The Future of Factoring: Identifying the Top Industry Trends for 2021

After a turbulent year for the factoring industry, Steve McDonald predicts which trends will carry over into 2021, specifically noting that a tightening of bank lending will cause many small businesses to look for alternative financing such as factoring.

BY STEVE MCDONALD

There is a mantra in the factoring industry that says: “Banks look primarily in the rearview mirror with respect to a client’s financial performance, whereas a factoring company looks at the opportunities a company has in the future.” Considering this, as we look to the new year, it’s going to be difficult for banks to evaluate a business’ performance in 2020. Therefore, does this present a potential growth opportunity for the factoring industry in 2021?

We are wrapping up an unprecedented year that was led by the devastating economic fallout and ongoing ramifications of the COVID-19 pandemic. With the recent vaccine news, we look to 2021 with the promise of a new year filled with renewed optimism for a return to normalcy mixed with a healthy dose of concern for the unknown. Despite this uncertainty, I expect the need for factoring to increase as companies look for financing partners to help them manage their cash flow and keep their businesses running smoothly during these challenging times.

As a larger-scale factoring and asset-based lending company, eCapital processes more than 125,000 invoices per month for 80 different market sectors. This data allows us to pick up on trends and get a snapshot of which areas are doing well and which are not. Looking at that data, I see many reasons to be bullish about 2021, but first let us see what we learned in 2020.

TRENDS HERE TO STAY

The world has changed. More specifically, consumer spending habits and priorities have all changed as a result of the pandemic, which has forced businesses to adapt in real time. We all experienced this change in behavior almost immediately with the somewhat irrational uptick in the purchase and hoarding of paper goods, cleaning supplies and groceries in March. Later, this transition led to a surge of interest in home décor, housewares, bicycles, pools and other items that have helped people distract themselves during lockdown periods. These changes in consumer behavior and greater reliance on e-commerce have caused a massive shift across all facets of the supply chain.

As we look ahead to 2021 and the general outlook for factoring services, several aspects should be considered. For example, despite the overall negative economic impact of COVID-19, the freight factoring sector is thriving as a result of truckers having to adapt to the shifts in the supply chain that have occurred during the pandemic. Some businesses need funding for growth or ongoing operations, while some need financial support while they work to reduce expenses and adapt to the new normal. Transportation companies will likely continue to experience growth, as there is a shortage of supply and consumer spending is rising again, at least in the short term. Furthermore, equipment values are low, enabling firms to buy new trucks from auctions and increase their fleet size. These firms will have to rely on factoring to secure the funding they need to effectively scale their businesses.

On the consumer spending habits side, with more consumers relying on online shopping as a result of lockdowns, small shops on Main Street are struggling due to a lack of customers and reduced interest in shopping in person. The pandemic also accelerated growth and demand for last-mile carriers like Amazon, meal delivery services like Good Food and Hello Fresh, and many other e-commerce delivery companies. This shift from shopping at grocery stores to receiving premade meal kits through the mail will continue well beyond the pandemic.

FILLING GAPS LEFT BY BANKS

At eCapital, our client profile typically fits into two categories. They are generally experiencing rapid growth where “opportunity” is putting a strain on their cash flow, or they have tripped a financial covenant with their banking institution. In most cases, banks are uncomfortable financing fast-growing small and medium-sized businesses because of the strain that growth puts on cash flow and the uncertainty of future financial performance. Banks typically prefer to finance companies with predictable earnings, steady cash flow and manageable growth rates, while factors often can look past those issues and provide financing based on the quality of a client’s accounts receivable and overall account debtors. Earnings, cash flow and growth rates don’t present a roadblock for a factoring business if it can get comfortable with the overall collateral and customer base of the client.

Factors look past the numbers to understand the story, understand why the company is having issues, evaluate the company’s plans to address the problem and determine if they can support the company. Factors also look to evaluate the larger company story. For example, the company may have lost a significant customer or a contract, or won a new contract, and need help with financing as result.

In the coming year, banking relationships will become increasingly strained, with banks looking to exit long-held relationships that have become unprofitable. Bank clients that have tripped covenants will be forced to look for additional funding from non-bank sources. As a result, many companies will need alternative financing, and factoring is a good solution. The approval process is easier, it doesn’t create debt when clients use their own company’s assets and there are lighter underwriting criteria, translating into faster access to increased working capital.

DOUBLE DOWN ON TECHNOLOGY

The time it takes to submit applications and get cash in hand has been greatly reduced because of technology adapted by the factoring industry at large. Providing clients with online onboarding, direct digital payments and payouts is essential in providing capital quickly.

Giving them an online portal that helps them review and answer common questions about their account quickly and easily gives clients another level of self-service that can help their bottom line. In the long term, technology is critical, particularly when it comes to payments, but it will be important to scale up carefully.

Client demands also will vary. For example, freight businesses want their money quickly without complex requirements. They want more transparency and insight into their financing requests. On the commercial finance side, companies want smooth operations and want to secure alternative financing with less hassle and fewer requirements, such as strict covenant and revenue requirements from banks. While their funding requirements may differ, all businesses will want to work with a stable financier on which they can depend.

I expect the potential for renewed growth for our industry in 2021, especially if there is a lack of further federal aid and if the industry learns how to capitalize on the “new normal.” Since banks rely on their existing business models, they will have to decide if they can continue to support these businesses when they no longer meet their risk profile.

The bottom line is that factoring will play a larger role in helping companies improve their chance of success during this time of economic uncertainty. Factoring companies are uniquely positioned to look past numbers, listen and understand the story while working with these businesses during these “new” times. 2021 might just have the potential to be a good year for our industry after all.