Choosing an invoice factoring company can be a confusing process. This guide will help cut through the noise.
Waiting for your customers to pay is frustrating for any B2B company. Businesses ranging in size from one person shops to large corporations run into cash flow issues when payment terms are stretched. Some customers demand longer to pay simply because they can. For others, long payment terms are industry standard. Many businesses use invoice factoring to keep cash flow steady without selling equity or taking on debt. We’ll explain in this article the factoring process, its benefits, and if your business qualifies. Though this is a good overview, if you’d like to speak to a factoring expert, give us a call at (310) 817-0376 or fill out our contact form.
So what is Invoice Factoring?
Invoice factoring is an established form of financing that converts your unpaid invoices to cash. It solves the cash flow dilemma caused by net 30 / 60 / 90 payment terms that can drag a company down. The invoice financing process involves the sale of accounts receivable to a factoring company. Receivables (invoices) that are outstanding for up to four months can be sold for up to 98% of their face value.
Without cash at the right times, a business will miss opportunities to expand or fall behind on important expenses, like payroll or rent. Invoice factoring can eliminate many of these frustrations and allows management to refocus on growth.
There are usually three parties involved in a factoring transaction: (i) the business that issued the invoice, (ii) their customer who owes payment on the invoice (also called the account debtor), and (iii) the financing company who buys the invoice and provides cash (typically known as the factor).
Invoice Factoring, Invoice Financing, Receivables Financing… What Do I Call It?
Invoice factoring is used interchangeably with terms such as accounts receivable financing, AR factoring, AR financing, invoice financing, receivables financing or receivables factoring. Confusing… I know! Just remember that all these terms are referring to the same type of funding, which involves the purchasing of money owed to your business (outstanding invoices) that is expected to be paid at a later date.
How Does Invoice Factoring Work?
After a company delivers a product or service to their customer, they send them an invoice. The company can “sell” the invoice to a factoring company, and in return receives an advance amount, usually between 70 to 90% of the invoice value. With cash in hand, the company can take on new work, cover payroll, or buy supplies and inventory (even taking advantage of early pay discounts from their suppliers). After their customer pays the outstanding invoice, the business receives the remainder of the funds, minus a small factoring fee that is based on the term and value of the invoice.
In the end all three parties benefit: the company gets cash immediately, their customer receives favorable payment terms, and the factor earns a fee.
Invoice Financing Compared to Traditional Bank Financing
In contrast to bank financing, invoice factoring is not debt. A business sells its accounts receivable, receives cash and that’s it… There are no limitation to what the business can do with the funds. No debt equals no restrictions.
Another benefit of factoring is that the factoring company considers the credit quality of the applying business’s customers. This is great for early stage or not quite profitable businesses selling to established companies or the government. The effective rate businesses pay through factoring is much better than other financing alternatives that don’t rely on their customers’ creditworthiness.
Factoring also comes with a simpler application process, quicker time to funding, and much higher approval rate compared to bank financing. And in terms of size, Harper Partners can fund up to $5 million credit lines, which is comparable to what most banks are willing to provide small businesses. Seamless access to funding allows a business to meet payroll, grow unimpeded, earn supplier discounts for early payment or bulk buys, or invest in new equipment to improve productivity.
The simple application process eliminates the major hurdles that banks place on small businesses when applying for a loan. The quick speed to funding allows a company to take advantage of immediate business opportunities such as large orders or timely expansion. Furthermore, the high approval rate allows many to qualify for factoring even if they’ve been declined for a bank loan. Ultimately the factoring company is underwriting your customers as much as they’re underwriting your business. Additionally, funds from factoring invoices can augment your available bank credit if needed.
Finally, Harper Partners can help you collect on your receivables, but only if you want us to. We have account managers who politely follow up on outstanding invoices, at your direction. If you prefer we don’t talk to your customers at all, that’s not a problem. They won’t ever hear from us. Payment for invoices are directed to an account we set up under your company’s name.
How Much Cash do I get Right Away?
An advance rate is the percent of the invoice’s face value that you’ll get right away. Industry advance rates range from 70 to 90% of the face value of the invoice. So, for example, if your customer owes you $10,000, expect to receive an advance payment of $7,000 to $9,000, depending on the advance rate.
The remaining $1,000 to $3,000 is sent to you once the customer pays the invoice, net of the factoring company’s fee.
How Much are Factoring Fees?
Factoring fees range from 1-5% per month on the face value of the invoice. Harper Partners’ fees typically range between 1-3% per month.
When considering factoring fees, transparency is very important – factoring companies that don’t make it simple to calculate their all-inclusive fees are probably doing this for their own advantage. In these situations, proceed cautiously or move on to another factor that will be transparent with you. In addition, some receivables factoring companies will advertise very low factoring rates (1% or less), which they will then mark up with a bevy of hidden fees. Beware, one common trick is to charge a low monthly factoring rate, but then charge you for two months even if the invoice was paid in a month and one day. At Harper Partners we charge on a daily basis, so however long (to the day) the invoice is outstanding is the time we will use to calculate the fee. For instance, we won’t tack on an extra month of fees because the invoice was out for 31 instead of 30 days.
