‘Lenders of Last Resort’ Can Be Very Risky for Business

They are the lenders of last resort, the doors a desperate small business knocks on when banks are rejecting, the IRS is threatening and friends and family say no.

If payments aren’t made, sometimes entire businesses, homes, cars and other personal assets of the company’s owners are seized by the more hard-hearted bottom feeders of the corporate loan world.

“With these firms, you can go quickly from a bad business situation to living under the freeway,” said Larry Jacobs, a Los Angeles management consultant who works with the industry. “If you get in with one of them, there’s little chance your business will survive.”

Sometimes, police suggest, even the business owner doesn’t survive.

Last week, seven Southern California police agencies began investigating a series of violent crimes--including the murder last year of a Fountain Valley flight attendant and the killing of a Hollywood recording executive--linked to Huntington Beach lender Premium Commercial Services Corp.

Police say Premium would loan money to mostly struggling businesses and then, in some cases, strong-arm delinquent borrowers.

Premium is a bit player in a largely unregulated $60-billion-a-year industry called “factoring,” in which companies loan money based on bills yet to be paid. Popular with cash-strapped firms, factoring allows them to get paid for a shipment of goods immediately rather than wait 60 days or more. Factoring is especially prevalent in Southern California, which is an incubator for small business.

There are about a dozen top-tier, mostly bank-affiliated national factoring firms that report billions of dollars of business each year. And there is a second tier of mid-sized firms that specialize in certain industries such as the garment business.

Then there are the thousands of firms that service smaller, risky companies that have been rejected by more established lenders and are willing to pay higher rates.

As critics describe it, Premium provides a window into the world of factoring at a frightful extreme. But many Southern California factoring firms say events alleged at the company are not in any way indicative of common industry practices.

Alarmed at news of the allegations against Premium, many factoring firms in Orange and Los Angeles counties would not speak on the record, concerned they would be cast in a negative light.

“There’s a lot of these little guys around. And they serve an economic purpose in society--helping really small companies get access to cash,” said Harvey Feig, regional manger in Los Angeles for CIT Group/Commercial Services, the nation’s largest factoring company, with $12.7 billion in sales in 1995.

“But there are some who step over the bounds,” he said. “They may promise X-Y-Z, and then the fees are higher than you think.”

These firms operate mostly in industrial parks, storefronts and mini-malls, and can charge interest rates ranging from 35% to 120%.

The smaller factoring firms defend the practice because they are lending to companies on their last legs. Many of the tiny firms they lend to go in and out of business quickly, sometimes without enough money left to hire a lawyer and file for bankruptcy, consultants said. Many borrowers would go out of business even if they didn’t resort to such demanding lenders--only sooner.

Risky Business

Turned down by traditional sources, these clients are willing to pay high rates because, as one Huntington Beach business client of Premium said, they need to solve repeated cash-flow crises as they wait for bills to be paid.

“They were expensive, but factoring is a risky business, and Premium had to have charges that were in keeping with that risk,” she said.

About half of nearly 100 former clients of Premium contacted last week by The Times appeared to have gone out of business.

The allegations made against Premium have centered on Coleman Allen, who owned and operated Premium until he died a month ago of heart disease. He once had admitted to clubbing a delinquent lender with a lead pipe.

A lawyer for Premium said in a prepared statement that “there is absolutely no evidence of any connection between any of the alleged criminal activity under investigation and any current owner, officer, director or employee of Premium.” That includes the fatal shooting of flight attendant Jane Carver, whom police believe a hit man mistook for a Premium client.

“What’s being alleged in California sounds like a throwback to the old days in New York when people used to loan money in dark places along side streets,” said Alan G. Millstein, who edits the New York-based Fashion Network Report. “The old running gag in the New York garment district was that when you borrowed from a loan shark you never had to worry about a personal guarantee because you owed them your life.”

Although New York always has been the major factoring hub, many smaller finance firms now operate in Southern California because of the many start-up companies.

In fact, in the East Coast garment industry there is a term for just the type of lender a small business wants to avoid, said management consultant Jacobs.

