Calling for capital? ‘Receivables financing’ may be your answer
March 1, 1998 5 minutes read
Calling for capital? Receivables financing’ may be your answer
Asset-based funding offers unique solution for private duty providers
Squeezed between short-term obligations and slow-paying insurers, some independent private duty home care companies struggle to meet day-to-day cash flow requirements. Misunderstood by traditional funding sources and cash-poor, with few fixed assets and low operating margins, chances of securing commercial bank loans or credit lines can be slim.
Growth, in the form of new positions, technology, and services, may seem like an impossible dream under such circumstances. But you may fund both your organization’s growth and ongoing operations by selling or borrowing against your account receivables.
"As most of a home care company’s assets are going up and down in elevators, the only asset that can be used for working capital financing is account receivables," says J.B. Dollison, managing director of StaffCapital, a Houston investment banking firm specializing in home care. "[It works well] for start-up, high growth, or distressed organizations with no great earnings track record who probably have no other alternatives," says Rene Felius, president and chief executive officer of MCH Services Inc., also in Houston, whose own company achieved its rapid expansion plans using receivables financing.
Commercial finance companies, lacking commercial bank risk and regulatory constraints, now drive the home care account receivables financing market, says Dollison. Commercial banks generally shun home care providers because they don’t understand the industry and favor loans collateralized with fixed assets.
Growth is best-suited, most common circumstance
Dollison says there are three conditions that might prompt you to seek receivables financing for your private duty agency:
1. Rapid growth.
Most companies that Dollison consults for have simply outgrown their existing funding sources. The owners may be unwilling or unable to contribute more of their own resources, yet the organization’s operations cannot support the capital requirements of growth.
A pediatric specialty company, MCH Services, faced this situation when it first used receivables financing five years ago. The organization had an aggressive growth strategy but was undercapitalized, says Felius. It had also either already exhausted or found other financing options such as slowing payments to vendors, receivables factoring, and equity funding unacceptable. Commer-cial banks would not issue loans because MCH Services’ largely private duty case mix was heavily Medicaid waiver-reimbursed.
Facing no other viable options, and assured the company would continue managing its own billing functions, Felius pursued receivables financing. Carolyn Briethaupt, vice president and chief operating officer, says receivables financing gave MCH Services "a reprieve to focus on growth and not have to worry about daily cash flow."
2. Financial distress.
Distressed organizations use receivables financing to fund short-term losses and stay in business while revitalizing the company. Usually the provider has suffered a significant but temporary downturn such as loss of a major referral source or disputed payment on a large receivable with good prospects for ultimate recoupment.
3. Restrictive existing financing arrangements.
Some home care providers switch to receivables financing because of their existing lender’s onerous debt covenants.
Dollison says commercial banks’ unfamiliarity with home care prompts them to require that owners personally guarantee or pledge outside assets to collateralize loans. At some point, owners eventually find such conditions too restrictive and seek other capital sources.
Receivables financing is complicated and not without hazards. Felius says, "It is a tricky area. Unless you know what you’re doing, it’s useful to have someone advise you."
Companies can run aground by misunderstanding what they have committed to and not meeting funding source obligations, or by not achieving collection or operational improvement targets, says Dollison. He cautions agencies to thoroughly examine agreements before signing on the dotted line. Sources offered this advice to private duty managers:
• Understand agreement terms and conditions.
Private duty providers should be fully aware of their financing covenants such as account receivable and cash reserve requirements, or interest-to-debt ratio obligations. Those that sell receivables should also be prepared to invest in information systems. Their own and that of the purchasing entity must be compatible to facilitate ongoing account transfer and collection efforts.
• Understand the deal structure.
It is important that providers enter financing agreements fully cognizant of fee mechanisms and their associated costs, says Dollison. A slew of fees typically accompanies each contract. For example, providers must pay a commitment fee when they sign the agreement and usually also incur due diligence fees for pre-contract financial analysis and legal preparation.
Watch out for hidden costs
Many loans also have unused line fees, which penalize the agency for borrowing less than their overall credit line. Others have days-long float periods before collected accounts are credited to the outstanding loan balance, effectively increasing finance costs.
Providers should "carefully analyze deals and get competing offers. It is a mistake to take the first offer," Dollison cautions.
Felius concurs. "Watch out for the add-ons and hidden charges which boost rates," he says. "What initially appears closer to bank financing can [be more expensive]."
• Know how to get out of the deal.
Providers sometimes do not understand how to get out of receivables financing arrangements says Dollison. They are not required to draw off the credit line, and can avoid doing so with strong collections and successful expansion, he adds. Those that effectively implement growth strategies usually graduate to commercial lending arrangements, cashing out the receivables agreement in the process. Others close out the deal by merging with or being acquired by other companies. Agencies that unsuccessfully manage their financing arrangements or have failed growth strategies may face liquidation.
MCH Services outgrew its receivables financing agreement after three years. When commercial banks started calling on him, Felius says he knew the company entered a different playing field.
• Operate efficiently.
Operational improvements should go hand-in-hand with financing arrangements. "Don’t think you got the money and don’t have to do anything differently," Briethaupt warns. MCH Services tightly managed operations after receiving funds. Briethaupt reviewed payer and case-specific financial reports weekly. Gross margin variances were closely scrutinized and acted upon.
While some operations were streamlined, expenditures were made in other areas. For example, the company upgraded its information system and hired a controller for the first time. MCH Services also stepped-up its case management negotiations and revamped intake forms to obtain all potentially valuable information such as secondary or even tertiary policies, required out-of-pocket payments, and deductibles.
• Work receivables.
Aggressive receivables management is critical, Briethaupt says, because initially qualified receivables that age beyond loan parameters fall out of the collateral base and must be paid out in cash or replaced with like receivables. Collections staff turnover, changes in a payer’s payment timeliness, or significant payer mix shifts can all wreck havoc with finance costs and ultimately a company’s growth plans.
MCH Services changed over its collections staff, bringing on experienced billers. It also tightened account receivables billing and follow-up standards. For example, it began billing weekly and required staff to call payers on the contractually outlined clean claim payment date. In the past, such follow-up phone calls may have been made 15 to 30 days after the contractually obligated due date.
Receivables financing offered MCH Services a "perfect solution," says Felius. "We were able to get through a crunch, and it allowed us to retain control [of our operations]. It cost us a little bit of money, but in the grand scheme of things it was worth it."
The company’s high-teens financing rate cost about 1% of its revenues but fueled growth. In the five years since MCH Services first financed account receivables, the company has expanded into two additional states, opened 10 new offices, and increased revenues 10 times.
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