Why small businesses may use an invoice factoring company
Invoice factoring is a fairly common practice, especially for small and medium businesses (SMBs). It’s the process of selling an invoice with credit terms to a financing company called a factor. The factor buys the invoice for less than its total value, and charges fees based on the amount of the invoice. Then, the factoring company takes over the job of collecting the full amount of the invoice from the company who owes the funds. A business may use invoice factoring services once in a while to get near-instant capital when they need it. Or they may sell almost all of their invoices.
When accounting software company Sage conducted a survey of businesses, they learned that over 30% of businesses they contacted were either already experiencing challenges because of late invoice payments, or they were anticipating financial challenges in the near future.
These businesses spent substantial time chasing late payments. Whether those payments eventually arrive or not (with 10% getting written off as bad debt with no repayment), the impact on day-to-day operations was noticeable.
For some businesses, using an invoice factoring company means getting paid without the long wait and resources spent trying to collect late customer payments. Some companies resist chasing late payments because they worry about the impact it may have on relationships with their customers. Others—especially small business owners—lack a system or the resources to invest in pursuing late payments.
The basics of invoice factoring
First off, invoice factoring is for invoices that have credit terms. This may be any time frame from 14 days to 120 days. Companies who are invoiced are expected to pay the invoice in full within this time frame. (Of course, if companies did always pay in full, there would be almost no demand for invoice factoring.)
It’s ideal to look into different factoring companies and options before you have any outstanding invoices. Some only work with certain industries like trucking companies or food services. All have slightly different approval processes, terms and conditions, payment terms, and pricing.
Speaking of fees, they’re one of the most important things to know about a factoring company before you decide to work with them. Some may appear to offer low factoring fees, but there may be other fees built into the agreement that are only in the fine print. Look for a company that’s transparent about its fees. There may be minimum invoice amounts or minimum numbers of invoices required by a factoring company, so it’s worth the time to read the details of the agreement, especially when you're a small business owner. Another good source of information about a factoring company is customer reviews. Good companies have good reviews.
The next thing to consider is recourse vs non-recourse factoring. This topic is worth its own section, but in a nutshell, recourse means you’re still on the hook for the invoice amount if the customer fails to pay the invoice.
And finally, look for how the factoring company pursues late invoices. Some are extremely aggressive, and their tactics may impact your relationships with customers whose invoices you’ve factored.
The best invoice factoring companies
altLINE – With a solid reputation for low fees, altLINE also provides very good transparency. They’re a division of the Southern Bank Company, so funding comes directly from this source. They don’t charge application fees, and also offer accounts receivable financing.
BlueVine - Quick approval with low rates. One of the best-known invoice factoring companies, BlueVine charges a low weekly fee for the time an invoice is outstanding. They also offer approval in 24 hours, so cash can arrive quickly.
BlueVine requires businesses to have a minimum 3-month history, at least $10,000 monthly revenue, and a FICO score of 530 or higher so it's not the best option for most startups.
Breakout Capital – Flexibility is a key selling point for Breakout Capital, including a flexible payback schedule and options for businesses that have been declined by other companies or don’t have enough time in business to apply for other options.
Although there are no minimum requirements for monthly income or FICO score, they do charge higher fees than other companies.
eCapital Commercial Finance – This company offers non-recourse factoring, so it’s an option if you’re worried about liability for unpaid invoices. There are no requirements for FICO scores, however, their minimum monthly revenue requirement is $30,000.
Resolve – Resolve is a complete B2B net terms and credit management solution that pays invoices directly to your bank account in one day. They approve net terms and credit limits within hours, and offer discreet credit checks and an easy online platform for customers to make payments.
Riviera Finance – Offers guaranteed credit and non-recourse factoring. Riviera is also known for quick payments of up to 95% of qualifying invoices. Their online receivable management system offers real-time alerts, and you can quickly check the status of your account and invoices.
TCI Business Capital – Primarily for month-to-month contracts, and when you factor more invoices with them, you get a discount rate. They have real representatives you can call to discuss your situation as well as an online tool to calculate factoring costs. You can also factor invoices with invoices that have net terms of up to 120 days.
Triumph Business Capital – Primarily for trucking, freight companies, and freight brokers. They also offer other financial services and provide account access via a web portal.
The company in this list that’s different than the others is Resolve. While it offers a solution for quick payment of invoices, it also removes the risk of net terms invoices (similar to non-recourse factoring), while offering lower rates, QuickBooks Online integration, and a branded payment platform. This means that your customers will always feel like they’re working directly with you to make payments, rather than going through a third-party collections or factoring agency.
