As any entrepreneur will tell you, getting financing for a small business or one just getting off the ground is almost impossible. Banks are not interested in loaning money unless the business has a solid credit history and plenty of cash to cover loan payments. But, bank financing is not the only option an entrepreneur has. Factoring is a financing option open to businesses of all sizes and shapes, no matter how old or new they are.
Getting the Facts about Factoring
Factoring allows your company to free the cash that you have tied up in open invoices. Instead of waiting 30 to 90 days for your customers to pay, you can get up to 90 percent of the value of those invoices from a factor instead. Then, when the customer pays, you get the remainder of the invoice value, minus the 3 to 8 percent factoring fee for using the service.
Unlike bank financing, factors don't really consider the creditworthiness of your business. Instead they look for two things.
- First, you cannot have any liens against your business' assets, particularly your open invoices. If you have any tax or bank liens, you are likely not going to be able to use factoring.
- Second, the factor looks at the creditworthiness of your customers. The factor wants to know that the customers who owe you money are known for paying their invoices on time. If your clients are slow to pay, or have a poor credit rating, the factoring company may choose not to do business with you.
This financing option works well for small companies as well as those who are just getting started. The application process is normally finished within three to five days. Once approved, the factor will start advancing funds within two to three days of your submission of invoices.
What Makes Factoring Such A Good Option for Entrepreneurs?
Even though the Great Recession is a thing of the past, banks are still hesitant to make loans to small businesses and especially those just getting started. This is what makes factoring such a great option for entrepreneurs. As long as your business has creditworthy customers and you have no liens, the chances of getting financing are pretty good.
Then, you can do whatever you want with the money that you free up. Here are just a few things entrepreneurs do with the money they get from factoring:
- Meet operating costs without struggle.
- Pay bills on time to build a better business credit rating
- Buy extra inventory to meet growing customer demand
- Purchase new equipment to expand operations
- Get caught up on bills to relieve financial pressure on the business
- Use the cash to start up a new line of business or a completely new company
Find the Right Factor for Your Business
Before you sign up with the first factoring company that you encounter, it pays to consider different factors and find the right one for your business. Many factoring companies specialize in specific industries. It is usually better to go with a factor that is familiar with your industry and the standard credit terms extended in it.
Another thing to consider is the fees that the factor charges. The most obvious charge is the factor fee. But, some factors have other charges that are not so obvious. Read the fine print and look for things like deposit fees, bank transfer fees, application fees, and credit profiling charges. These "hidden fees" can add up quickly.
Ask the factor how they handle unpaid invoices. There are two ways this is handled. In non-recourse factoring, the factor will absorb the loss. With recourse factoring, you will need to repay the advanced funds for the invoice as well as the factoring charges. The fees are usually higher for non-recourse factoring because the factor is assuming higher risk.
Factoring is a great option for entrepreneurs and small business owners. But, it needs to be done in a smart way to minimize charges and maximize benefit.