Does your business need an infusion of cash for payroll, to pay vendors, or for other operating requirements? If so, you can definitely make use of conventional financial tools, such as bank loans and the like. However, it might be worth considering working with a factoring company instead. There are quite a few advantages to partnering with a factoring business, but you’ll need to know a bit more about how factoring works, as well as how to choose a factoring company with which to partner.
What Is Factoring for Business?
Factoring is really nothing more than the process of selling an unpaid invoice owed to you by one of your customers to a factoring company. When the customer pays the invoice, the factoring company keeps that money.
It’s pretty simple, but there are some specifics that you’ll need to understand, as they will impact not only your choice of business factoring service, but also the type of factoring that you make use of.
When a factoring business buys an invoice from you, they will typically pay between 70 and 90% of the total invoice value. Depending on the company in question, you may have this money in as little as 24 hours.
Once you have the money in hand, you can use it for pretty much anything. It’s your money, and it can go to pay creditors, to pay employees, to buy new merchandise, and much more.
When you start comparing potential partners in the world of business factoring, you’ll need to determine the right type of factoring for you. There are two primary types (as well as combinations of those types) available, and they both work differently.
Recourse Factoring: Recourse factoring is really nothing more than you being responsible if your client/customer pays their invoice late, or doesn’t pay at all. However, this can be problematic, particularly if you don’t have another invoice of equal or greater value to replace that defaulted one with, or if you have already spent the money the factoring company paid you for the invoice. It’s crucial that you only factor invoices from clients that you know will pay their bills – you can’t really afford to take a lot of risks with recourse factoring.
Nonrecourse Factoring: Nonrecourse factoring is the opposite of recourse factoring. In this situation, the factoring company is responsible if your client pays late or fails to pay. You’re completely off the hook. Obviously, that’s good news, and chances are good that this is the type of factoring that most appeals to you.
However, understand that with increased risk, factoring companies require increased compensation. This is most often achieved through higher factoring fees (called discounts). In the normal course of the factoring process, you’re required to pay a fee of between 1 and 5% to the factoring company (in exchange for the payment on the invoice). However, with non-recourse factoring, the fee can be exorbitantly high with some companies.
You’ll find that some factoring companies also use blended factoring, or a combination of recourse and nonrecourse factoring. What that means is you need to scrutinise your contract very closely and ensure that you understand fully any obligations imposed on you and how the language of the contract impacts your business.
Finally, you might find that one factoring company requires that you sign a long-term contract with them, and that you factor all of your invoices for a particular client through them. Others offer what is called “spot factoring”, which is a one-time deal.
If you only need to factor every now and then, spot factoring is definitely a better option. However, understand that the fees here are sometimes higher than what you’ll pay with a long-term contract.
Finding a factoring company isn’t actually that difficult. There are plenty of them out there today. However, it can be a challenge to find the right factoring business. They’re far from being identical. One of the key ways that factoring businesses can differ from one another is in the focus of their operations. For instance, there are some generalist firms, but there are also quite a few that specialise in a particular industry or niche.
Working with an industry specialist is often the better choice. Why is that? Simply put, they know your industry inside and out. They’re familiar with your business, and the challenges that you face on a regular basis.
A generalist firm may not have that vital experience with your industry. If you’re in the medical industry, the transportation industry, the staffing industry or the construction industry, a specialist factoring company might be the best option due to the intricacies involved with your industry.
The Costs of Doing Business
Before we dive deeper, understand that every factoring company will charge fees. The only real question is how much (and what type). The most obvious example of this is the factoring fee charged for the sale of the invoice. Again, that will usually between 1 and 5% of the total invoice amount. However, it may be higher if you’re working with a nonrecourse factoring company, or you’re using spot factoring.
Now, there are also other fees that you might be charged depending on the factoring company in question. Some require that you pay an application fee. Others may charge you the discount each week until the invoice is paid, where another company might only charge it per month. There may be an ACH fee involved, as well as a fee for not meeting the company’s minimum factoring requirement.
A Word on Minimums
Some factoring companies are open about the fact that they have a minimum amount policy. However, others do not have such a requirement, and yet others pretend that they don’t by masking their minimum in confusing languages.
