What’s Behind Misleading “Prime Plus Pricing” in Funding Sales Pitches
Steve Capper, Founding Principal/Managing Member Flexible Funding - July 18, 2017
Funding company offerings of pricing at “prime plus” something, such as prime rate + 3%, is the latest funding industry tease of many companies and is in most cases misleading. A Federally chartered bank may be at pricing of prime rate plus some additional figure, but payroll funding companies and invoice factoring companies secured only on accounts receivables generally are not at prime plus something–when you add up the other all-in costs that are included with it.
When a funding company sales representative verbally proclaims to you that the pricing is “prime plus” something, do not get excited and rush to give him or her a deposit. These deposits usually run between $500 and $2,500, and are commonly “nonrefundable” if you do not go ahead with the program. You might be paying $2,000 just to get the pricing details–to find out that the all-in cost is really greater than a prime plus quote. A pitch would be made that if you end up funding with that company, the deposit will be applied to future funding fees or costs…and therefore nothing is lost. This can create internal personal pressure to go with that funding company so that you get something for your hard-earned deposit, even if the program is not exactly right for you.
Do everything in your power to get fine-print details of a payroll funding program without having to hand over a deposit that is nonrefundable. But do expect for there to be information requests to comply with and some pre-qualification standards to meet before getting to see contract fine print.
The most common and largest dollar add-on costs in prime-plus pricing teases include the following:
- A Floor or minimum on the prime rate figure. In an example, the funding company representative may tease you with “prime + 3.” Prime rate might be 3.25%, and the addition of plus three would bring it up to 6.25% annually. In reality, there can be a minimum amount or floor to the prime rate amount stated as, “at no time shall prime rate be any less than five percent.” In our example, the cost becomes 5% + 3 = 8% annually. This is only the starting point for the add-on costs to follow.
- A discount or administration (“admin”) fee. An administration fee, service fee, or discount fee may be stated as something that sounds small such as 1%, but it is really quite significant; it is not one percent annually, but rather one percent for every turn of the accounts receivables. Receivables that get paid in 30 days from the invoice date turn twelve times per year –360 days divided by 30. And each time invoices are presented for funding and turn, the payroll funding company gets 1%. 1% X 12 times per year = 12% cost annually. Continuing with the example in the prior paragraph, the prime rate floor of 5%, and the plus component of 3%, and the discount/admin fee of 12% all together add up to 20% annually.
- Fee on the maximum credit line offered. There can be an “annual fee” on the maximum credit line offered. An example would be 1% of the maximum credit line of $500,000, which is $5,000. It is easy (and enticing) to offer a larger credit line and get a larger annual fee, as everyone is concerned about having enough credit limit headroom. Too often, people are paying a fee on a large maximum amount they never use, and as a result, whenever they borrow less they are being penalized for borrowing less.
- Minimum monthly volume amount. This could be stated as a minimum monthly sales volume, a minimum amount of invoices that must be presented for factoring, a minimum loan balance that must be maintained, or a minimum amount of interest and/or of fees the payroll funding company must receive in a month. The minimum may not be for a monthly period, but rather quarterly or some other time period. The reason(s) for going below a minimum, such as a seasonal drop, are not taken into consideration… usually there are no grace clauses in the fine print. If you don’t meet the stated minimums, but still pay fees for the minimum amount, the APR Annual Percentage Rate on the money you are actually utilizing is higher.
- Clearance day floats. Financial floats are probably the least understood of all rate-increasing tactics. A clause in contract fine print may state that incoming checks/monies that are coming into the funding company will be held for three days for “clearance”. Although this may imply that every incoming amount takes three days to clear through the Federal Reserve banking system, that is not always the case. Payments often clear overnight. When payments are held for three days for clearance, they are not applied to the loan balance that you have — they do not reduce your loan for three days. Interest or fees accumulate for three days longer, costing you more. Take the weekend days into account (on a three day clearance) and the holds/float often become four or five days. This amounts to a lot of additional rate.
Why do many funding company business development people tease a simple “prime plus something” pricing to staffing agencies when, with all of the above add ons, it is not really true? Sales people have to get applications in the door for consideration. They must show upper management that they are producing. Getting a nonrefundable deposit is money in the door to the funding company.
A good percentage of staffing agency owners are essentially salespeople or recruiters; they are not really business people. The prime plus something pitch WORKS on them. They fall for it because they want to believe so badly that they are going to get cheap money, and don’t have the kind of funding industry consumer information included above.
Lastly, the phrase “prime plus” something is a lending/finance cliche that many people are familiar with, including staffing agency owners. Other profitable long-term businesses that have solid collateral security for a loan, such as inventory, equipment, accounts receivables AND real estate may actually get “prime +1”, or “prime+2” pricing. But the prime plus cliche stops there. You don’t hear people say “prime +9, or prime +14. It would sound too expensive. So a funding company sales rep may tease a low prime plus figure and get the real higher rate with add-on costs.