Some small and medium-sized East Valley businesses facing cash crunches in an economy marred by frozen lending are using a historic but seldom-used escape route called factoring - selling accounts receivable at a discount to gain money quickly.
The primary goal is to spur cash flow for companies that are unable to get traditional bank loans. Businesses sell customer invoices at a discount for immediate cash to a factor, which collects from the former customer in an effort to make a profit.
"Factoring goes back hundreds of years," said Anthony Sanders, a professor at the W.P. Carey School of Business at Arizona State University. "And because of the current economic situation, it's becoming more popular today in the Valley."
Sanders said factoring as a method of raising cash in today's tight lending environment is risky, particularly for the factors.
"Unless they do thorough research into the sellers' background and current financial status, it could result in substantial loss of money," Sanders warned.
He referred to some sellers whose invoices are invalid or whose customers are unable to pay when factors knock on their doors.
There are several factoring companies in the Valley, including Factors Southwest in Phoenix. FSW was started seven years ago by Robyn Barrett, a former ASU student who worked in corporate finance before opening her own firm.
"Our business started picking up last June when the subprime loan issue started and the credit crisis began," Barrett said. "We've been getting calls from small businesses who need cash ever since."
Since the financial crisis began, she said Valley banks and lending agencies have returned to old-fashioned methods of qualifying potential borrowers, including raising the bar on their capacity to repay a loan, a high scoring system to rate their financial status and cash flow.
"The latest trend is that small businesses can get loans today, but not enough," Barrett said.
Barrett said besides loan refusals from banks, many of her clients have also had the limits on their credit cards cut. Many are unable to get loans even though they are creditworthy. Some are referred to factors by banks, she said.
Her clients are mostly medium-to-small commercial janitorial, manufacturing or business services firms. Since starting FSW, Barrett has provided more than $36 million to sellers each year. Her annual purchases are expected to reach $72 million this year and possibly more than $300 million by 2010.
"We expect our business to keep growing, although we want to remind people that the credit crisis is going to get better," she said. "It's not as dark as it seems. People need to be more optimistic."
Desert Controls LLC of Chandler recently sold its invoices for immediate cash to FSW.
"We tried to get a loan from a bank, but they wouldn't give us enough," said Kristen Peterson, co-owner with her husband, Sean. The home-based company provides climate-control systems for companies.
"Also, our credit cards were tapped out, and we wanted to make our payroll, so our financial adviser recommended factoring."
The Petersons sold their invoices for 20 percent less than their actual value. They will also pay a collection fee when the money is handed over from their customers to Factors Southwest.
Like most invoice sellers, the Petersons were due for payment from their customers in 30 to 90 days.
"It's expensive, but it's a lot easier than going through the process of applying for a loan, especially with the strict loan requirements," Kristen Peterson said. "It's keeping us afloat during tough times."
Ed O'Brien, a spokesman for Grant Thornton LLP, a national accounting firm, described factoring as a credit vehicle, but, he added:
"It's typically the last resort."