Never spend your money before you have it. —Thomas Jefferson
What some might consider a bad habit—waiting 60-90 days to pay invoices—has birthed a business sector whose purpose is to bridge that gap by advancing money on those unpaid debts. Known as factoring or accounts receivable (AR) financing, this service allows companies—usually service providers—to stay in line with Thomas Jefferson’s recommendation. They get to have their money while waiting to actually have their money—for a small fee.
With private equity funds becoming scarcer than hair on a cue ball, many providers are looking for other ways to improve their cash flow. In previous years a boots-on-the-ground company might simply contact their PE firm for extra funds to get through a period of slow collections. No more.
JD Factors, based in The Woodlands, bridges that gap for clients in a number of industries, including oil and gas, said Business Development Officer Chris McClain. “Basically, the factoring companies turn a business’s unpaid invoices into immediate cash,” he said. “This happens by the particular company
Chris McClain
selling their invoices at a discount. If they have AR, then there’s a way for them to get cash without necessarily incurring debt,” at least not debt in a traditional sense. This cash can help pay bills, make payroll, replace equipment, and keep the lights on while awaiting payment by the client.
For Midland-based Velocity Financial Senior Vice President of Operations and Compliance Irene Hinojos, the PE drought does mean factoring can offer an alternative. “That would create opportunities for a factoring company if either the oil service company wants to make money now, [or] wants to grow the company faster, they’re going to need the cash, instead of being tied up in receivables, to be out there building more inventory or buying more equipment more quickly.”
Factoring could also benefit a company that—by choice or by circumstance—is not connected with PE but still needs to improve cash flow, she continued.
In the bigger picture, one issue that has choked off investment is the good-but-not-great price of oil and the uncertain outlook for pricing in 2020. It has also led to some bankruptcies and acquisitions, but Hinojos said the marketplace has not affected the factoring business like it did in the downturn of 2015-16, when she was with a different factoring company (she joined Velocity at its founding in January of 2019).
A downturn first affects companies involved in fracturing because, “When that price of oil takes a hard dip, that’s the first thing they put on hold,” she said. “But right now, we’re not seeing that.”
The effect is less for companies who service existing wells because those continue to produce no matter the price, and they continue to need service.
McClain sees the factoring market ebb and flow in sometimes counterintuitive ways. “Sometimes when the market is strong, folks may not need factoring as much, but on the other hand, they may because the demand is so high that their cash flow just can’t keep up with the demand. Factoring always seems to be a pretty strong industry,” he said.
When considering taking on a client, factoring companies handle their due diligence differently than banks do. Before extending credit, a bank looks at the borrower’s financials to make sure the money is likely to be repaid. A factoring company, on the other hand, expects to be paid back by the debtor company, so that’s whose credit score they’re concerned about. The debtor firm must also agree to pay the factoring company instead of the billing firm—which occasionally is a sticking point.
And in a significant downturn, said McClain, the challenge may come in dealing with debtors who want to balance their own books by stretching payments out an extra 30 to 60 days.
In some cases, Hinojos pointed out, that can actually create new factoring business. “Recently, a large company had net-30 terms and our client really didn’t need to factor it because it was turning really great in 30 [days] or less,” she said. “Well, they made a decision in the last couple of months to notify all their vendors, ‘We’re going to net-60.’ So now our client said, ‘That’s a little too long for us to hold onto that, so now [Velocity] can factor that entire account.’”
Irene Hinojos
Companies like JD Factors and Velocity, which are established in an industry, don’t actually have to evaluate every debtor every time. When taking on a new client, they look at that company’s client list—the ones paying the bills—and usually already have a track record with many companies on their prospective client’s list.
That makes the lending decision easy and much faster than a bank loan, in most cases. McClain and Hinojos both said they can usually get money to clients in a few days. For the factoring firm, the only asset they need is the invoices and a debtor company that’s likely to pay within no more than 90 days.
But what happens if they don’t?
If payment is just a little late, the factoring company may start by reviewing the invoice to make sure it’s accurate and complete, which Hinojos said Velocity does up front, before buying any invoice. It’s a service she says customers appreciate, because finding and dealing with errors helps Velocity’s clients maintain good relationships with the debtor firms.
And, while stressing that “We’re not a collection agency—we’re not pushy,” wanting instead to keep the relationship intact, Hinojos said they do help with collections when necessary. If the invoice has been lost or if the aforementioned updates are needed, Velocity works with the debtor on those issues. McClain confirmed that JD Factors does the same thing when needed.
Velocity has what Hinojos called a 90-day recourse, in which their client company could be required to repurchase unpaid invoices after 90 days, an agreement she said was typical of the factoring sector. But exceptions can be made under extenuating circumstances.
McClain said his company also helps with some collections.
Lubbock-based HUB Funding Solutions works in the sector also, but more as a clearinghouse than a direct factoring provider, although they do some factoring themselves. HUB’s President of Business Development, Kalah Sprabeary, explained it this way: “We actually work as a matchmaker. We have about 15-20 factoring companies that we’ve partnered with, and when a client comes to us we look at their needs and the way they’re set up, and help match them with different factoring companies so they can interview them and see who’s the best fit.”
As with JD Factors and Velocity, Sprabeary said the first point of evaluation is whether a company’s clients allow factoring, known as “taking notification,” and if those firms have good credit.
The size of the service provider is less of a factor than in previous times, she said. “Most of the [factoring] companies now don’t have a minimum that you have to factor, but it’s more worthwhile on a cost factor for the larger companies that are doing more [billing].”
Even a startup—if they have a contract with a significant client that takes notification and is in good standing—can start factoring right away, so there’s no 60-90-day lag before getting their first income. “It just helps them get off on the right foot,” Sprabeary said.
Kalah Sprabeary
Money is not the only service a factoring company should provide. “A factoring partner should really be that—your partner. You should be able to talk to them when things are good, [and] when things are tough, you work through it. It is definitely a partnership.”
A new factoring client should be ready not only to communicate but to learn—for Sprabeary, those two are the top needs.
On that score, she addressed some factoring misconceptions.
“I think one is that it’s really expensive. It used to be really expensive but it’s not so much anymore, because of technology and volume. Risk has become a lot lower, so you can get a 1.5-2.0 percent for 30 days and then negotiate a good rate.”
The tradeoff for her is that, yes, a business may pay as much as three percent, but they get their money for bills and payroll much sooner.
Another misconception is that online factoring firms are always better. In most cases, she contended, online lenders don’t get to know their clients or their client’s clients and “most of them don’t know anything about oil and gas and they don’t know how the language works with company men and the people that are signing those invoices.”
She spoke of a new client for HUB who had previously signed up with an online company that nearly lost him some clients because that online company did not know the language or the manners of the oil and gas industry.
Even within the industry there are sectors such as trucking, drilling, completions, and others—plus geographic differences. “There are a lot of national [factoring] companies, and a company that has a focus in the Bakken is not going to know the same companies that are in the Permian Basin.”
On the topic of nonpayment, Sprabeary said some factoring companies take out credit insurance. Or, if there is an indication that a payor is in trouble, preventive action can be in order.
A client in another state “saw that the company they worked for was going under.” The client called Sprabeary, who directed them to call the factoring company, which filed liens on the payor’s wells. All this happened because the conversation happened early enough to give time for recourse.
As with any other issue, to factor or not is a decision that is up to each company. But it can offer another alternative to PE or bank financing when cash flow is needed.
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Paul Wiseman is a freelance writer in Midland.
Good read!