How Factoring Can Help Fill The Credit Void

The overall misconception about factoring is only companies in dire consequences would consider using one. In reality this could not be further from the truth. Today’s factoring companies are sophisticated enough to know your financial situation. If it appears that a potential client is heading into bankruptcy or liquidation, or has a significant tax lien against it, the factor (a lender) will not finance that client. Rarely will a successful factoring company fund a badly mismanaged business.

These are some examples of why businesses use factors:

1. A bank will not give a credit line large enough to be effective – so they would use a factor to build the company short-term to be able to go back to the bank for the line they ultimately need.
2. A new or established company is growing faster than the money coming into the business will allow – use of a factor will pay suppliers or payroll to keep up with growth.
3. Companies that get large orders on an irregular basis that soak up capital – the factor will enable these orders to go through without the major disruption of normal operations.
4. A company is shopping for a long-term relationship with a bank or equity investor and needs short-term bridge financing to keep the performance running smoothly while not having any effect on the equity or liability on the balance sheet.

Generally speaking the pecking order for commercial financing is; a) friends, family, savings, b) an “angel” investor who believes in you, c) small credit line from bank or factoring d) venture capital or factoring; e)large credit line from bank or Asset Based Lending, f) merge, sale, or IPO.

Treat a factor like a lender. Like any lender the costs are directly related to the risk involved. They will fund a client and have to assume the credit risk of repayment. The difference between Full Recourse and Non Recourse accounts receivables financing: Full Recourse is essentially a loan against an invoice. The client retains full responsibility that the invoice will be paid, if not they have to pay the lender themselves, usually automatically after 90 days. Non Recourse is a purchase of the invoice where the lender is assuming full responsibility for the credit.

Meaning, as long as there are no performance issues related to the work that is being billed, the lender will risk losing their investment if the customer fails financially.

Join the Bizmore discussion: "What are the negatives of a line-of-credit' for my small business?"