Small Business Funding Alternatives

The first method of finance that led to the emergence of the cash flow industry was owner financing.

In an owner-financed sale, a real estate seller accepts a promissory note as a portion of the purchase price. The note is then secured by placing a mortgage on the real estate being sold.  Homeowners and commercial real estate investors in this country have used owner financing as a method of buying property since the early 1900’s.  However, it wasn’t until much later that it became popular.

During the high interest rate periods of the Seventies and Eighties, home buyers found it difficult to obtain affordable financing from banks. Interest rates and inflation had skyrocketed to double digits, making it almost impossible for people to sell their real estate. If a real estate seller was willing to take a down payment from the buyer and hold a mortgage note for the remaining balance, the transaction was much more feasible for the buyer–and certainly more convenient.

By the time inflation drifted back down, thousands of individuals were holding private mortgage notes. Individual investors and investment companies recognized a tremendous profit opportunity in those notes, and they began to buy them directly from sellers.

These privately held mortgage notes have turned into a commonplace investment nationwide. Today, privately held mortgage notes are even securitized and traded on Wall Street.

The second method of finance that impacted the development of the industry is factoring, also called the sale of a business’ accounts receivables.

Factoring has a long, rich tradition dating back some 4,000 years to Mesopotamia (which some think of as the cradle of civilization).  In addition to many other things, the Mesopotamians first developed writing, put structure into business code and government regulation, and came up with the idea of factoring.  Mesopotamia and its citizens eventually became extinct but the concept of factoring definitely did not.  Indeed, almost every civilization which valued commerce has practiced some form of factoring, including the Romans.

The first documented use of factoring occurred in the American colonies before the revolution. With the advent of the Industrial Revolution, factoring became more focused on the issue of credit, although the basic premise remained the same. By assisting clients in determining the creditworthiness of their customers and setting credit limits, factors could actually guarantee payment for approved customers.

Prior to the 1930’s, factoring in this country occurred primarily in the textile and garment industries, as the industries were direct descendants of the colonial economy that used factoring so specifically. After the war years, factors saw the potential to bring factoring to other forms of invoice-based businesses and the expansion began.

Today, factors exist in all shapes and sizes: as divisions of large financial institutions or, in larger numbers, as individually owned and operated entreprenurial endeavors.

Many of these private factors sprung up in record numbers as interest rates rose to new heights in the 60’s and 70’s. This trend intensified in the 80’s, primarily due to the increasing impact of interest rates and changes in the banking industry. With banks becoming too expensive and too inflexible due to heavy regulation, the small businessperson was forced to find other sources of financing for expansion and growth. As more and more banks stopped being a funding source for the small businessperson, factoring has increasingly become an option used by the small business owner.

This year alone thousands of businesses will sell billions of dollars in accounts receivable, and they are doing it for profit, growth, and survival.

Prior to the 1980’s, factoring was used primarily in the garment, textile and furniture industries and was only otherwise available to “big business”. So, with the banking industry upheaval of the 80’s and the rise of the independent broker network in the 90’s factoring of accounts receivable has taken its place as an acknowledged financial tool that can assist many businesses - both large and small.

Clearly, the concept of selling an income stream has been a part of the financial services industry for “many” years. However, until the last decade, cash flow transactions were essentially limited to private mortgages and invoices.

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Since the formalization of the cash flow industry, approximately 14 years ago, its growth has steadily increased. 

Cash flow brokers are entering new markets and discovering new ways to provide cash flow services to businesses and individuals.  Also, new income streams are discovered and added to the never-finished list of pieces of paper which can be sold in the cash flow industry.

Many who start out as cash flow brokers go on to become Master Brokers or funding sources mentoring other brokers just getting started in the industry and/or purchasing income streams with their own funds.