That’s the “Beverly Hills Factor,” nicknamed because so many small firms charging particularly high interest are located in Southern California. “If you go to one of those, you’re in big trouble,” Jacobs said.

An old business with European roots, factoring began in the United States about 150 years ago to pay importers of textiles upfront for goods they expected to sell in the United States.

As American textile mills began replacing imports, factoring firms did the same work for the mills and eventually broadened into other industries.

Nowadays, factoring firms make profits by purchasing a company’s invoices and collecting on them, charging the company a fee.

There are two ways business is typically done.

In one, a factoring firm charges a flat fee based on the value of the invoices.

In the second, which was used by Premium, a firm makes a profit by lending against the as-yet-unpaid bills until they are collected, charging daily interest on the amount due plus a one-time commission.

Large Profits

Either way, factoring firms take on a big risk. But if the invoices are collected in a timely fashion, their profits can be handsome.

For example, a factoring firm might buy $100,000 in invoices from a company at a discount--say, for $80,000--and charge the borrower 2% or 3% a month. That amount would be paid out of the remaining $20,000 based on how promptly the bills are paid.

That sliding fee could start at 2% or 3% a month, which would give the factoring firm $2,000 or $3,000 in the first month alone. For invoices that take 60 or 90 days to pay, the fee increases.

With Premium, though, clients complained that loan terms were changed without notice and that the company’s promises occasionally were omitted from written contracts.

Ralph Mangubat, owner of Sea Reflections--a Huntington Beach company that makes ceramic dolphins and knickknacks from seashells, said he left Premium in a hurry--one day after signing a contract--after loan terms were changed.

“They treated you like you were a crook from the very beginning,” he said. “They were so suspicious and even looked up the title on my house.”

The businessman said Premium officials told Mangubat that fees would range from 5% to 9% per month on the loan, depending on how long it took Sea Reflections’ creditors to pay, standard rates for a factoring firm.

According to Mangubat, Premium also said it would immediately pay him 80% of the value of his invoices, another standard practice, and that the loans would be non-recourse, meaning Premium could not seize his personal assets.

But when it came time to sign the contract, Premium committed only to paying him 70% of the value and included provisions for recourse loans, he said.

“The picture they painted up-front and what was in the contract were two different things,” Mangubat said.

California has usury laws against charging abnormally high interest rates, but factoring typically falls through a loophole because the financial arrangements aren’t technically loans. They are sales of unpaid bills.

Except for companies affiliated with banks, there is almost no government regulation of California factoring firms.

Commercial and consumer lenders must be licensed by the state Department of Corporations. But factoring firms that only buy companies’ invoices and don’t place liens against their property are not viewed as lenders.

“They are just buying an asset, the receivables. Just like you were going to Sears and buying something. We don’t regulate this,” said Dale Lucas, chief examiner for the Department of Corporations in Los Angeles.

However, federal prosecutors and the Securities and Exchange Commission have taken action against factoring operations that have violated securities laws.

In one case, three operators of B.H. Rothchild & Gray, a factoring firm in Tustin, were indicted last year and since have pleaded guilty to conspiracy and fraud charges for running a $24-million fraudulent investment scheme. The company enticed investors with invoices written on phony orders.

One of the more high-profile cases involved Towers Financial, a New York-based factoring company controlled by Alan Friedman, once a suitor for the New York Post. Towers was seized by the SEC in 1993 for failing to register $34 million of securities before selling them to the public.

Factoring is not something that small-business advisors usually recommend, outside of the garment industry and a few other fields, said Russell R. Diehl, a Newport Beach financial consultant.

“A consultant who advises someone to get a factor has failed,” he said. “He hasn’t been able to get the company the money it needs.”

Many of Premium’s clients said they had good relations with the firm, which helped them out in a time of need.

Clients’ Complaints

But others tell a more disturbing story.

Frank T. Jackson, president of Tech-Star Co. in Anaheim who sued Premium in the early 1990s, said he became concerned when Premium began sending monthly handwritten statements on the status of his account.

