Credit-starved SMEs turn to debtor finance to fund growth

SMEs who are unable to get traditional funding from banks are turning to debtor finance in increasing numbers to fund expansion opportunities, an industry leader says.

Rob Lamers, chief executive of debtor finance firm Oxford Funding (a wholly-owned subsidiary of Bendigo and Adelaide Bank), says the traditional use of debtor finance as a way to solve short-term cashflow problems was changing as SMEs struggle to find finance from expansion.

“I think if you go back 10 years, it was more about helping the immediate short-term cashflow problem,” Lamers told SmartCompany.

“But we are seeing companies increasingly trying to use the equity in their debtors’ ledger to take advantage of market opportunities.”

Lamers comments come as new figures from the Institute of Factors and Discounters (IFD) revealing total factoring and discounting turnover for the June 2010 quarter reached $14.1 billion, an increase of $716 million or 5.3% on the March 2010 quarter. Close to 5,400 businesses were using debtor finance facilities across Australia.

The majority of firms use a form of debtor financing called discounting, whereby a debtor finance company essentially buys the debt of its client, providing 80% of the debt amount upfront and another 19% when the debt is paid (the cost of using debtor finance is about 1% of the invoice).

Lamers says entrepreneurs looking for funding for growth are increasingly attracted by the idea of using the equity in their debtors’ ledger, and also attracted by the fact they do not have to use property to secure finance.

Indeed, Lamers says he is seeing a trend whereby entrepreneurs use debtor finance to free up property assets, and either remove them from the business completely or sell them and reinvest the profits.

“You might find a spouse doesn’t want the family home in the business, or we are seeing a lot of partnerships where the different partners don’t want to have their homes in the business. To try and find a situation where different partners are putting up similar levels of equity is difficult.”

Lamers says he has even started to see very smart companies using debtor finance to try and make money.

When a company uses discounting and gets money for its debts upfront, it then goes to its suppliers and uses that money to demand a discount for early cash payment.

Lamers gives the example of a wholesaler who buys a product for $50 and sells it to $100, and then uses discounting at a cost of about $1 a product.

If the wholesaler can use the cash unlocked by discounting to get a 5% discounting from the supplier, then they end up paying $47.50 for the product, selling it for $100, paying $1 for the debtor finance and enjoying an extra 1.5% profit.

“If you are turning over $10 million, 1.5% is $150,000 – and you don’t need property security. People are becoming very smart about this.”

Of course, there are some downsides. Most debtor finance companies will require a personal guarantee and will only extend finance to companies with strong financial track records.