The term "Factoring" has gotten a bad reputation in the world of small business credit over the years.
Many small business owners view it as financing of a "last resort" and worry about what their employees or customers will think about the longevity of the business once they learn their employer/supplier has entered into such a financing arrangement.
While business owners should be concerned about how their customers perceive their business, entering into a factoring arrangement is rarely the "red flag" that many fear it will be due to the fact that factoring has become a much more common means of providing a company with access to working capital. The odds are excellent many of your customers are RIGHT NOW paying many of their invoices to factoring companies in lieu of their suppliers who have taken advantage of this valuable financing tool.
Since access to credit for small business owners has contracted over the last several years, it has become more challenging for small businesses to obtain traditional credit lines. Many lenders reserve these facilities for only their "best" customers, which are often defined as those who have strong profits, increasing revenue trends and high balances on deposit.
Financing may still be available to these strong companies who also have "hard assets" to pledge as collateral. These are often defined as property, plant and equipment. In other words, if you own a business with good profits and stable revenue trends and have equity in a commercial building filled with valuable equipment, you may qualify for a small business loan. However, if a business owner operates out of rented space and provides a product or service which does not require much in the way of equipment, small business loans can be elusive.
Factoring can be a convenient alternative to businesses which cannot meet today's stringent criteria for small business loans but have a strong base of customers. Under most factoring arrangements, the factoring company ignores the financial condition of the client and strictly focuses on the credit quality of their customers.
If the customers are creditworthy, there is an strong likelihood a factor will be interested in "factoring" the accounts receivable. When factoring a receivable, a business sells the right to be paid by their customer to the factoring company in order to receive the bulk of the amount due (usually 75%) shortly after issuing the invoice, with the balance, less a factoring fee, remitted to the business once their customer makes payment to the factoring company.
Fees can range from 2% - 5% of the invoice amount for each 30 days an invoice is outstanding. In other words, if a customer typically pays their invoices in about 40 days, the business would take on average about a 3% discount on their invoices in exchange for the factoring company advancing 75% of the invoice amount shortly after it is issued.
Like any industry, there are also unscrupulous factoring companies out there. It is important to ask for references and to Google the name of the factoring company you select to see what, if any, complaints are out there. Many factoring companies are run by long-time veterans of the business and are often the best choice with which to develop a financing relationship.
While many business owners fear what they do not understanding, the truth is that factoring can provide businesses which cannot yet qualify traditional bank financing with the working capital bridge they need until they can meet the standards for traditional business credit lines.
For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.
Chris Lehnes is a 20 year veteran of the small business lending industry. He has held positions in commercial loan documentation, credit analysis, operations management and business development at one of the country's largest small business lenders. Currently, Chris is a Business Development Officer at Versant Funding where he provides non-recourse factoring to businesses in a wide variety of industries with annual revenue from $1 - $50 Million. You can reach Chris at 203-493-1663, clehnes@VersantFunding.com, or www.ChrisLehnes.com