SFNet’s Beyond the Basics: Expert Perspectives on Niche Industry Factoring & Lending webinar this summer focused on some of the more specialized areas within factoring and asset-based lending — industries that can present tremendous opportunities, but also unique underwriting, operational, and legal challenges. Construction, staffing, PACA/PASA, healthcare receivables, oilfield services and SaaS were discussed.

Panelists included Brian Center, partner, Quasar Capital Partners, Donna Dawson, senior director of Operations, Legacy Corporate Lending, R. Lindsay Gordon, SVP, senior portfolio manager, Goodman Capital Finance and Richard Stehl, chairman, Otterbourg P.C. Farrah Vargas, senior director, Portfolio, Haversine Funding served as moderator.

Brian Center kicked off the webinar discussing construction factoring, which can be highly profitable, but filled with hidden risks. A lender must understand which unpaid subcontractors, suppliers and vendors may hold lien rights against a project.

“Whether it be subcontractors, suppliers for material, or other vendors, if they have lienable rights where they can file a lien against the project that your client is working on and you don't administer those by either reserving or by paying those accounts payables, you're going to learn many hard lessons,” Center said.

“You will want to make sure you're always in constant communication and hold a tight relationship,” Donna Dawson added. “Any lack of communication could prevent you from getting paid. Not only do you want to relate to people at the top, but workers as well, who can tip you off if there is a problem. Going out to the physical sites is important. We want to make sure that your physical inventory is there, in place, in addition to your payables. It is also important to know payment terms and cycles since construction pays in phases, following certain milestones.”

Center believes the construction client should be just next to being bankable. He looks at three things: sophistication (or how the client reports information), making sure that you're lending on completed work, and that you can tie that work to an American Institute of Architects (AIA) document that will be submitted to their customer.

Staffing

Staffing can be an attractive industry to finance, but it is operationally intensive. Because employees are typically paid every one to two weeks, staffing companies operate on rapid payroll cycles and generate a high volume of invoices.

Gordon shared advice on underwriting and monitoring staffing companies to avoid problems further down the road, such as having proof that work was performed in the form of signed timecards or via access to the debtor’s portal that shows they have signed off on the invoice.

“Other things to look for that are not typically thought of in factoring are making sure the taxes are paid,” Gordon said. “Employment taxes are a very important part of our business.  While we use a service such as TaxGuard to look back to see if things have been paid, a lot of times when you get to that stage of the game, it's too late--they are already a lien or liability.”

“Ask clients for bank statements on a monthly basis. If they're using a company such as ADP or Paychex, that's great, because you will know that they're being paid,” Gordon continued. “They'll send the money to the payroll company, and the payroll company makes sure the taxes are paid. But many factoring clients are small companies and try to do it themselves. You can look at their bank statements, but if they are not sending statements, they are not paying taxes. It’s also important to get a payables aging statement.  A lot of times, especially in consulting work and programming work, 1099 employees will go around you directly to the debtor and ask to be paid. Insurance and workers' compensation copies are also important components of lending to staffing companies.”

PACA and PASA

The Perishable Agricultural Commodities Act (PACA), and The Packers and Stockyards Act (PASA) create unique risks for lenders because of the protections afforded to unpaid suppliers under those federal laws. PACA was designed to protect the sellers of perishable agricultural commodities while PASA protects unpaid sellers of livestock and poultry.

Stehl provided a legal perspective on what factors and asset-based lenders should understand before entering these industries, and what due diligence or monitoring practices can help minimize exposure.

Under these statutes if there's a buyer of these products, a trust is created over those products to make sure that, once sold, the sellers will get paid. Until they get paid, that trust continues. There's no public filing that is required; it arises by law.

Under PASA, the seller of a product must notify the Secretary of Agriculture and the buyer of non-payment within a certain timeframe. Under PACA, the seller has to assert his or her claim for the trust benefits and the sale has to be on 30 days or less terms. If the seller does not comply, they will not get the benefit of the statute.  In both situations, the trusts over the products are outside the buyer so when financing a buyer, inventory products are not subject to a lien.

Oil and Gas

Panelists discussed what distinguishes the companies that can weather oil booms and busts. Gordon said a larger company is fine in an up or down market but to take caution with subcontractors.

“The problem is, and this is more on the construction side, if they are a subcontractor of somebody who is ultimately working for an XTO or Halliburton, you shouldn't take solace in the fact that the ultimate payer is Halliburton, because in a downturn, if that middleman who you're relying on to then pay your client does run into financial problems, they can't follow through. In this case, more than most, the debtors really matter, in addition to knowing all the nuances of oil and gas,” Gordon said.

Healthcare

With medical receivables varying from commercial insurers, Medicare, Medicaid, Workers Compensation and managed care, each has its own nuance. There are many complexities in the business and regulatory environments, extensive federal and state laws, with state laws varying from state to state, governing the delivery and payment of healthcare services.

Panelists stressed the importance of reviewing what is being financed and what the net invoice amount is as well as historical dilution.  Also keep in mind many providers negotiate contractual discounts with Medicare, Medicaid, HMOs, and commercial insurers.

In dealing with Medicare and Medicaid receivables, in which only the provider is paid, a typical solution is a double lockbox to comply with Medicare and Medicaid anti-assignment regulations.

SaaS Deals

A common challenge with Software as a Service (SaaS) deal is that many are a combination of losses plus a bill in advance component. Panelists advised that lenders should ask how critical the service is that is being provided and what the funding looks like in the financial component behind the software company, whether its venture capital, or private equity.

“It's not a great underwriting tool, but something to be cognizant of is how much does this venture capitalist, private equity company, or investor, stand to lose on its multimillion-dollar investment compared with my $2 -$3-million-dollar loan?” Vargas added.

Final Takeaways

The webinar concluded with panelists sharing their actionable takeaways for lenders entering niche markets.

Gordon said to pay attention to a client who comes on as a small client and grows too fast, operating normally the first few months, then flooding the lender with invoices and requesting line increases.

As the industry enters a new era of AI and various new technological tools, it is important to do field exam monitoring, verifications, calling, and checking, Dawson stressed.  

“We have to be extremely careful because, especially in an economy like this, things are going to get tricky and numbers are going to be fudged, and you have to be diligent on all facets.”

“One of the biggest takeaways from this discussion is that success in niche industry factoring and lending really comes down to understanding the details — whether that’s the legal framework, operational execution, underwriting discipline, or ongoing portfolio management,” Vargas concluded.