Know Your Product: A Brief History of Factoring

As a factoring broker, the better you understand your product, the higher the value of your “personal stock”.  Commercial Finance Consultants have value because they are experts in their particular field.  It is easily understood that the more you know about factoring and alternative commercial finance products, the more you will be looked at as an expert by other local business professionals and the more  likely such professionals will send referral business your way.  Unknown to most, factoring has a rich and colorful history and learning about its contributions to business finance throughout the ages can be important when it comes to networking.  Discovering more about the history of factoring is a good idea for any serious factoring broker.

An Ancient Source of Business Finance

Factoring is often referenced as having its roots traced as far back as the 18th century BC and the ancient Babylonians, although you can probably say this about all types of commercial finance.  At that time, the city-state of Babylon was ruled by the much celebrated Amorite king, Hammurabi, drafter of the Laws of Hammurabi.  Among its 282 decrees, these laws set forth various guidelines for merchant transactions of the day and rules for the repayment of certain types of business debts.

True factoring-styled transactions become more recognizable at later points in history and particularly throughout the Mediterranean trade corridors.  Phoenicians, the greatest traders of their day, are said to have employed factoring-related finance transactions as they ventured to foreign ports.

Characteristically, factoring services throughout the ages usually involved the service of warehousing goods and not just that of financing.  This important additional feature, unknown today, did not really fade away until the early 19th century.  Ancient traders depended heavily on trustworthy warehousing agents for their export goods who would:

  • take physical possession of goods on consignment
  • warehouse the goods
  • act as sales agents and find buyers for the goods
  • collect payment upon sales for the selling trader

 In ancient Rome, it was common for producers to employ the services of a “mercantile agent” to manage the sale of and assure delivery and payment for goods.  There is also evidence that theRomans formalized methods and regulations for the sale of promissory notes at a discount, a direct characteristic related to modern factoring.

The Roots of Modern Factoring

The roots of what can be called “modern factoring” are traced to the textile trade in England during the 17th century and Blackwell Hall.  Blackwell Hall, originally built in 1397, acted as a merchant clearing house for the cloth trade, England’s primary commodity of that era.  Blackwell Hall Factors acted as fee-based group of agents who monopolized the handling of the sale of textiles.

By the end of the 17th century, there were roughly fifty factors at Blackwell Hall who sold the raw materials to manufacturers and then additionally provided credit to clothiers, drapers, and the various exporters of the day.  Throughout this period of English colonization, English factors were used to facilitate trade between Britain and her colonies, and especially her highly-prized American Colonies.

Factoring Arrives in America 

During America’s Colonial Era, factors provided payment advances to the colonists for shipments of cotton, furs, tobacco, and timber.  As set forth in regulations contained in the Navigation Acts of the day, the colonists were strictly forbidden to manufacture goods in direct competition with the “mother country”.  They had little choice but to send raw materials to England, but to do so, required the services of a trustworthy “middleman” who could be counted on to transact the business.  The middleman was, of course, the period’s trade factors and the services provided by such factors survived America’s War of Independence, with little change in methods for many decades to follow.

During the 19th century and the heyday of “king cotton”, industry cotton factors provided substantial funding for exports to Europe which accounted for nearly 80% of America’s annual cotton crop.  The historic warehouse district known as Factors Walk, in Savannah, Georgia, still evidences the importance of factoring during this period and in the history of this vital commodity.

The actual birth of modern factoring in America is most associated with the creation of the Mercantile Credit Corporation which was established in 1904.  It is considered to be the first true commercial finance company.  Mercantile was started by two encyclopedia salesmen, Arthur Jones and John Little, who were well acquainted with the need for creating time payments related to their book sales. They wondered if such installment financing based on accounts receivable as collateral might be suitable for other industries.  The factors had been using similar financing methods for centuries although almost exclusively in the textile industry.

After some initial successes and the creation of Mercantile, competition quickly entered the market with the formation of St. Louis-based industry giant Commercial Credit & Investment Company (CIT) and also Baltimore-based Commercial Credit Company, both being started around the same time.  All of these early institutional lenders initially focused on developing installment payment systems for asset finance rather than the more expansive credit and collection services provided by the factors. As an important feature, these early asset-based finance companies structured and provided services without notification to account debtors.  Notification was a perceived stigma of factoring which discredited users and evidenced a level of financial weakness.

It did not take long for these early lenders to begin offering types of installment payment programs for automobiles, appliances, and many other consumer “pleasure” purchases of the time.  The installment finance industry began to expand exponentially with lenders eventually offering unsecured financing products in addition to those styled as asset-based loans.

As for factoring, it still flourished in the garment and textile industries since it provided the much needed services of credit and collections characteristically required with the period’s large retailers.  From the banking and asset-based lending viewpoint, factoring was still looked upon as a financial accommodation for weak, under-capitalized manufacturers and suppliers selling goods to retail companies considered to be “sub-prime” credits.

Postwar America saw a significant transition in the factoring industry as large banks and asset-based lenders realized there was additional business to be had by embracing this popular method of financing.  Although factoring had still not shed its image as a financing method of last resort for businesses of marginal credit, the banks came to realize that since they were providing the investment capital to finance the nation’s factors, they were really exposing themselves to the same sub-prime lending risks by proxy.  So the large banks made the decision to begin purchasing and acquiring the nation’s leading textile factors.

A positive result of the entry of the competitive banks into the factoring industry was lower financing rates.  Well established banking names also added a new legitimacy to the industry and in general, factoring began the process of building respect as a primary source of business finance.  Also during this consolidation period, factoring began to expand its service areas to include not just garments and textiles, but hundreds of other industries and product areas.  Factoring grew rapidly through the 1970’s and 80’s resulting in the creation of factoring giants such as CIT, GMAC, HSBC, Heller, Rosenthal & Rosenthal, Milberg, and many others.

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