It can be difficult finding the right factoring company, yet it is one of the most important decisions you can take for your business. You will be working with the factoring partner aka funding or lending partner for a long time and your financial success directly depends on this relationship. This post explains everything you need to know about selecting the best factoring company.
Understanding Factor Invoicing
You may want to skip this section if you understand what a factoring company is and how they can be beneficial to your business. Factoring refers to a process by which a lender or a funding partner essentially finances your current and not yet due invoices from both government and commercial clients. Typically, your client may take anywhere from 30 to 60 days to clear their dues.
Most small and medium sized businesses cannot afford to have their capital tied up for this long. This is where a factoring company comes in. They purchase your invoices at a discount and pay you an upfront amount. This advance amount is usually 80 – 90% of the invoices. You benefit from the immediate funds that can be ploughed back into the business to pay off suppliers or purchase new materials.
The remaining payment is made once the factor receives the full payment from your client. The variable terms of a factoring agreement is why it is necessary to work with a factoring partner that understands your business and needs.
Types Of Factoring
There are two basic types of invoice factoring – recourse and non-recourse. In simple words, recourse factoring makes you liable for the client payment even after you have sold the invoices. In simple words, it is selling your invoices with “recourse”. The factoring company can hold you liable for any overdue or default invoices.
You don’t need to worry about this with non-recourse factoring. However, because of the added risk, factoring companies usually charge a higher fee. They may also not offer more than 70% of the invoice amount as upfront payment. You shouldn’t blindly choose non-recourse factoring for your business needs.
Most funding companies are experienced and pretty good at making sure that they only purchase high-quality and creditworthy invoices. Chances of a client declaring bankruptcy or defaulting on the invoice are slim. Hence, you should never take a stubborn approach when it comes to choosing a factoring company and take into account certain important considerations.
Finding The Best Factoring Company
You need to take the following steps to find a factoring company that is perfect for your business:
1. Shortlist Candidates
You should never choose the first factoring company that comes your way or makes an offer that you think is good. Always get quotes from at least four to five companies. You need to shortlist candidates based on your unique and individual business requirements. Recommendations are a great way to shortlist factoring partners. However, what works for your friends or family may not necessarily work for you.
Make sure you keep an open mind and have a pre-screening process in place. The candidates that clear the pre-screening process should be interviewed thoroughly. Never negotiate with more than four companies at a time. This can be overwhelming and confusing. Factoring is all about the numbers. You need to stay as sharp as possible.
2. Complete Applications
Almost all factoring companies have the same process. You will be required to provide basic information about your business and yourself. You will also need to provide the latest invoice aging report. This will allow the factoring company to get a broad view of the kind of invoices you usually have with pertinent information regarding, major clients, credit period, on time payments and defaults among other things.
Depending upon the scale of your business, you may be required to provide other reports, such as the Balance Sheet and a Profit and Loss Statement. Experienced factoring companies generally don’t take more than a day to provide a proposal. Any company that unnecessarily delays in submitting a proposal should be removed from your list of shortlisted candidates. This clearly shows that your business is not important to them.
3. Compare Terms
Factoring applications are usually similar, but factoring proposals can be unique. Almost all proposals have similar terms – advance percentage, rate structures, recourse or non-recourse, and fee terms. However, the proposal amounts and terms of factoring arrangement can vary vastly. You need to calculate the different proposal figures to find the best option.
You need to find the most lucrative option in terms of advance rate, fee, terms and cost per factored dollar. For instance, company A may offer 70% advance at a 3% 60-day rate while company B may offer 80% advance at a 3.43% 60-day rate. Which one is better for you? Which one costs more in terms of per dollar of financing received?
4. Finalize
The factor will issue legal documents once you make your decision. You would need to sign and notarize them. The process doesn’t take more than a few days. However, it may take longer if you have an especially complex transaction.
Factors To Consider
While the process to choose a factoring company may seem straightforward, there are a few factors you should consider before making your final decision. These are 9 things that you need to consider if you want to select the best factoring company for your business:
1. Type Of Factoring Offered
A factoring company may offer recourse factoring, non-recourse factoring, or both. You need to ask whether they are offering something you are interested in. Terms of an agreement can vary based on the factoring type you choose.
2. Industry Experience
Does the factoring company have experience working with other businesses of your scale in your industry? Most companies are specialized to work in few industries while others claim they can work with all industry verticals. It may be better to work with a funding partner that understands your business and industry.
There are two ways to determine if a factoring company understands your industry – ask for client references or ask industry specific questions to the sales representative.
3. Advance Rates
If you are considering factoring to raise some immediate capital without adding on to your debt, you should consider advance rates as a priority. Depending on the company and type of factoring, you can get anywhere from 70% to 95% of the total invoices. However, the most popular advance rate is between 80 – 85%. Construction industry has a lower rate because of the high level of risk.
4. Competitive Pricing
While advance rates are important, they should not be considered alone. You also need to compare the cost per dollar of factoring financing received. Few lenders may offer a higher advance rate but charge more for their risk while others may have stricter payment policies. Factoring companies draft a proposal based on the total factor plan, average invoice size, and credit quality of clients.
Factoring rates tend to range from 1% to 3.5% per 30 days. You can get better rates for terms less than 30 days. You need to find a company that is transparent about its pricing. There are several funding companies that resort to charging more through hidden costs.
5. Factoring Minimums
Factoring minimums refers to the amount a business has to get factored every month, quarter or period. You may need to pay the difference if your factoring agreement has a minimums clause and you factor a lower amount that period. Minimums are liked by businesses since they are a great negotiating tool for lower rates.
6. Account Set Up
If you want money fast, you don’t want to wait weeks for the account to set up. Larger factoring accounts may take 7 – 10 days, but regular accounts should not take more than 3 – 5 days.
7. Customer Service
While this may not seem an important consideration when compared with costs and advance rates, good service is very important when you opt for recourse factoring. You don’t want the factoring company to pressure you for default payments. Ask for client references and speak with these clients directly.
8. Longevity
One of the most fundamental questions to ask a factoring company is the time they have spent being in business. It is not a wise decision to partner with a new factoring company. Besides a few exceptions, the best factoring firms have been around for decades. This long term experience is important to manage accounts during difficult economic and financial situations, such as recession. Also, it can be difficult to be good at something if you are fairly new at it.
9. Funding
You need to determine the ways in which your funding partner gets funded. The manner in which they are funded can be vital to the health of your firm. Poorly funded factors may cut your credit line unexpectedly when you most need it or stop funding your invoices completely. This happened with several factoring companies during the last recession.
You should open the door for a factoring company that has the capability to finance a major portion of invoices through self-funding. This can be through private funds or line of credit from banks.