But, the most significant reasons for continued growth of this industry include:

1.  The emergence of the cash flow broker (like myself) which helps to spread the word about the availability of these funding options to businesses previously unaware of same;

2.  The economy is increasingly operating based on debt (unfortunately);

3.  Cash Flow income streams provide an investment alternative for investors seeking large yields on their money;

4.  The cash flow industry is gaining visibility in the financial services marketplace.  In fact, Wells Fargo Bank recently purchased one of the leading government contract funders in this industry.

So, let’s look at these reasons in a little more depth.

1.  Emergence (and development) of the career of cash flow specialist/consultant. 

During the 1980’s, private mortgage investors operated in their own exclusive sphere — focusing on mortgage notes and, generally, not buying other income streams. They also usually bought notes only in their own geographic areas.

Additionally, private mortgage investors typically worked directly with private mortgage note sellers. On occasion, though, an investor would come across a note too large to buy and would broker it to one of the larger investment companies.

But, generally, for the most part, transactions were between buyers and sellers directly.

Over time, the income potential in brokering private mortgage notes was realized and the broker network grew. The availability of brokers, in turn, provided more investment opportunities for investors.

It was a winning situation for everyone. Rather than tracking down notes directly, investors could put up investment capital and rely on brokers to bring them transactions. In addition, investors could do business nationwide rather than just in their local neighborhoods. Today, most major private mortgage investors rely on brokers to bring them transactions.

The same process occurring in the private mortgage business occurred simultaneously in the factoring industry.

Traditionally, factoring had been provided by major factoring companies, often subsidiaries of large banks. It was available only to companies with annual sales in excess of $100 million a year (”big business). For smaller companies, factoring services were out of reach.

Soon, a small group of companies recognized an opportunity in providing factoring services to small and mid-size companies and emerged as factors, targeting businesses with annual sales below $100 million. Their activities, too, were focused on the geographic areas in which they functioned. And in most cases factors dealt directly with businesses, not with brokers.

Eventually, some companies began to examine factoring brokerage as a career possibility. As was the case with private mortgage brokering, training programs helped to popularize the factoring broker as an occupational category.

Today, many factoring companies which in the past dealt directly with businesses now depend exclusively — or at least significantly — on brokers (as with private mortgage investors).

Brokers specializing in private mortgages and brokers specializing in factoring were essentially doing the same thing — brokering future payments — which resulted in the foundation for what we now call the cash flow industry.

When the first cash flow brokers started looking for individuals and businesses with a need or desire for cash, they came across other types of income streams that offered similar opportunities for brokering. As a result, brokers started actively seeking new income streams to broker with funding sources  ready to purchase them.  At last count, there were some 60 income streams.

2.  The economy is increasingly operating based on debt.

A USA Today article on 8/27/05 entitled, “Experts warn that Heavy Debt Threatens American Economy, “ states:

“You owe $145,000. And the bill is rising every day.

That’s how much it would cost every American man, woman and child to pay the tab for the long-term promises the U.S. government has made to creditors, retirees, veterans and the poor.

And it’s not even taking into account credit card bills, mortgages — all the debt we’ve racked up personally. Savings? The average American puts away barely $1 of every $100 earned.

It’s not a rosy picture, I know. 

But, the cash flow industry — and/or its investors – is doing its part in helping to stimulate the economy by helping small businesses to leverage their “liquid assets” rather than acquiring “debt” and thereby self-financing their own growth and expansion. 

And this is no small contribution to the economy, as we know that the total of small business is larger than big business and is the backbone of this country.

3.  Cash Flow income streams provide an investment alternative for investors seeking large yields on their money and buying future income streams is not only a very profitable form of investing but also relatively secure.

When investors buy future income streams, they do not pay face value and this equates to a high yield on their investment. 

Also, with this type of investment they know, in advance, exactly what that yield will be (provided the payments come in on time).  If they have thoroughly researched the income stream they are purchasing, they will be fully aware of whether there is the possibility of default and will have factored this into the offering price for the income stream.

Investors who either fear a decline in the stock market or dislike the daily management of their investments can earn significant returns in the cash flow industry with very little management time.

