If Set Up With Care, Relationship With a Factor Can Be Key for Apparel Makers
Babette Altman, like many entrepreneurs, had little luck when she approached bankers to help launch her upscale, hand-knit sweater manufacturing business.
One banker made her a modest loan but refused to approve a credit line. “Another banker told me I should come back and visit them when I grew up,” said Altman, the 32-year-old founder and president of B.B. Designs Inc. in West Los Angeles.
Frustrated but determined, Altman turned to the world of factors, companies that buy a client’s invoices to keep the cash flowing, the employees paid and the doors open.
Long a tradition in the textile and apparel trade, factors today provide financial services to thousands of toy, shoe and furniture manufacturers, importers and others willing to pay higher interest rates for a steady source of cash, credit and up-to-date credit information on their customers.
The first thing the client does is submit a customer’s order to the factor for credit approval. If the order is approved, the factor advances the client some cash, typically 80% of the face value of the receivables. The remaining 20% is credited to the client as the factor collects it.
The service that factors provide and the money they lend is not cheap: Most factors charge between 2% and 3% above the prime rate for this short-term financing. They also charge commissions ranging from 0.5% to 1.5%, which means that a company with sales of $2 million could spend about $25,000 a year on commissions. However, factors point out that they save companies money by virtually eliminating the need for hiring a credit and collection staff. And if a customer is insolvent and cannot pay, the factor absorbs the loss.
“The industry lends itself to products sold on short terms, usually consumer products which end up in a store,” said David Rubin, president of Republic Factors Corp., one of the nation’s largest factors with 400 clients and offices in Los Angeles, New York City and Charlotte, N.C.
Rubin, who has been in the factoring business for 37 years, said traditional bankers are wary of lending to apparel and textile companies because such businesses are usually highly leveraged and undercapitalized.
Clothing manufacturers are also taking risks by selling to a highly volatile, fashion-conscious retail market. When stores suffer a drop in sales or other problems, manufacturers can lose everything. A perfect example is the recent bankruptcy filing by the giant Campeau Corp., which sent hundreds of clothing manufacturers into a spin.
Republic and other major factors, including Heller Financial Factoring Group and Bankers Trust, prefer to deal with companies with capital in excess of $200,000 and annual sales of about $3 million.
However, smaller companies rejected by the larger factors can turn to second-tier companies such as Allied Business Capital in Los Angeles, which specializes in helping small-business owners, according to President Richard Cohen.
“We will finance and factor companies with as little as $75,000 in capital,” said Cohen, who has been Babette Altman’s factor for nearly four years.
Although the factor takes a risk by lending to high-risk businesses, factors also protect themselves by buying credit insurance, according to Cohen.
Altman says Cohen not only extends her credit but found her a good accountant and other key business advisers. Allied also helps her establish credit with new suppliers.
“If it wasn’t for being financed, I wouldn’t be in business,” said Altman, who started her business about seven years ago with $800. She also knitted the first 600 sweaters on a knitting machine by herself.
Today, 35 employees create her Babo line. The sweaters sell for $200 to $350 in better department stores and boutiques.
As good as it sounds, factoring does have its dark side, according to Richard Reinis, a Los Angeles attorney who represents dozens of apparel manufacturers.
“A factoring agreement is a Mephistophelean deal,” said Reinis. “It is very easy to get into and very difficult to get out of.”
Reinis said it is especially hard to change factors because they are so involved in your company’s day-to-day operations. One of his clients was recently forced to pay $60,000 in legal fees to disentangle herself from a factoring agreement.
Reinis said business owners should be aware of the tremendous control the factor has over your business.
“You should know that the advances, which become the mother’s milk of manufacturing, can be altered at any time if there has been a material adverse change in your financial condition.”
“There is a reason why all the great movie moguls came out of the apparel business,” said Reinis. “You have to have guts of steel to make a go of this business.”
FACTOR TIPS
Los Angeles attorney Richard Reinis offers these tips on choosing a factor.
Take 10 to 20 orders and give them to three or four different factors to see how much credit they will give you. Choose the one that gives you the most credit.
Choose a factor that understands your niche in the market and may even represent your competitors.
Choose a factor that has a large enough credit staff to properly review your accounts. The more accurate you are the better off you are.
Be sure to meet the actual person responsible for supervising your account. The personal care and attention you receive will affect your business.
Find a factor that gets back to you quickly, because fast responses on credit matters are essential.
Try to include a bailout clause in your factoring agreement permitting you to end the relationship after giving 60 to 90 days notice.
Keep careful track of all your credit approvals and advances. Document all conversations with follow-up letters to your account representative to protect yourself.