Recourse factoring vs non-recourse factoring
The most common type of factoring (sometimes called receivable factoring) is recourse factoring. When you select this option, your company must buy back any invoices you’ve factored if the customer fails to pay the invoice. Generally, factoring companies exhaust their options for collecting an invoice before you’re required to buy it back. But it does mean that the funds you initially receive are not guaranteed until the invoice is paid in full.
Although businesses would prefer to not run this risk, recourse factoring is often substantially less costly than non-recourse factoring, and this is why it’s frequently used. But just because a company says they offer non-recourse factoring doesn’t mean you’re in the clear. There may be stipulations in the terms and conditions that exclude the invoice from non-recourse.
In order to qualify for the non-recourse option, even when you’re willing to pay higher additional fees, the customer with the invoice must have a good credit score and payment history. In any non-recourse agreement with a factoring company, it should be clear when the company will begin to pursue further action to collect an invoice, and at what point in the invoice lifecycle they’ll require you to buy back the invoice.
FAQs about invoice factoring
Q: Is invoice financing the same as invoice factoring?
A: Although the terms seem to be used interchangeably (and both help with working capital), invoice financing is different than invoice factoring. When you finance an invoice, you borrow money from a lender against outstanding accounts receivables. Bank loan amounts tend to be similar to invoice factoring (up to 80% or 90% of an invoice).
With invoice financing, you’re still completely responsible for collecting the amount of the invoice. With invoice factoring, the factoring company takes over responsibility for collections. Factoring also tends to charge higher interest (by a few percentage points) than financing.
Q: Can I decide which invoices to factor?
A: Yes, as the business owner, you’re in control of which invoices you factor. But there is a caveat. If you’re working with a factoring company that has a minimum value of invoices factored, you’ll need to meet their requirements. And every application for factoring will consider the creditworthiness of your customer.
If you have customers that you know will pay their invoices on time, it’s a good idea to not factor these unless you’re in need of a prompt cash flow solution.
Q: What’s the most common feature businesses look for in a factoring company?
A: Speed of funding is the top feature companies look for. There are two aspects to this. First, there’s the length of time it takes to approve each customer for factoring. This can take anywhere from minutes to weeks, depending on the application process. Then there’s the time until the actual payment. Again, this can happen quite quickly after approval, but companies such as altLINE take up to four days to issue payment.
Q: What fees or factoring rates do companies charge?
A: As we’ve mentioned already, there can be quite a bit of variability between the fees factoring companies charge. There’s also variability in transparency, so researching different companies is important so you can identify any hidden fees.
Types of fees charged may include application fees, services fees, charges for renewals and transfers, early termination fees, default fees, and origination fees. Origination fees (also known as a draw fee) are a flat rate based on the total invoice amount. This can really add up for invoices, so make sure you look for it.
Factoring fees can be as low as 0.25% and increase from there. Most companies charge higher fees the longer an invoice is unpaid.
Q: What’s a customer limit?
A: Some factoring companies have something called a customer limit. This is the overall maximum dollar amount of invoice values they’ll allow you to factor with them. There may also be a limit in the number of client accounts you can have with a factoring company at one time.
Q: What’s the difference between flat-fee and variable-fee structures?
A: When a factoring company charges a variable fee, they will continue to charge fees on an invoice until it is paid in full. Flat-fee structures will have a set fee for the first 30 days, and then set fees after that for each block of 30 days that the invoice is outstanding.
Q: What’s a Notice of Assignment (NOA)?
A: With formal factoring companies, they are obligated to notify any company whose invoice you factor that they are now collecting all payments on the invoice. This is done by issuing a Notice of Assignment (NOA) to the company. NOAs also provide ways the company can make payments on the invoice.
There are two ways of looking at NOAs. Companies familiar with them tend to have no problem directing their payments to the specified channels (although some will connect with the business that they originally purchased from to make sure the NOA is valid). However, other companies feel that this reflects badly on their business, as it suggests they’re having financial or cash flow problems.
(Note: Resolve is one company that offers a branded payment platform, allowing customers to make payments on invoices using a site that’s branded with the selling business. Because of their business model, they are not required to send NOAs.)
Q: Is it worth it to factor my invoices?
A: If your business needs cash quickly, invoice factoring may be a good financing option. Although you do pay a percentage of each invoice in fees, the quick payments allow important activities like maintaining staffing, keeping your own accounts payable up to date, and completing urgent upgrades or repairs.
However, if your business balance sheet is in a good position, and you don’t need cash upfront, you may be better off with a longer term (and lower cost) business financing solution like a business loan or line of credit.