Thermo Credit, LLC

The Goal: Solving Cash Flow Issues

In today’s economic environment, a company will encounter many challenges in raising cash to build the business. All companies need working capital to grow. However, after the initial capital raise has been exhausted, many companies find themselves in the unenviable position of having to raise cash to take the business to the next level. Missteps at this stage can be disastrous. Management has a responsibility to understand the risks and full costs of the financing agreements they enter.

The following are the top three means of funding for growth companies: Banks, Venture Capital Firms, and Factoring Companies.

BANKS

On almost every corner there is a bank, large nationals and smaller locals, each with their own lending criteria. If you qualify, Banks can offer one competitive advantage-the interest rates they charge are relatively low. However, the prerequisites can be daunting and the consequences of an “event” can be debilitating. Banks typically require a lengthy track record and a strong financial position before extending credit. When securing Bank financing, it is important to consider the following:

1. What is the true interest rate? Make sure you understand how the interest is calculated and charged, including fees to have the facility in place and attended to by third-party professionals. Be aware of anything that might trigger an unexpected increase in the rate.
2. What is the collateral? Most Banks will require a company to put up collateral that equals between two and three times the amount of money borrowed.
3. What UCC’s (liens) will be filed? A UCC on all of your assets can make it extremely difficult to raise additional funding in the future.
4. What guarantees are required? Be cognizant of corporate guarantees, cross-collateralization, and personal guarantees.
5. What can trigger a default and what are the consequences? Many financing agreements will include certain performance requirements, such as working capital ratios. Most companies cannot react quickly enough if a Bank calls the loan for non-compliance or terminates distributions of cash.

VENTURE CAPITAL FIRMS

Venture Capital Firms typically provide capital and become partners (sometimes controlling) in the companies in which they invest. They offer very low interest rates or no interest charge at all. However, the fact that you always give up equity, usually more than half the value of the company, to a Venture Capital Firm makes this very expensive money.

When working with a Venture Capital Firm, make sure you understand the following:

1. Is there an interest charge or deal fee on top of the equity being provided? Many deals will include interest and equity. These may come in the form of preferred shares which can include dividends, another cost of funds.
2. What control are you giving up? Will this arrangement move the current shareholders to a minority position? A majority position will allow the Venture Capital Firm to control the company.
3. How many board seats will the Venture Capital Firm have? Almost all Venture Capital Firms will require board seats as part of the arrangement.
4. Who has anti-dilutive rights? Venture Capital Firms typically put a clause in the agreement that does not allow them to be diluted. This means that any equity given up in the future will come exclusively from current shareholders, which is particularly onerous if current shareholders are in a minority position.
5. Are there any other restrictions? Be aware of things such as UCC filings, default clauses, etc.
6. Venture Capital Firms typically have a short-term exit strategy. Ensure that your business plan mirrors the Venture Capital Firm’s exit strategy.

FACTORING COMPANIES

Factoring is the process of accelerating the collections on your receivables. A Factoring Company advances funds against the receivable that you would typically collect over the next 30, 60, or 90 days.

Factoring, when done properly, can be the least expensive money available. There are many things to consider here as well:

1. What is the discount rate? Discount rates vary from 1.5 – 6% on a 30-day invoice.
2. Are there “hidden” fees? Understand the rationale and implications of all fees being charged. Please see Costs of Factoring (pg. 3) for further detail.
3. Is the agreement Recourse or Non-Recourse? Is your company ultimately responsible if the accounts are not collected?
4. Are there any guarantees in the agreement? Just like Banks, some Factoring Companies will ask for corporate or personal guarantees.
5. What UCC’s (liens) are being filed? A Factoring Company should only take a UCC on the receivables being purchased.

Different Types of Factoring Companies

There are two different types of Factoring Companies: Non-Recourse and Recourse.

Under a Non-Recourse Factoring Arrangement, the Factoring Company purchases all receivables and reserves the right to offset one batch against another. At the end of the day, if there is a collection shortfall on the receivables, the company generally will not be required to write a check to fund such shortfall. Another benefit of a Non-Recourse Factoring Company is in the way a company’s arrangement is reflected in their financial statements. In a Non-Recourse arrangement, a company is not required to show the advances as a loan, as it is a true purchase and sale transaction. As the table below demonstrates, this has the effect of improving your working capital ratio. A strong working capital ratio makes it easier to raise additional funds in the future.

A Recourse Factoring Company will require a company to satisfy any shortfalls on a batch of receivables. A shortfall occurs when the collections on a batch are less than the amount advanced. Be aware of any guarantees you give, especially personal, in case you do have a shortfall. The last thing you want to do is write a personal check to make up the difference!

Costs of Factoring

Fee structures for factoring can be structured in variety of forms. The three most typical fees you will see are:

• Discount Fees -
  Although these can vary, they are typically a fixed percentage of the re-ceivables purchased and are generally assessed at the time of the purchase. Discount fees can be charged as a one time fee or on a monthly basis.
• Origination Fees -
  These are usually charged to cover the cost of due diligence and legal fees associated with originating and closing the transaction. This is usually due at the time the term sheet is signed.
• Commitment Fees -
  This is the cost of having funds set aside for your company. These are usually assessed on your first purchase or on an annual basis. You will want to have a commitment amount in your agreement to allow for growth in your company.

Some Factors will forgo the origination fee and/or the commitment fee and offer a higher discount fee. Be wary of any agreement that lets you get in relatively cheap on the front end. As this table demonstrates, the long-term cost differential can be substantial.

Why Consider Factoring?

Factoring, if done right, can be the least expensive money available to you. In many instances, you should be able to obtain funds for your company without the hassles of keeping up with financial ratio requirements, signing personal guarantees, or selling equity in your company.

These funds can be used to:

• Increase sales and marketing efforts
• Purchase needed equipment
• Hire quality personnel
• Create better credit terms by paying vendors quicker
• Help you meet payroll and tax obligations
• Offer customers better credit terms
• Provide funds for acquisitions