A Brief History of Commercial Factoring

For prospective clients, the better you understand a particular product, the higher the product’s value to your business.  As commercial finance consultants, we have become experts in this specific product simply because its use is so common to provide solutions to so many cash flow-related problems.  Just as from the consulting side of the equation, the more you learn about factoring as a business owner, the better you will recognize the many benefits you will see as you employ it for your company. 

Unknown to most, factoring has a rich and colorful history. As commercial finance consultants, this article about factoring’s rich history helps us explain its role as a core product in business finance throughout the ages.

An Ancient Source of Business Finance

Factoring is often mentioned as having its roots traced back to 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, who drafted 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 became more recognizable at later points in history, 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 significant additional feature, unknown today, did not 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 sale 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 the Romans formalized methods and regulations for selling promissory notes at a discount, a direct characteristic of 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.  Initially built in 1397, Blackwell Hall acted as a merchant clearing house for the cloth trade, England’s primary commodity of that era.  Blackwell Hall Factors acted as a fee-based group of agents who monopolized the handling of the sale of textiles.

By the end of the 17th century, roughly fifty factors at Blackwell Hall sold the raw materials to manufacturers. They 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, especially her highly prized American Colonies.

Factoring Arrives in America

During America’s Colonial Era, factors provided payment advances to the colonists for cotton, furs, tobacco, and timber shipments.  As outlined in regulations in the Navigation Acts of the daythe 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, which 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 birth of modern factoring in America is most associated with the creation of the Mercantile Credit Corporationwhich 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 to create 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.  These factors had used 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 by 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.

Factoring in Post-War America

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 factories.

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 1970s and 80s, resulting in the creation of factoring giants such as CITGMACHSBCHellerRosenthal & RosenthalMilberg, and many others.

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