If you’re interested in factoring but aren’t sure how it works, then you’re in the right place. It’s critical you understand the entire process to help alleviate any concerns that are natural when it comes to borrowing money from non-traditional sources.
You’re right to be doing your research.
Let’s walk through the process of how factoring works for a small business in need of additional financing. Below are the steps from start to finish for this small business.
1. As a small business, you invoice your customers
Once you have provided products or services to your B2B or B2G (Business to Government) customer, you issue an invoice for them to pay you. Often, to qualify for factoring, these invoices must be payable within 60 days.
2. You Sell & Assign the Invoice to a Factor
After doing your research, you find a Factor you want to work with and go through the process. Below is an example of a typical factoring process and what you can expect:
- Have a general conversation to determine whether the factoring company is a good fit for your business (and you for theirs).
- If it is a good fit, you would complete an application and provide all of the requested information. Generally, the requested information includes – AR Aging, AP Aging, Customer List, Sample Invoice, Purchase Order (“P.O.”), and Proof of delivery (“POD”).
- Factor will do their due diligence and research your company, this can include business & personal credit checks, credit check debtors, evaluating invoices and corresponding backup documentation (P.O. & POD’s).
- If all of this information checks out, then Factor will connect with you to better understand your business and billing cycle.
- Factor will then evaluate the level of risk with you, and issue a Term Sheet if the Factor is interested in moving forward.
The Term Sheet defines the details of your financing.
3. The Factor Pays You an Advance
The Factor gives you an initial advance called an advance rate. The advance rate is generally around 80% of the value of the factored invoice. The amount of your advance depends on the size of your transaction, your industry, and other risk parameters.
At this point, the Factor may also send out a “notice of assignment” to the clients you have chosen to factor, or they may ask you to do so. The notice of assignment states that your company has assigned the Factor as the entity to receive future payments for invoices you issue them. All payments will go to a lockbox account (like a designated account for the factored invoices to be paid) which is set up by the Factor.
Some industries are more accustomed to invoice factoring than others. Trucking and shipping companies commonly use freight factoring and staffing companies and recruiting agencies use staffing factoring. In industries where factoring is common, telling a client you’ve assigned their invoice might not be a problem.
If factoring isn’t common in your industry, you will want to make sure you clearly communicate it with your clients. This is often the biggest hurdle for our clients to get past. Factoring doesn’t indicate a weakness of the company. The majority of the time, factoring can be a positive sign of business growth.
4. Your Client Pays the Factor
Your client will pay the Factor according to the terms of the invoice. This means you no longer have the responsibility of collecting on these invoices and following up with clients. You can take the financing and get to work on your business!
5. The Factor Forwards You the Remaining Balance (Minus Fees)
After receiving payment from your client, the Factor will give you the remaining balance of the invoice, called the reserve amount, minus their fees.
Invoice Factoring Costs & Qualifications
Invoice factoring is a good working capital solution for businesses of many different ages and sizes, as long as you have qualifying invoices. Many factoring companies will even work with you if you’re a startup. The typical fees and overall costs can be tricky to understand, and it’s incredibly important that you do.
Now that you know what to expect, you can see that it is a very straightforward process.
If you want to learn more, reach out to the Primary Funding Team. We can answer your factoring questions and get you started through the process!