From one statement to another, interest due was calculated differently, none of the ways in accord with the original agreement, he said.

“I called them up, and they just laughed in my face and said basically what are you going to do about it,” Jackson said.

During Allen’s deposition in that litigation, Jackson said, the former Premium owner threatened to kill him.

Premium officials declined to comment about their clients.

Another former Premium client, Bakersfield businessman Glen Sharp, 67, turned to Premium in July 1994, when his struggling athletic uniform manufacturing company needed a cash advance.

His one previous experience with a factoring company had turned out poorly, but he took a chance on Premium because “I needed the money,” Sharp said. “And, at first, it seemed like a good deal. Their rates were high, but not unfair.”

But within weeks, Sharp wrote a check for $10,405.42 to pay off his obligation to the firm.

“Nothing was as it was represented,” he said.

Premium, as promised, advanced Sharp’s company thousands of dollars, using its unpaid bills as collateral. Terms of the arrangement were standard, and Sharp said Premium initially agreed to let his company collect its own bills.

Within days, though, that apparently changed. Premium began sending its own invoices to Sharp’s customers, he said.

“I started getting calls from my customers saying, ‘What the heck is going on?’ ” Sharp said. “Premium immediately started harassing my customers for payments. These were customers I’d known for years and here they were being threatened.”

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Growing Business

The nation’s largest factoring firms assumed $61 billion in accounts receivable in 1995, $10 billion more than five years ago. Factoring volume (in billions):

‘95: $61.0

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Interest Rate Comparison

Annual percentage rates charged by various sources of receivables financing:

Commercial banks: 11%-14%

Finance companies: 20%-40%

Factoring firms: 38%-48%

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Factoring Defined

Factoring originated in the textile industry and is still common among apparel firms and small businesses. Example:

1. Manufacturer receives order from a retail store.

2. Manufacturer submits order, with the terms and conditions, to factor for approval.

3. Factor checks retailer’s credit and approves terms and conditions.

4. Manufacturer ships goods and bills retailer.

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Two Ways for Factor to Profit:

1. Factor purchases account receivable from manufacturer and charges manufacturer flat commission based on account value for risk absorbed and handling credit checks, records maintenance, billing and collection.

OR

2. Factor lends portion of account (usually 80%) to manufacturer at a daily interest rate plus a one-time commission until account is paid.

Sources: National Commercial Financial Assn., Larry Jacobs, Stonefield Josephson Consulting

Researched by JANICE L. JONES / Los Angeles Times

Carver Murder Mystery: The Story Up to Now

Last June, a 46-year-old Fountain Valley woman was shot to death during her morning jog. Jane Carver’s murder baffled police for months because they could find no motive. Then, last week, they announced a break, alleging Carver was mistakenly slain by a hit-man tied to a Huntington Beach finance company. James Wengert, owner of a San Clemente financial investigation firm, was shot in the face April 10--as Carver had been. But he lived and gave police a description of the gunman.

The principals:

Jane Carver. Premium Commercial Services Corp., the finance company, was owed $400,000 by Wengert. Carver was shot three days after Wengert’s wife, Margaret, filed a lawsuit accusing the firm of using pressure tactics to seize her Fountain Valley home.

Coleman Allen, founding president of Premium Commercial, died April 6 of a heart attack. Police are investigating if he was linked to a string of violent crimes against clients who failed to pay their debts.

Barry J. Skolnick, a Hollywood record company executive, owed $900,000 to Premium Commercial, which also had a $2.5-million life insurance policy on him. He was gunned down in a Hollywood parking lot in January. Police believe Allen orchestrated the murder.

Leonard Owen Mundy, a Los Angeles electrician, was charged with shooting Carver. Police say he was actually after the wife of James Wengert, who also lived in the neighborhood.

Paul Gordon Alleyne, a Los Angeles auto parts store owner, was charged with the attempted murder of Wengert. Police were then led to Mundy when they determined that he, Alleyne and Wengert owed money to the Huntington Beach finance firm.

Source: Times reports; Researched by PETER M. WARREN / Los Angeles Times