Sell A/R for quick cash? Don't

The practice—known as factoring—can just as easily put you in a financial jam as get you out of one.

By Robert Lowes
Senior Editor

Borrowing against your next paycheck is a rough way of understanding what some physicians turn to for quick cash—an expensive form of financing called factoring.

Say you have $60,000 in accounts receivable—what you expect to collect after discounts and adjustments—but seem to be constantly short of cash. So you turn to a factoring company—called a factor, for short—and within a week or so, it buys your A/R and advances you 80 percent of its value, or $48,000. The factor gives you the remaining $12,000—minus some hefty fees—once it receives your A/R.

That infusion of cash solves today's emergency, but how will you pay your bills a month or two from now? Sell a new round of A/R? It's little wonder that practice management consultants warn doctors to think twice about factoring. "You can end up taking out a perpetual loan at an interest rate far higher than what the banks charge," says consultant David Scroggins with Clayton Scroggins Associates in Cincinnati.

If factoring sounds as predatory as loan sharking, well, even executives in the factoring industry acknowledge that the waters can be dangerous. "Most companies are on the up and up, but there are some bottom feeders who profit from distressed physicians," says Winston Sitton, CEO of a medical capital company in Nashville called PhySurg Financial.

How factoring deals are structured

Factoring is a common financing mechanism in industries ranging from construction to apparel. Factors have branched out into health care in recent years, finding ready clients in medical practices and hospitals beaten down in the insurance wars. Companies that cater to doctors are easy to find: Just type in a phrase like "medical accounts receivable" in an Internet search engine.

(Don't confuse factoring with another form of A/R financing, in which a bank or finance company lends you money using your A/R as collateral. In this scenario, you keep your A/R, although it's at risk if you don't make your loan payments.)

Medical factors generally won't purchase A/R owed by patients. Some even turn down receivables from workers' compensation. Instead, they focus on cash flow from traditional third-party payers. Checks from private insurers either go straight to the factor or else to a "lockbox" bank account in the doctor's name. Daily deposits in such an account are automatically "swept" into another account owned by the factor. Meanwhile, the physician is still responsible for continuing to bill insurers, post payments, and chase down A/R.

Technically, factors can't buy A/R from Medicare and Medicaid outright: Federal law prohibits doctors from assigning those claims to other parties. However, doctors can still throw this A/R into factoring deals without breaking the law, as long as government checks first go to a lockbox account in the doctor's name.

Most factoring companies offer the same basic terms. They usually advance up to 85 percent of A/R on a daily, weekly, or monthly basis. Bigger advances go to doctors with more reliable, faster-paying insurers. Factoring contracts are generally for one year, although some companies will cut shorter deals.

The main differences among factors lie in their fees. The discount or factoring fee—equivalent to interest charged by a bank—ranges from 1 to 6 percent for every month A/R remains uncollected. The more A/R you sell, and the more collectible it is, the lower the rate you can secure.

Other fees pile up on top of the discount rate. If you don't read your contract carefully, these charges can ambush you. Factors charge any number of initial, one-time fees—an application fee, a due-diligence fee for evaluating your business, an origination fee for setting up your account. You may also be stuck with monthly fees for services such as monitoring your account and forwarding you cash. "Suddenly a monthly fee of 3 percent doubles to 6 percent," says Sitton. "This is where the unwary get trapped. Honest factors will disclose fees up front."

What happens if a factor buys $100,000 in A/R, but collects just $90,000? The company protects itself in two ways. It can recover its $10,000 from your reserve account, which holds the money the factor didn't advance you. Or the company can subtract $10,000 from your next advance. "The factoring company never gets hurt," says Scroggins.

Does factoring ever make sense?

Factoring may look like a life raft to physicians sinking into debt, but, in fact, it can increase debt, especially if you have slow-paying insurers, and interest builds up. A monthly discount rate of 3 percent translates into an annual rate of 36 percent, twice as much as what you'd pay on an expensive credit card. "Factoring is seductive, but it's addictive," says Sitton. "I see it only as a short-term solution. We want to move our clients to the cheapest capital possible."

The long-term solution, of course, is fixing the management problems that drove you to the point of selling your A/R. "Unless a doctor has a plan to make his practice profitable, factoring will only make things worse," warns consultant Ronald Present with RBG&Co. in St. Louis.

