Factoring and purchase order financing are not a loan that a financial institution would offer its clients. ANAPLANS will purchase accounts from their clients. Once the accounts are purchased, and consideration is given from the ANAPLANS to the client (in the form of a cash advance or Letter of Credit) title to the invoice has passed from the client to ANAPLANS. ANAPLANS now owns the rights to payment of the invoice and can collect from the customer accordingly.
Traditional Bank underwriting is based upon the financial condition of a client. A banking client must have two to three years profitable operating history, good equity and liquidity ratios and a sound business plan in order to qualify for a loan. ANAPLANS’s clients may lack one or the entire bank underwriting criteria.
ANAPLANS should be acutely aware of the value of the invoices and purchase orders they purchase and that they own the rights to collect payment from the customer. Much analysis is given during the underwriting process as to the quality of the collateral held as security for repayment.
Additionally, because ANAPLANS purchases invoices with recourse (client must repay the advance plus fees to ANAPLANS in the event their customer or insurance provider does not) to their client, ANAPLANS must also underwrite their client’s credit.
6.1 Management Review
Management plays a key role in the financial performance of a client. One of ANAPLANS’s four pillars of credit centers on the integrity of the company’s principals we do business with.
Clients with high integrity are less likely to default or engage in fraud. Prior to funding, ANAPLANS must engage in a thorough background check of the client company’s principals. ANAPLANS may seek to obtain other references throughout the life of the factoring relationship.
If a client or one of its principal begins to experience financial difficulties, client integrity may be compromised; it is therefore important to identify any potential problems early. By maintaining close relationships with clients, ANAPLANS will be better able to identify potential concerns.
Unresponsive management or poor documentation in dealings with a client will inevitably lead to problems.
ANAPLANS should consider the following when evaluating the client’s management.
Skills
- Does management possess the skills required to run a successful business?
- What is their educational background?
- What is their experience in this industry?
- What other businesses have they been managed in the past?
Performance
- How has management dealt with past challenges?
- How well have they managed their current business plan?
Commitment
- How well do they communicate with ANAPLANS?
- Have they demonstrated a significant commitment to their business?
Personal Guarantee
- ANAPLANS will request annual credit checks and deliver the credit reports to ANAPLANS.
- ANAPLANS should review a personal credit report to confirm the liabilities that exist against the principals assets in case liquidation is in order.
6.2 Business Risks
Aside from collateral & client risks, another form of risk exists which are Business Risks. ANAPLANS has compiled a list of questions to understand about the client’s business.
- What is the risk of obsolescence of the client’s goods or services?
- What makes the client unique to its competitors?
- What is the client’s share of the market, how might that change?
- What market does the client target?
- Does the client utilize its own advertising and marketing, or do they rely upon third parties?
- What are the risks of inventory spoilage?
- How much bad debt loss has the client incurred historically? How does the client handle their bad debt losses?
6.3 Financial Stress
If the review concludes that the client’s overall financial status is in a decline, then the client is experiencing financial stress. ANAPLANS has many options in addressing the issue of client financial stress.
Many of ANAPLANS’s clients enter into the factoring relationship under financial stress. ANAPLANS understands that is probably the single reason the client has agreed to enter into the Purchase & Sale Agreement. ANAPLANS will monitor that the client is benefiting from the increase in working capital that ANAPLANS has provided.
It is ANAPLANS’s expectation that advances made to the client are paid back to ANAPLANS by their client’s customers. If the client’s financial stresses result in continuing low performance and ultimately declining solvency there is a high probability that the client will cease operations. It is extremely difficult to collect on invoices wherein the supplier no longer exists.
Furthermore, the risk for fraud increases. The management, while past indicators reflect are individuals of high integrity, may commit fraud. Fraud may occur in the form of client depositing or redirecting checks that are the property of ANAPLANS or submitting fraudulent invoices to ANAPLANS for funding.
When fraud occurs, the client’s collateral base is compromised. Usually the realistic value of accounts is less than the value ANAPLANS is holding as security to repay advances made to the client.
To that end, whenever possible, ANAPLANS should be aware of the level of financial stress the prospect is experiencing at the beginning of and throughout the factoring relationship.