Navigating in the Matrix: Documentation and Due Diligence
Cheryl Mayo of Haversine Funding invites factors to enter the matrix, the underwriting matrix that is, outlining the tools and best practices to make the best funding decisions in today’s credit environment.
BY CHERYL MAYO, CAEF, DIRECTOR, PORTFOLIO MANAGER, HAVERSINE FUNDING
What if I told you it’s possible to create efficiencies, identify holes in your processes and be more prepared for the new credit environment? Although Morpheus never said, “What if I told you…” the concept of being introduced to an entirely new world from The Matrix is comparable when ensuring best practices in factoring.
Let’s say you have a new deal and it’s time to start the due diligence process. This critical fact-finding mission is the basis for determining the future for both the deal and your crew. The result then becomes a decision:
“You take the blue pill, the story ends, you wake up in your bed and… [move onto the next opportunity]. You take the red pill, you stay in [underwriting wonderland and you can see how deep the rabbit hole goes].”
Quickly getting to a no or (preferably) a yes means you and your potential client can be successful. Having best practices in your factoring company can help with that. As an organization, knowing what is most important to you will help guide the process. Does your shop focus solely on the collateral and the account debtor credit? Do you incorporate financial wherewithal in any capacity? Does the client have to be in business to complete projects or orders? Do you focus on a key industry or the nuances of various billing types or monitoring within certain industries? What is your stance on the business owner or guarantor’s credit or background?
Every shop has different profiles and weighs these categories at varying levels depending on their focus. What is your focus? What do you care about and how do you review and then document around those priorities? Like The Matrix, there are rules in factoring that can help you enter and exit safely. Moreover, with the credit environment changes expected in the coming months, it may be time to resurrect some of those rules.
The First Step is Understanding the Rules
Technically, the first step is that no one can tell you what the “underwriting matrix” is. However, we’re going to attempt to break down the rules. It is imperative to have processes and procedures in place for consistency and for properly reviewing the information on each new deal. If you don’t have one, and I get this sounds basic, start with a checklist. Something generic that includes multiple options so you can customize the checklist for each deal. This will become a great tool, a check and balance and a stop gap before funding to ensure your crew has done what they need to do before you hit the fund button.
Your list may include the documentation to be received as well as action items such as setting up tax monitoring, reviewing lienable payable requirements, completing verifications and identifying if there are thresholds to be met for those and/or other specific pieces necessary to fund the transaction. The list can also create efficiencies, as your team will know where to look and get accustomed to certain steps in the process.
Like any tool though, the key is to know how to use it. Checklists require a person to be responsible for each task. If no one is responsible, then no one can be accountable. Additionally, if everyone is responsible, then no one is responsible, so no one can be accountable. Nothing is worse than getting to the day of funding and realizing the tax reports are not back, verification hurdles haven’t been met, there’s a document missing, the search to reflect hasn’t come back yet or other challenges have cropped up that effect meeting funding timeframes that impact both you and the client.
Checklist Considerations
Documentation needed (i.e., signed application, driver’s license copies, corporate documents, etc)
Due Diligence tasks (i.e., tax, lien and judgement; internet, business and owner background searches; account debtor credit limit reviews, etc)
Side note: Google is a great tool and some factors do not include this as a step in the process, but there’s a lot of information you may find that may not show up in all the search results received. The internet is forever; you may be amazed when you search the company or the owners.
Approval process and set up (i.e., what do you require for your approval steps before funding)
Monitoring set up (i.e., payroll taxes, UCC, client business entity or other ongoing tracking)
Pre-Funding (i.e., invoice verifications with multiple verification methods, invoice and backup review, client set up, recheck approval requirements and verbal wire instruction verification to help protect against fraud)
Technology in our industry is increasing and there may be additional tools you can build into your workflow to help with underwriting and tracking and give you greater efficiencies and more controls in your process. Consider researching software options for your business to help streamline what works best for your team.
Takeaway No 1: Create tools that help gain efficiencies, add controls, ensure documentation is received and give the opportunity to review the transaction before funding occurs.
Takeaway No. 2: Assign roles and responsibilities. Again, if everyone is responsible, then no one is responsible and no one is accountable.
Learning Fast is a Necessary Superpower
Just like in The Matrix, the ability to download and process information quickly to understand a deal is necessary for survival. But simply having items on this fantastic checklist that you created without the ability to interpret, verify and/or understand the data serves no purpose; it will only end in failure. So, once you have the data and the right expertise to review and interpret that data, it is time to begin your underwriting process.
Due Diligence Review Considerations
Review the payables aging as well as the receivables to identify contras.
Look through the financials and bank statements to find anomalies; see if the deposits and expenses make sense in what the business is doing or to see other potential lenders or creditors (including MCAs).
Review the invoice billing documentation requirements to understand what triggers payment by the account debtor and what you would need as the factor to collect on those invoices if the client is no longer in business (only getting an invoice without the supporting documentation may not help you).
Analyze the creditworthiness of the account debtors and assess credit limit needs for the future.
Know your sources and uses (Are you funding working capital needs or losses?).
Understand the industry for potential hidden liens such as lienable payables or past due taxes along with potential offsets that may arise for returns, volume rebate incentives or other items.
Know the industry you finance, know your strengths and, more importantly, know your weaknesses. Learning an industry after funding adds more risks, and what you don’t know can hurt you. Does your team have the experience needed to manage the deal? If the answer is no, then you may want to act like you have seen Agent Smith and run.
Research and ask questions about changes expected in a different credit environment, what trends are occurring in the client’s industry, what challenges may occur and how could you mitigate around those.
Learning fast means staying curious, probing, investigating and seeking to understand. Encourage your crew to ask questions and really dig into the deal. The hard part is not to go down every rabbit hole but instead to inquire more to lead to a better understanding of the transaction and the risks.
Takeaway No. 3: Know what you are looking at to best understand your prospective client, the key areas where a potential loss could occur and the mitigating factors to manage around those, if possible.
Takeaway No. 4: Ask clarifying questions, and then ask more.
Seeing the Matrix Before the Decision
Once the due diligence process is completed, your new mission is to make the final choice. By now you’ve reviewed the information received, independently checked and verified that information and worked through the various discussions and key concerns. By now you should also have enough data to ensure the proper set up and monitoring that can be implemented for the long term.
Along this journey, time has passed, accommodations have been made, exceptions created, and it may be hard to remember to look at the deal as “a whole” at this point. But before you make the jump, stop and look at the deal you are funding. Is it the same as what you thought you were getting into or are you moving forward because you are too far down the road?
This is where if you decided to take the red pill and go down the rabbit hole, you can pause the movie and ask yourself, “Does the data provided match their ‘story’ and does it all make sense?” If, however, you opted out during the process, taking the blue pill, and then let’s pretend you remember the dream you had, there could still be a valuable lesson: What did you learn?
Cheryl Mayo joined Haversine Funding in August 2021 and oversees the account management, operational compliance and ongoing relationships with Haversine’s customers. She has more than 25 years of factoring and asset-based lending experience. Prior to joining Haversine, Mayo was a senior account executive with Allied Affiliated Funding, a division of Axiom Bank, and the operations manager for USA Funding, a factoring division of Fidelity Funding Financial Group. She was one of the first in the factoring community to receive the Certified Account Executive in Factoring (CAEF) certification from the International Factoring Association.