Why Small Factor’s Existence is Threatened

Many small factoring organizations are the heart and soul for small business that require some financing or factoring using their accounts receivable to access cash post shipment. But in speaking with many of these small factoring organizations, I find there are three big threats to their future existence, two which are well known, and the third which is mostly ignored.

First, the biggest impact on their portfolios today is coming from merchant cash lenders. Merchant cash advances became popular back in the early 2000s as a way for small companies to access unsecured credit based on their credit card receivables. Over time this product has become more sophisticated and includes Bank Only ACH Product which funds all revenue, not just credit card receivables. For marketplace lenders, factors, and other specialty finance companies, that first access to cash creates a disadvantage.  If a borrower takes a loan deal for an inventory line of credit or some asset based finance solution, even though they may be positioned as a first lien lender, the Merchant Cash lender has access to daily cash even though they may be in a second or even third position.

Second, customer acquisition costs are daunting. Factors typically live by the rule of thirds, a third of companies renew, a third of companies move on, and a third of companies go out of business. It’s a brutal customer cycle, and one where acquiring customers that will stay is no easy task and requires investment in origination and relationship management. Many small factors by definition just don’t have a deep bench.

Third, small factoring companies lack the technology investment to build new solutions. Third party API interfaces, digital compliance, digital document exchange, interfaces with purchase to pay or B2B networks, proprietary underwriting models that link with social media data and other sources, data extraction tools, etc. all this increasingly matters in a digital age. Going to various conferences and saying we are not seeing this new form of lending is putting your head in the sand. It’s coming and it’s only a matter of time.

So if you are a small factoring organization, what can you do?

  • Perhaps now is the time to sell your book before the value is reflective of the new world.
  • Focus on a niche sector where you can build the relationships and expertise (of course you have portfolio concentration risk). Contract staffing, media, and construction are just a few sectors or supply chains that come to mind. These may be challenging supply chains, but you can own a piece.
  • Jump the curve the way China did by not building landlines and moving straight to wireless. How? Start building the technological expertise around APIs to become more an information advantaged lender.
  • You can also choose a partnering strategy with the various network platforms out there (and there are a ton), but many of the larger ones have already started to develop their funding strategies so that horse is already leaving the barn.

Do relationships still matter? Of course they do. Lenders that can offer an array of financing solutions that are backed by various forms of collateral may not have the same issues as those that are mostly receivable based. Still, hoping and praying this is all going to go away is not the answer.

Jason and I see lots of opportunities here, and the changing dynamics of how credit is formed, underwritten and injected into supply chains is becoming pretty impressive compared to traditional methods. If you like to reach out to us, you can contact me at dgustin(at)globalbanking.com

 

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