A minimum policy is exactly what it sounds like – in order to avoid excess fees and charges, you need to factor invoices worth a minimum amount (which varies from one company to another). Minimums might be one-time fees, or they could be monthly, depending on the factoring company and its policies.
It would be ideal to work with a factoring business that truly has no minimum if your invoice isn’t worth a great deal, but finding a company that doesn’t charge a minimum fee can be difficult, simply because so many of them claim not to have a minimum, but then use the contract’s fine print to contradict that claim.
Scrutinise any agreement or contract prior to signing to ensure that you know exactly what you’re being charged, when and why.
Other Contract-Specific Considerations
In addition to the fee structure and potential hidden charges, you need to look over your contract very carefully for other information. These can be quite lengthy, and they’re generally written in legalese, so if you’re not fluent, it pays to have someone on hand who is.
For instance, you might find information that tells you how long the company will keep the reserve in place (this is the portion of the invoice price not paid at the beginning of the contract, less the fees charged). Some companies pay the reserve as soon as your client pays the invoice, but others keep it for longer periods.
Your contract will also inform you of whether or not the factoring company requires a notice of assignment. Essentially, this is a notice sent to your customers informing them that their invoice has been sold to a factoring company, and that this company will be collecting their debt, not your firm. If you would prefer to keep your factoring actions discreet, make sure the company does not require a notice of assignment.
Qualities of a Factoring Company
Let’s talk for a moment about the qualities of a worthwhile partner in the factoring industry. These are all areas that bear investigating, as they’re not only crucial, but will have a dramatic effect on your experience with the company and your working relationship. They might impact you down the road, as well.
Length of History
While there’s nothing technically wrong with working with a new factoring company, there’s a lot of peace of mind to be gained by partnering with a company that has years of history under its collective belt.
A company that has been serving businesses for many years is obviously doing something right. Otherwise, it would have failed. A new factoring company is something of an unknown in this regard, as even positive customer reviews and feedback can be suspect in this day of paid-reviews.
If there is one quality that most businesses struggle to assess when it comes to choosing a factoring company, it’s reputation. It can be hard to quantify, and hard to research. Again, this is compounded by the tendency for newer companies to use paid customer reviews rather than actual customer ratings.
One place to begin your search is with your area’s consumer protection agency. These government agencies aggregate complaints about predatory or unethical activities by businesses, and can provide some information about what to expect in terms of your working relationship.
Another place to research is with the company’s previous clients. Most factoring companies worth your time will provide not only the business name of their clients, but the contact name of the person in question. Contact these individuals and ask about their experience with the factoring company. This can give you in-depth information about how the company works, its practices, and whether or not they’re worth your time.
While you’re a business owner, working with a factoring company puts you in the role of a customer. Therefore, you should expect the company to provide outstanding customer service that actually fits your specific needs and requirements.
If your requirements are significant or very specific, it might be worth finding an industry-specific factoring company. To help you determine the level and quality of the customer service provided by a factoring company, answer the following questions:
- How quickly do they respond to questions or concerns?
- How knowledgeable are their representatives?
- How quickly is the company able to process invoices?
- How clearly can representatives explain the fee structure and any additional charges so you understand completely what’s involved?
- How well do company representatives deal with your customers?
- Does the company do what they say they will?
Again, speaking to referrals can provide you with a significant amount of insight into the level of customer service you can expect.
Flexibility and Customisation
There’s no such thing as a one size fits all factoring company. Every single business seeking invoice factoring has different needs, even if they are in the same industry. Make sure that the factoring business you ultimately partner with offers the flexibility you require. This can come in many forms, including:
- The ability to take advantage of spot factoring for one-time or one-off financial needs.
- The ability to outsource all of your accounts receivable functions (in this situation, the factoring company takes over all of your invoicing processes).
- The ability to avoid factoring all invoices, or all invoices from a particular customer for the duration of your relationship.
Ready to Make a Change
If you’re ready to provide your business with the financial liquidity necessary for stability and growth, working with a factoring business can be ideal. However, finding the right partner is easier said than done. We invite you to take advantage of our free factoring consultation with an experienced factoring specialist. We can help you connect with the right company for your industry, your specific requirements, and your future.