Bite-sized chunks of information you can digest in a few minutes.
By Steven Hausman

Lesson #5 – Three-Party Financing

Quick Review

In our first four lessons, we learned:

1.      Factoring is a form of financing suitable for any business that issues invoices paid in 30-90 days.

2.      Unlike banks, factors are buyers and not lenders. Banks lend you money based on collateral. Factors buy your invoices.

3.      Factors make their profit by paying less than the full value of your invoice. How much less depends on a lot of variables, but the two most important are whether you’re doing Recourse or Non-Recourse factoring.

4.      Recourse factoring means if your debtor fails to pay your invoice, the factor has legal recourse to get its money back from you.

5.      Non-Recourse factoring means if your debtor doesn’t pay, the factor is stuck with the debt. It has no recourse.

6.      For obvious reasons, Non-Recourse factoring is more expensive than Recourse. However, both have their advantages and disadvantages.

Zach Borrows: Two-party Financing

The great majority of financing is between two parties. Put simply, it goes like this:

Zach has a small trucking business call Zoom Trucking. He has two tractors and one of them has broken down. Cost of repair: $5,000. Fortunately, Zach has exactly that much in US Savings Bonds inherited from his late aunt Zelda. He goes to Bigheart Bank, forks over the bonds and gets the money to fix the truck. His deal with the bank is a non-renewable one-year loan at (example only) 4.5% interest. At the end of the year, Zach pays the loan plus interest and gets his bonds back.

Two parties have been involved in this transaction: Zach and the bank. Most financing, no matter how complicated, is ultimately two-party. When you buy a car from, say, Longhorn Motors, you usually set up monthly payments with either a bank or your credit union or Longhorn’s finance partner. You sign a contract with Longhorn to buy the car but you also sign a contract with, let’s say, your bank to pay for it. At that point, the dealer is paid by the bank and out of the picture, at least debt-wise. Longhorn may continue to be responsible for warranties and so on, but the loan itself is between you and your bank. If you default, the bank may repossess but not the dealer. Even if your car loan is transferred to another bank, the terms don’t change and the contract is always two-party.

Factoring is different.

Zach Factors: Three-party Financing

Let’s go back to Zach. This time around, it turns out that Zach already spent Aunt Zelda’s money so his wife could go back to school and get her certification as a veterinary assistant. Good investment, but how does he get his truck repaired?

Zach’s a hustling trucker and since all he has to sell is his hustle, that’s what he does. He’s got full loads coming and going. In fact, he’s just delivered one for $6,000 of patio furniture to Patio Palace. They’re a reliable customer, though sometimes slow to pay. 

From time to time, Zach has done business with a solid factoring company called Crown Factors. He goes to them now and sells his $6,000 invoice for $5,550, which is 7.5% interest (again, example only). Crown’s fee of $450 isn’t as good as the $270 Zach would have paid Bigheart (at 4.5%), but Bigheart won’t loan money on an invoice. 

Zach overnights his invoice to Crown, three states away. Crown gets it the next day, Tuesday, and by Wednesday, Zach has a check for $5,000, just enough to get his second tractor repaired.

Question from the back row: How come Zach got only $5,000 when Crown said it would pay $5,550? That held-back amount is called the “reserve” and nearly all factors do it almost all the time. They keep a certain amount of money until the invoice is completely paid. Unless something bad happens, Zach will get that money, but not just yet.

Definition: factoring is a three-party transaction involving (1) seller, (2) debtor and (3) buyer.

Two Parties, Three Parties – So What?

As we said, three parties have been involved in this transaction: the invoice seller (Zach), the debtor (Patio Palace) and the buyer (Crown). Why does that matter? Because the debt relationship continues to affect all three, whether the arrangement is Recourse or Non-Recourse.

Suppose for some reason Patio Palace doesn’t pay. If Zach’s deal with Crown is Recourse, Crown can demand payment from Zach. In other words, unlike the car dealer, Zach is still in the picture. He’s part of a three-party transaction.

On the other hand, if Zach’s deal is Non-Recourse, he doesn’t have to repay Crown. Technically that may sound like a two-party deal (same as you and Longhorn’s finance company) but in practice it’s not, because Crown isn’t likely to make Zach an advance on any more Patio Palace invoices. In fact, Patio Palace’s default might even affect his future relationship with Crown, which could decide he’s not a good risk.

The Factor in Your Wallet

Granted, this lesson is on a slightly more abstract and less practical level than our previous ones. It’s still important, though. If you run or help to run a trucking company—big or little—you’ve got to know about factoring, because it plays a huge role in keeping the big wheels moving. Matter of fact, you ought to know about it regardless, because factoring affects all of us all the time, at least anyone who uses a credit card.

How’s that? Whenever a restaurant takes your plastic for a meal, it’s factored with a card company. The restaurant has transferred your check to VISA™, for example. In exchange for an instant advance, it accepts only 97% of your payment. You no longer owe Mel’s Diner; you owe VISA™. Just like Zach’s deal with Crown, that’s three parties: you, Mel’s Diner, and the card company.

Another question from the back row. Mel factored with VISA™ but what about his customer? In other words, have you? No, the relationship between you and the card company is a loan. You owe money and pay interest. VISA™ collects from both you and Mel, but in different ways. If you don’t pay all of your VISA bill this month, VISA™ doesn’t demand a little extra from Mel. Their deal is factored, over and done.

Take-away

There’s the bell! Quick summary for those of you who dozed through this lesson, plus a short lecture on why you should pay attention, even for things that don’t seem immediately useful.

Knowing that factoring is a three-party transaction may seem purely academic, but knowledge is power. The more you know, the quicker you can make decisions and the smarter those decisions will be. You’ll have more power to get ahead, whether you’re an O/O or a mid-manager working your way up the ladder in a hundred-truck company.

Everybody’s milling to the door, so before you get out of the room, here’s this lesson’s take-away.

·        Bank loans (and loans of any kind) are two-party transactions.

·        Factoring is a three-party transaction.

·        The three parties are the invoice seller (you, the trucker), the debtor (whoever owes the invoice) and the factor (who buys the invoice from you).

·        Fun fact: credit cards are a form of factoring!

For many truckers factoring is a good deal, but of course not always. Stick with this course and you’ll learn how to tell good deals from bad, and how to make factoring work for you. See you next class!

Advance Business Capital (ABC) provides both Recourse and Non-Recourse factoring services for owner-operators, small- to medium-sized trucking companies and factoring brokers. Check us out at Advance Business Capital.