As you may have already discovered through your business loan research or in talking with your peers and associates, there are many options to evaluate and consider.
However, not all of these options are well understood; and it’s not the fault of borrowers. Rather, it’s because some companies in both the conventional and alternative funding marketplace don’t do a good job of explaining the advantages and disadvantages of their products. Or to put things more bluntly: some companies just don’t WANT borrowers to know about the disadvantages, because they might not move forward with their application.
And that brings us to a business financing option known as purchase order financing. Here’s how they work:
- The borrower sells pending purchase orders to a lender (who is also called a “factor”) in exchange for cash.
- The borrower’s customer (i.e. the party that the purchase order is made out to) pays the lender directly.
- The lender keeps most of the money received to cover a portion of the principal and interest.
Now, although we don’t offer this option here at Mulligan Funding, we are not opposed to it — because for some borrowers, it is a viable option. However, in our view, and also based on the feedback we’ve received from our customers over the years, there are 3 key disadvantages with purchase order financing that are not as widely known as they should be:
1. As noted above, borrowers don’t get the total value of each purchase order when it’s paid – which can put a big dent in cash flow needs. Typically, borrowers receive about 80 percent of each purchase order. The lender will keep the rest to cover some of the principal and interest. This will continue until the loan is fully paid back, including all interest.
2. A borrower’s customers deal directly with the lender. This can be a significant problem for some customers who aren’t pleased that their information has been “sold” to a third party. What’s more, borrowers have no way of governing the lender-customer relationship to ensure that their customers are well treated. For example, lenders may be more aggressive than borrowers would like them to be when it comes to collecting overdue payments.
3. Payment on purchase order financing is taken up, front rather than as portion of daily sales. This can be a major drawback for some borrowers who experience an unexpected dip in revenue, and therefore need more access to cash. If the deal is that the lender keeps 80 percent of each purchase order, then that is what will happen, regardless of whether a borrower is having a great month or a terrible month sales and revenue-wise.
Once again, our goal is not to talk anyone out of pursuing purchase order financing if it is the right option for them. However, this decision should be made in light of the facts – not based on misunderstandings or withheld information. We hope that this blog post gives you some food for thought, and supports your research process.
Call Mulligan Funding at 855-326-3564 to discuss your financing options today!