All factoring companies also have a one time diligence fee which can range from $400-$600 for new clients. These fees are to run all their credit and background checks, tax diligence, analyze your business and customers. Look out for exorbitant diligence fees well above that range. At Harper Partners, we charge only as much as it costs us to run our diligence, not a penny more. And our diligence fees will always fall within that range, oftentimes even less. We can also have the diligence fee taken out of your first advance, so you’re not paying it upfront. Unfortunately, most factoring companies will not do this.
Can Invoice Factoring Improve My Business?
It’s common for businesses to choose invoice factoring over a bank loan or merchant cash advances. It’s often the lowest-risk option for the business because the sale has been made, the work completed, and the invoice confirmed. The only thing left is for the customer to pay. As long as you’re comfortable that your customer will pay at some point, there’s no need to worry about paying off the factoring advance.
Contrast that with a bank loan, where monthly interest payments can be a heavy burden on a business. In addition, bank loans either amortize (pay back the principal in installments) over the loan term or is all due at the end. The stress of too much debt is severe for business owners, who in dire situations sometimes must decide between making payroll or interest payments.
With factoring cash in hand and no worries about paying off the advance, you’re much better equipped to take your business to the next level. Check out these factoring case studies to see real life situations where factoring was used.
How do I Know I Qualify?
Fortunately, it’s relatively easy to qualify for invoice factoring. While credit scores, annual revenue, and profitability can be an obstacle for banks and other lenders, it’s usually not the case with factoring companies. Factoring companies typically consider 3 things:
Must work with business or government customers.
Invoices must be due and payable within 90 days and unpledged to other loans. For example, you cannot have another loan where the same invoice is claimed as collateral. You can however, have another loan as long as it’s subordinated to the factor’s claim to your accounts receivable.
Your business should not have a history of serious tax or legal issues. Some factoring companies have a minimum credit score or time in business, but Harper Partners does not.
Choosing the Best Factoring Companies
You’ve decided your business can benefit from invoice factoring. Okay, so now what? There are so many factoring companies out there, how do you decide who to work with?
Choosing a factoring company should be done carefully. You want a factor that can provide more than just funding. There are companies out there that claim they are the fastest, easiest to use, and most technologically advanced. However, be careful – in the rush to get cash, look out for high fees and a lack of personal touch. These factoring companies charge higher fees to cover losses they experience exposing themselves to poorer quality clients because they underwrite so quickly. There’s also a lack of personal touch that we believe should come standard with any financing relationship. Without it, you can be left wondering why certain invoices were rejected for funding or your credit facility was suddenly reduced. Often it’s better to be able to speak to a knowledgeable relationship manager than to have a flashy dashboard.
Why Harper Partners?
We named ourselves Harper Partners (not Harper Capital, Funding, Financial, etc) because we see ourselves as just that, a partner to your business. We’ve helped our clients with many business-building items outside of providing capital.
We asked ourselves: “If there are angel investors, why can’t there be angel lenders?”
Below are just some of the pro bono, value-add services we’ve provided to our clients:
- Prepared model templates and general fundraising materials to help our client raise equity
- Introduced clients to leads in our network that led to immediate revenue opportunities
- Walked client’s CFO through our custom cash flow model template that helped him project business cash flow
- Introduced client CEO to equity investors (venture, growth and private equity) in our network
- Referred clients to banks offering the best terms when they became eligible for bank financing
- Wrote and shared our collections best practices to shorten client payment terms. Shortened our clients’ average payment wait time by over two weeks
In addition to partnership benefits, we’re efficient and fast. We can approve credit facilities up to $5 million within 5 business days. For a line amount below $500,000, we approve even faster. You will have your money within 24 hours once the facility is set up, with same day wiring available upon request. We offer a seamless user experience. Uploading invoices for funding, monitoring your funds outstanding, and getting notifications are all a breeze.
Your Harper Partners credit facility will grow as your business grows. In addition to increases in size, the factoring fee rate quoted at the start of our relationship will decrease over time as you do more volume, your business grows, and you develop a track record with us. We’re backed by an FDIC insured bank. Once you’ve reached a point where factoring may not be the right fit anymore, it’s a seamless transition to ABLs and other types of bank financing. All your documents are already on hand so the transition is seamless.
Another benefit of factoring with Harper Partners is flexibility. You can pick the invoices you want to advance money on. Only request advances when you need it. For instance, if you need cash to cover next week’s payroll, you can pick a smaller invoice to factor. If you need a larger amount to take on a big order, factor a larger invoice or several invoices. The control is in your hands. Advance requests become cash in your bank account within 24 hours (same day wires also available).
Learn More About Harper Partners
Want to learn more about invoice financing and Harper Partners? If you’re interested in quick, transparent funding along with a dedicated partner for growth, give us a try. Call us at (310) 817-0376 or submit your contact info on our Get Started page. We look forward to learning about your business and going to work for you!
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Very helpful article. This will definitely help a lot of beginners in factoring. This will definitely help me find the best factoring provider for my business. Thanks for sharing this article. This tips are truly all very helpful.