SMBs to sell invoices to multiple institutional investors, so they get competitive, market-driven pricing— 99-98 cents on the dollar, on average.
“When I heard about the Exchange, I was immediately intrigued by the possibility of increasing liquidity in a couple of days rather than months--and all without giving up the relationship [with our customers],” remarked Mr. Ortega. “My second auction sold in minutes and the funds were wired to us the very next day. It is remarkable to be able to get access to cash that fast.”
Using receivables in commercial finance transactions is not a new idea; they are widely used as a collateral component in business lines of credit, asset-based lending solutions and factoring deals. What’s different about online receivables financing is the way in which the transactions are structured. Businesses sell their receivables directly to a global network of institutional Buyers, including hedge funds, commercial banks, asset-based lenders, and family offices. Sellers control the terms and timing of each auction by setting minimum advance and maximum fee amounts and the duration of the auction. They can also set a Buyout Price—similar to the “buy it now” price on an eBay auction. Sellers can track the bidding on their receivables in real time, 24/7, and the auction remains open for the amount of time stipulated or until the Buyout Price is met. Once the auction closes, the proceeds are wired into their business account the next business day.
Another key innovation of the online receivables financing approach is the lack of a long-term contract and other covenants and agreements. There are no all-asset liens, for instance, because the lien is on the receivable for sale. Unlike traditional factoring, a company’s customers are never notified that they are selling their customers’ invoices, so the business keeps control of the customer relationship.
Furthermore, online receivables financing does not require a personal guarantee on the invoices that are sold. Investors assess their risk based primarily on the credit rating of the selling company’s customers, not the credit rating of the company itself. Businesses are not judged by their short track record or lack of tangible collateral. Instead, they are able to leverage the credit quality of their customers to increase their short-term liquidity. Sellers do assume some obligations: If their customers do not pay, they have an obligation to repurchase those invoices.
The fact is, an undercapitalized business is vulnerable in any economy, and maintaining sufficient levels of liquidity is what keeps it healthy and less susceptible to a challenging and volatile economy. Every day more companies like United Tobacco are turning to The Receivables Exchange’s online capital marketplace to turn their invoices into cash, giving them alternative ways to finance growth and increase liquidity.
Nic Perkin is co-founder and president of The Receivables Exchange, an online marketplace for sale and purchase of accounts receivable. The Receivables Exchange allows businesses to access working capital flexibly and affordably, without the constraints of traditional financing.