Summary: Many electric utility restoration contractors and brokers face cash flow problems during busy storm seasons. They face increasing payroll costs to cover their ground crews
Invoice factoring can be an effective solution that provides funding to cover payroll and other operating expenses. This article discusses how it works, its advantages, and important differences that apply to the industry. We cover the following:
- Big storms and payroll expenses
- What is factoring?
- Factoring for subcontractors
- Factoring for brokers
- Qualification requirements
- Advantages and disadvantages
- Evaluate factoring companies
1. Big storms and payroll expenses
Electric utilities prepare for large storms by staffing and staging storm response crews in key locations. These crews are essential to restoring electric service quickly to customers.
Most of these crews are not staffed by electric utility employees. Instead, the utility ramps up its crews of linemen by hiring electric utility restoration companies.
They typically staff crews for:
- Storm response (primary/secondary)
- Assessment/inspection
- Vegetation management
- And other services
Storm response contracts can be substantial. They may go from a few hundred thousand to several million dollars. These contracts are an excellent opportunity for utility restoration contractors and brokers. However, these contracts also present a major challenge.
a) Payroll is a challenge
The cost of payroll adds up very quickly during a storm response. This expense can be a major challenge for small utility restoration companies that may struggle to pay their linemen and other crew members on time.
The main issue is that utility companies typically pay their invoices in 30 to 60 days. It may take even longer if the utility is in crisis mode. Consequently, your company must have funds in reserve to cover payroll for that time.
A small company that just won a large contract may not have the financial resources to pay its staff while waiting for payment. This situation leaves them with few good options and can lead to cash flow problems.
b) Using financing
The best way to solve this problem is to use temporary financing. It enables your company to cover the financing gap between covering \ payroll and getting paid by the utility or the broker.
Ideally, this type of gap in your cash flow is best fixed with a line of credit. There is one problem. Getting temporary financing from a lender is difficult.
Lines of credit require extensive underwriting and take weeks to set up. Even then, the line can only scale up to their credit limit. Increasing the initial credit limit takes time and requires additional underwriting.
There is one alternative that can solve this problem. It’s called invoice factoring. It’s a solution that offers many of the benefits of a line of credit but is simpler to obtain.
2. What is factoring?
Invoice factoring enables you to finance the invoices from the electric utility company. This provides you with immediate funds to pay your crews and handle large projects.
The line can adapt to your business and scale quickly up to meet your company’s needs. Most lines can be set up in a week or two. Read “What is factoring?” to learn more.
a) How does it work?
Factoring companies don’t provide loans. Instead, they buy your accounts receivable in exchange for an immediate payment.
The factors’ payment is typically broken into two installments. Your company gets the first installment once it submits the invoice. This transaction is typically referred to as the advance.
Your invoice must cover completed work only. After verification, the factor processes the advance and deposits 85% of its value in your bank account.
Your company gets the remaining 15%, less the factoring fee, once the electric utility pays the invoice. This payment settles the transaction. Read “How does invoice factoring work?” to learn more.
b) The advance
The average advance for the industry is 85%. However, the advance for factoring transactions varies based on the transaction’s risk profile.
The advance percentage depends on the factoring company’s ability to verify your invoices with the electric utility company. Factoring companies can verify invoices through some or all of these methods:
- Vendor payment systems
- Backup documentation
- Email, etc.
Obtaining an invoice verification can be difficult, especially during storm responses. Factoring companies can sometimes estimate the value of the invoice by reviewing your backup documentation. In those cases, they may risk-adjust the advance accordingly.
c) Brokers vs. subcontractors
Electric utility restoration companies can operate as direct providers or as brokers. Direct subcontractors employ the crews of linemen, vegetation specialists, etc. On the other hand, brokers operate as intermediaries between the electric utility and subcontractors.
There are important differences regarding how invoice factoring is offered to direct electric utility contractors as opposed to brokers. We cover these differences in the following sections.
3. Factoring for brokers/intermediaries
In these types of transactions, the electric utility restoration company acts as a broker. This benefits electric utilities because brokers work with several subcontractors and can scale up their response regionally or nationally.
The broker has contracts with the electric utility and subcontractors. They receive the payment from the electric utility and then pay their subcontractors accordingly.
The problem for brokers is that electric utilities pay them in 30 to 60 days, while their subcontractors want their money sooner. After all, they need to pay their crews.
a) How do factors handle these?
These transactions follow the same steps as a conventional factoring transaction, with one exception. Most factoring companies will want to pay your subcontractors directly. This ensures your subcontractor’s lien does not infringe on the utility company’s payment.
4. Factoring for direct contractors
Some restoration contractors have direct contracts with electric utilities. Others have contracts through brokers. These distinctions are important since factoring companies handle each case differently.
a) Working directly with an electric utility
Transactions where the subcontractor has a direct contract with the electric utility company are the simplest. They follow the steps of a conventional factoring transaction, as we described in section 2a.
b) Working through a broker
Transactions where a subcontractor works with a broker are more difficult. This is due to how these transactions are structured.
While the electric utility is the end customer, your contract is with the broker. From a factoring company’s point of view, the utility company is not your client. The broker is your client.
Factoring companies finance transactions based on the credit strength of your invoice. In this transaction, your invoice is to the broker, not the electric utility.
This may seem like a small detail, but it is very important to the risk profile. Most factoring companies can’t finance these transactions unless you enlist your broker’s cooperation. They handle these transactions on a case-by-case basis.
5. Qualification requirements
Qualifying for a factoring line is simpler than obtaining a line of credit. These are the four most important requirements.
a) Electric utility clients
The main collateral for the transaction is the invoices from the electric utility. This is an advantage for brokers and subcontractors that have direct contracts with the utility.
b) Good paperwork
Your company needs to have good invoicing and backup documentation. Backup documentation is essential, especially in cases where verifications are difficult.
c) No encumbrances
Your invoices must be clear of encumbrances. They cannot be pledged as collateral for financing or encumbered by liens.
d) Reasonable profit margins
Factoring lines work best in transactions with a minimum profit margin of 20%. It can work in transactions with lower margins, but only if the invoice is financed for a short time period.
6. Advantages
Factoring has several advantages for small and growing utility contractors. These are the three most important advantages for subcontractors.
a) Easier to obtain
Lines have simple qualification requirements and don’t require all the documentation of a conventional bank loan. This makes them an ideal option for new and fast-growing companies.
b) Quick setup
Most lines can be underwritten and set up in 5 – 10 days. This is an important advantage for companies that need quick financing.
c) Grows quickly
The line is adaptable, and its ability to grow is determined by the credit quality of your invoices and your ability to service clients effectively. This is an advantage for companies that handle storm response, as your invoices to utility companies can be substantial.
7. How to evaluate factoring companies
Selecting the right factoring company is important to the success of your business. Evaluate prospective factoring partners carefully and narrow down your list to potential partners with experience in the electric utility contracting industry.
To learn more, read “How to select the best factoring company.”
a) How long have they been in business?
You will usually be better off if the factoring company has been around several years. This will ensure they have a track record managing a client portfolio.
b) Are they familiar with the storm response industry?
Most factoring companies operate in niche industries. Even those who are generalists have preferences. You will be better served with a company familiar with the electric utility restoration industry.
c) What is the size of their maximum facility?
Some storm response companies can go from invoicing a few hundred thousand dollars to several million dollars in a very short time period. You need to ensure that the factoring company’s maximum financing is enough to support your growth. Otherwise, you could max out your line during a project.
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