Many factors advertise that they'll provide consulting in addition to cash to set a practice on its feet. "Often we're able to show doctors how to improve their billing and collection system," says Peter Baronoff, CEO of Sun Capital Group in Boca Raton, FL.

Even stable practices have short-term crises, and factoring can come to the rescue, says Indianapolis consultant Michael Brown. "I knew a gastroenterologist in Los Angeles who sold his A/R after he lost his top collections clerk," says Brown. "He used factoring for six months until he found the right replacement for the job."

In the case of a six-doctor group called Valley Healthcare in Burbank, CA, a temporary need for factoring turned into a long-term relationship. Three years ago, Valley Healthcare decided to drop its outside billing company, which was inept, and bring that function in-house to improve collections, according to internist Richard Kroop. That meant buying a computer system and hiring more staff. At the same time, the doctors expected collections to dip during the transition. Making ends meet looked challenging.

"The banks weren't interested in loaning us money because our cash flow was so poor," says Kroop. "So we used accounts receivable financing." Even though its cash flow is now healthy, Kroop's group is in no hurry to drop factoring. "Maybe we'll try to go out on our own someday," he says.

Factors also pitch their services to practices that need capital so they can grow in ways that will generate more revenue—launching a satellite office, buying an X-ray machine, or adding an associate (who'll require a subsidy until his patient schedule is full). In these circumstances, factoring might make sense, especially for a doctor who can't get a bank loan—or doesn't want one. "A lot of physicians don't like putting up their house as a personal guarantee," says consultant Ron Present.

However, doctors with reasonably sound practices can easily get a bank loan—even without personal guarantees. "Bank loans are very cheap right now," says David Scroggins. "And there are ways to improve your credit rating." He adds that if a doctor needs new equipment, he can lease it rather than buy it.

In light of these alternatives, doctors would be hard-pressed to justify factoring. "Your A/R represents next month's salaries and rent," says Scroggins. "You don't want to jeopardize your operational cash flow."

Medical factoring has its own Enron

Like any other field, medical factoring has had its share of dubious players. The biggest black eye arguably is the recent collapse of National Century Financial Enterprises based in Dublin, OH.

NCFE bought billions in health care A/R each year from hospitals, nursing homes, and physicians and used it as collateral for bonds sold to investors. Last fall, it filed for bankruptcy after it stopped paying cash advances to long-term clients, several of whom also filed for bankruptcy as a result. Two days before NCFE went to bankruptcy court, FBI agents had raided its headquarters, signaling that the company was facing possible criminal prosecution in addition to civil litigation for fraud.

One victim was PhyAmerica Physician Services in Durham, NC, a practice management company with 2,200 physicians working in hospital emergency departments and clinics.

Another was anesthesiologist David Leak in Columbus, OH. Leak, who operates a pain-control clinic, says he signed on with NCFE in 1996 for the sake of predictable cash flow. "It's like a pimp giving his girls cocaine and money," Leak told one newspaper reporter. "You get hooked on the good stuff and you can't leave." He watched his cash advances shrink until they amounted to just 20 to 25 percent of his collections last summer.

Leak claims NCFE owes him more than $1 million. He says it was hard to break away from the company once the relationship began to sour because the NCFE never told him how much it would take to buy out his contract, despite repeated requests for the information.

"It's been quite an education for us," Leak says ruefully.

Selling your A/R? Pick your buyer carefully

The scandal surrounding National Century Financial Enterprises (see "Medical factoring has its own Enron"), which used to buy health care accounts receivables, should remind physicians to shop carefully if they choose to use a so-called factor.

Perform the normal background check you'd conduct for any business partner. Ask for a list of current clients and interview them. Does the company have a record of complaints at the local Better Business Bureau?

Let your attorney and accountant scrutinize the contract.

Insist that the factor spell out all its fees.

Ask what the company has done to comply with HIPAA. After all, it handles patient information.

Find out how well its computer system would "talk" to yours as you exchange information on receivables, cash advances, and other financial data. Will you need to pay a software programmer to write an interface program?

Make sure that any bank "lockbox" account set up to receive Medicare and Medicaid payments is under your complete control. You should have the right to prevent lockbox funds from being transferred to the factor in the event you want to break the relationship.

Robert Lowes. Sell A/R for quick cash? Don't.

Medical Economics

Aug. 8, 2003;80:41.