How to Select the Best Invoice Factoring Finance Company for your Business
What is factoring?
Factoring is an innovative method of business financing that
allows clients to get an accelerated payment on their slow
paying invoices. Traditionally, when a company offers its
services to another business, they need to wait between thirty
to sixty days to get paid. Although companies that have a large
cash cushion in the bank can absorb the cost of waiting to be
paid, small and medium sized businesses cannot. This can
jeopardize a company’s ability to meet existing payment
obligations, or worse, prevent it from capitalizing on new
opportunities.
This is where factoring can be a very helpful tool. A factor can
provide a company with an advance payment on its accounts
receivable. The factor then waits to be paid by the clients’
customers, while the client gets use of the funds immediately.
The transaction is structured as the sale of a financial right,
rather than as a loan. Because of this, the factor focuses more
on the strength of the customer paying the receivable rather
than on the financial strength of the client. This makes
factoring the ideal financial tool for new, small and emerging
businesses.
Keys features when looking for a factor
Selecting the right factor for your company can be a very
complex task. Given the importance of the factoring relationship
to your company’s ability to succeed and grow, it is critical
that you do the proper due diligence when selecting a factoring
partner. Here is a list of some of the criteria that are
important when selecting a factoring financing company:
· Factors’ Comfort Zone: Almost every factor will
advertise that they can work with an account that requires as
little as ,000 per month and as high as a few million dollars
per month. Although that may be true in principle, the reality
is that managing a small volume account is very different from
managing a multi-million dollar account. Most factors tend to
develop a comfort zone or “preferred specialty” when it comes to
client size. When selecting a factor, always ask about the size
of their typical client. Ideally, the size of your business
should not be significantly below or above that figure.
·Monthly Minimums: Most factors will only take clients
that commit to transact a minimum financing volume every month.
The advantage of committing to monthly minimums is that the
factor will offer your company better terms. The main
disadvantage is that if your factored volume drops, your company
could be liable for making up the difference in fees. When
selecting a factor, be sure to select one whose minimums are
well below your expected minimums, or better yet, try and find a
factor with no minimums.
·Recourse vs. Non Recourse: Recourse is a term that
defines the ability of a factor to re-sell the invoices back to
a client if an invoice does not get paid within a given period
of time. Most factors prefer to operate in recourse mode.
However, there are a number of factors who offer non-recourse
agreements. Under a non-recourse agreement, the factor will
absorb the losses on an invoice if the account debtor becomes
financially insolvent. In effect, non-recourse factors offer
some protection against bad debt. Although you are generally
better with a non-recourse factor, most recourse agreements work
well enough.
·Contract Duration: Typically, factoring contracts
require a minimum term of one year or more. Whereas longer-term
contracts enable a factor to offer you better pricing, they can
also lock your company into a factoring arrangement that
outlives its usefulness. Your best bet is to try and find a
factor that will allow you to easily terminate a contract
(giving reasonable notice) once the service has outlived its
usefulness.
·Fee Structure: Factoring fees vary significantly across
the industry and are usually dependent on a) the financial
strength of your customers b) your monthly volumes c) the
duration of your contract and d) the payment cycle of your
receivables. The fee (also known as “discount”) can be as high
as 7% per month for small ticket deals (less than K per
month) to as low as a couple of points for companies that wish
to factor several hundred thousand of dollars.
·Level of Service: A very important criterion when
selecting a factoring company is choosing a company that will
give you the appropriate level of service. The industry is very
diverse, and there are many factors that charge very low fees
and provide a very impersonal “mass approach” to service.
Conversely, there are factors that provide a “high touch” level
of service, for slightly higher rates. Most companies tend to
choose the factor with the lowest rates (and usually lowest
level of service) thinking that they will save money. In the
long run, they end up regretting the decision. You are usually
better off looking for a factor that offers a better service,
even if it comes at a slight premium.
Should you work with a factoring broker?
One way to simplify the process of selecting a factor is to work
with a factoring broker. A good broker will help you determine
if factoring is the best solution for your company and will help
you find the factor that is best suited to serve you. The broker
will also help you position your company to a factor in the best
possible way, maximizing the chances of getting the funding your
company needs with the best possible terms. One of the most
significant advantages of working with a factoring broker is
that they will help you save time. As seen in the previous
section, the process of evaluating a factoring company can be
both tedious and time consuming. A broker can help you sidestep
the issue since they will do all the work of finding the best
factor for you. Lastly, most factoring brokers are compensated
through a finders fee by the factoring company, so you will not
have to pay them any fees for their service.
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