4.  The cash flow industry is gaining “visibility” in the financial services marketplace.  As noted in an earlier post, the cash flow consulting profession is growing and with the increasing number of successful cash flow professionals, comes increased visibility to the industry. 

Cash flow professionals are out spreading the word one on one, giving presentations to business groups, networking with business owners and government so that the business community is beginning to see that the cash flow industry is, indeed, an extra “Resource” for the cash-hungry new and growing businesses. 

I am regularly allowed to have booths in the Resource section of business fairs.  In one, right after Katrina, I am directly across from the SBA and right in the middle of the Resource area along with the La. Economic Development, Manufacturer’s Extension Partnership of Louisiana and other resource booths.

Many of the referrals I get come from bankers and others located in these Resource areas.  It is a win/win situation for them to have someone to refer customers to who they have not been able to help.   The ultimate objective for all in the Resource category is to help the small business survive and if that means referring a client to another Resource then that is the best thing to do.  Previously, the options available in the cash flow industry were unavailable to the little guy but that is different now and I and other cash flow consultants like me are out there spreading the word.

With increased visibility, more businesses and consumers are becoming educated about their cash flow options. And the more people learn about their options, the more people will begin looking for brokers and buyers to turn their income streams into cash!

Be Safe!  Debra

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Privately held income streams, like the one created by your daughter’s payments in the previous post, can be bought and sold in the secondary marketplace.  In this marketplace, individuals and businesses can get cash NOW for their “future” income streams. 

So, looking at our example where you financed the home purchase for your daughter, could you get cash in exchange for the future payments owed you at your local bank?  Most probably not.  But in the secondary marketplace, many investors would give you cash today in exchange for the right to collect the payments over time.

Another example would be, you delievered $10,000 worth of merchandise to a customer along with an invoice requesting payment within 30 days.  Although the customer owes you money within 30 days, that money is not yet available to pay your bills.

Now suppose a third party offtered to give you $9,000 in cash today in exchange for your $10,000 invoice.  Would you take it?  You would if you needed cash today in order to pay employees and buy supplies for new orders.  It would make it possible for you to stay in business and keep your customers happy.

Transactions like these occur every day.  Individuals and businesses collect future payments or income streams sooner, rather than later, by selling them to a third party. 

The third party pays cash today for the right to receive payments over time. The third parties that purchase these income streams can be either an individual investor or an investment company.  Either way, they are willing to pay cash today for the right to receive future payments.  And, since they are giving up cash today, they will need to earn a rate of return on this money which is the discounted amount they pay for the income streams they purchase. 

Just about any income stream, whether it is a mortgage to be paid over 20 years or an invoice to be paid in 30 days (factoring of accounts receivable), can be sold to a funding source in the cash flow industry/secondary market.

I am passionate about the Cash Flow Industry/Secondary Market because it helps SMALL businesses (or the little guy) by bringing financial tools that have been available only to BIG business in the past down to small business’ level. And since I am definitely a champion of the little guy or underdog…I like that!

Most of us have heard of or are familiar with home mortgages being bought and sold so that over a 30-year period a homeowner’s mortgage company may change hands 2 or 3 times. Well, this is an example of “paper” being bought and sold in the secondary market and previously it has been in vast amounts of dollars such as transactions with mortgages (usually in portfolios).

But, now, with the development of the cash flow industry during the last 14 years or so, similar options are there for small business now. So much so that invoices as low as $50 (for a limousine service) can be factored. Now “that” is bringing it down to the level of the little guy!

So, two primary themes of the cash flow industry (which is trading paper in the secondary market), in my opinion, are:

1. Help for “small business” or the “underdog” by
2. “Leveraging” of available assets.

These are two themes that will be interspersed throughout this blog as they are in my life, business and beliefs (i.e. I am always hoping, helping and pulling for the little guy and believe that leveraging of their assets is a solid tool for the Little guy to use to his/her advantage).

Stay Well, Debra, YCFC

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