Factoring – When Is It A Viable Business Funding Product?
By Eugene E. Valdez AKA The Loan Doctor
There have been thousands of articles written by business finance pundits on the subject of factoring. In the limited amount of space I have to work with I will provide my “spin” on this form of business funding. Specifically, I will share with you my “ABCs” of factoring and then provide a few scenarios when I think this funding product is a good fit for a business.
A few important definitions:
FACTORING – The process of selling your commercial accounts receivable, (invoices) to a third party business, (a factoring company) at a discount, (usually 80% of the face amount of the invoice) so that you can access your “AR/Future Cash” immediately.
LOAN?- Technically, factoring is not a loan. You are merely selling your invoices to a factor and the factor recovers the money they advanced you by collecting payments directly from your customers.
RECOURSE- A form of factoring where you are liable for payment to the factor in the event your customer defaults and does not pay the factor.
NON RECOURSE- The opposite of the above. If your customer does not pay the factor, that is the factor’s problem not yours.
NOTIFICATION- Your customers are notified of your arrangement with the factoring company
NON- NOTIFCATION- Your customers are not notified of your arrangement
There are many more definitions like “lockbox” and “reserves” but my goal is not to cover all of the definitions, but to just get to “heart of the matter”.
The Heart of the Matter- Why & when should you use factoring?
Why: When you need cash fast to pay all of your business expenses “on time”, (usually in 30 day cycles) so that you can maintain a good credit rating with all parties doing business with you, including employees.
When: You are a relatively young company (6 to 18 mos. in business) who has managed to land a few well known customers who are notorious for paying their bills slow, (slow defined as 40-75 days from your date of invoice). You know they are good for the money, they just make you wait.
-You are a mature company who happens to have a major concentration in your customer base. (25%-80%) such that this concentration has scared off banks and other lenders that do less expensive AR line of credit financing. These lenders have declined your loan requests because of this risk.
-You are a company that is fortunate to generate high enough profit margins that can absorb the expensive factoring fees.
-In general your business is just not bankable for a multitude of reasons.
-You have poor personal credit.
Factoring versus “On-Line lenders”
If you haven’t noticed on line lenders are springing up faster than sushi restaurants, (poke bowl establishments included.)
While I admit I may have a limited sample based on the number of prospects I have met the last 6 months, those prospects who have accounts receivable and are using on-line lenders are paying HIGHER rates & fees for their money than they would if they were using a reputable factoring company…. and factors aren’t cheap. The pricing differential can be as much as 50%. So all things being equal, if your contemplating taking out a loan with an on-line lender because it is quick and easy, slow down and contact a few factoring companies and do some rate and fee comparisons.
One more suggestion:
If you feel you are a good fit for a factor, contact at least four of them and get rate quotes. Tell all of the factors the names of the companies you are “negotiating with”. The factoring industry is highly competitive. Putting the factor companies on notice that you are “shopping” will give you the ability to extract positive concessions in such areas as advance rates, monthly rates, amount of reserves, recourse/non-recourse, length of contracts and pre-payment penalties.
Eugene Valdez is a 40-year veteran of business/financial management and owner of The Loan Doctor, a full service business loan consulting firm based in Upland. He can be reached at firstname.lastname@example.org.