This is a guest post by Richard Lewis, Financial Engineering Counselors, Ltd.
“While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second.” – U.S. Small Business Administration, “The Basics”
The good news: Your company has landed a new government contract, one that will result in a significant increase in revenues.
The challenge: In order to fulfill this contract, you must commit to additional people (payroll), training, materials, and related costs. This commitment must be made in advance of receiving payments from your customer (the US Government).
The solution: By planning ahead, you can get a loan from family or friends, use your credit cards, get an equity infusion (very costly and time consuming) or arrange delayed payment to vendors. However, you might negotiate specific terms into your customer agreement to dampen the impact of this challenge (e.g., extended delivery dates, or partial payment upon order placement).
You can also plan ahead in considering your financing options, which can include:
Your existing bank or lender – If your company has an existing line of credit or borrowing arrangement with a bank or other lender, try to negotiate an increase with them. A responsive lender may provide all of the short-term capital needed until the government agency begins payment. Of course there will some repercussions to consider, such as loan covenants or higher interest rates. It’s best to have this conversation as far in advance as possible, and to present a full financing/business plan.
Factoring – This is the sale of your customer invoices (accounts receivable), to a bank or finance company (the “factor”), as opposed to using them as borrowing collateral. The factor will advance a percentage, usually between 75% and 90%, of the invoice amount; the balance is refundable upon receipt of payment, less interest and transaction costs. Some factors may also provide other funding options. The factor will, through the Federal Assignment of Claims provisions, notify the federal government agency customer that the invoice has been financed and is payable directly to them. There are several advantages to factoring; much of the A/R bookkeeping, customer credit worthiness, collections, and credit risk become a shared responsibility with the factor, and the initial approval process can usually be a matter of days.
Although sometimes more costly, it is a viable alternative to traditional bank financing because of its increased flexibility and because the primary credit criteria is based on your government customer, rather than your credit history.
Contract financing/Purchase order financing – You may be able to negotiate financing based upon your federal government customer purchase order(s). Some lenders provide purchase order financing based upon the credit worthiness of your customer (in this case the US Federal Government). PO financing is easiest when your products or services are well established.
A note from Bill: Be aware that financing cost is not “allowable” under DCAA, those costs come straight from your bottom line. But nothing will derail a small business easier than not having the ability to pay the people and get the infrastructure in place. Listen to the experts and get help.
In the next post, we’ll explore four other financing options for federal contractors.
Richard Lewis is a consultant with Financial Engineering Counselors, Ltd. FEC is a diverse financial advisory firm that assists government contractors in obtaining their working capital needs. You can contact him at 703-992-8988.