SMALL BUSINESS FUNDING OPTIONS: FACTORING

Welfont Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.

Too often, small business owners rely on high-interest credit cards to fund their businesses, thereby saddling themselves with unnecessary debt. While this may be the only available financing route for some, it’s important to fully investigate all viable options before making that decision. I’ve previously published a startup funding primer and, in this article, I’ll present another (frequently overlooked) funding method: factoring.

Factoring requires that you establish a business relationship with a financing company (factor) offering this funding option to your particular industry. Factoring is not a loan and does notrequire a bank’s involvement. Rather, you’ll be working directly with a financing company or funding group.

Factoring is known by many names, including: invoice factoring, single invoice factoring, debt factoring, invoice discounting, and accounts receivable financing. Regardless of how it’s branded, the details of a factoring relationship are fairly constant.

WHAT IS FACTORING?

Entering into a factoring agreement with a financing company generally requires less paperwork than would applying for a bank loan and can result in receiving the desired capital more quickly. At its most basic, ‘invoice factoring’ refers to the discounted sale of an unpaid invoice to a financing company. The financing company initially gives you a percentage of the total invoice. Once the invoice is paid in full (to the financing company), they take their fees and credit you the outstanding balance. The percentages involved vary by company and by the creditworthiness of the payee.

Before approving any given invoice, the financing company will check the payee’s credit for an indication of their likelihood to pay. If the payee in question has very good credit, you may be able to negotiate the receipt of a larger upfront percentage. A payee with poor credit may lead to the application being rejected entirely.

COMMON FACTORING TERMINOLOGY

Some of the terminology used to discuss factoring can be confusing. Here’s a brief list of some common terms and definitions:

Account debtor: The client owing money on your invoice (the payee).

Accounts receivable: The outstanding invoices for completed work that your clients have yet to pay (what your clients owe you).

Advance: The money paid to you by a financing company after it purchases your invoice(s).

Advance rate: The percentage of an invoice you’ll receive from the financing company in advance of payment by your client.

Collections: The payment(s) received by the financing company on your invoice(s).

Concentration: In order to mitigate risk, a factor may allow only a certain percentage (or dollar value) of outstanding invoices to originate with a particular client. Concentration is obviously not relevant to single invoice factoring.

Confidential factoring: The practice of a financing group electing not to inform your clients that their invoices are being factored.

Factor: Another name for a factoring company or financial group engaging in the business of collecting another company’s current debts in exchange for a percentage of the receipts.

Funding period: The time that elapses between the purchase of an invoice by a factoring company and the payment of that invoice by the client.

Notice of assignment: The means by which non-confidential factoring companies may notify your clients that you’ve sold their invoice(s) and provide them with a new remittance address.

Rebate: The balance due your company from the factor following subtraction of their fees upon receiving your client’s invoice payment.

ABOUT THE AUTHOR

Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).

Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book The Science of Why Most Entrepreneurs Fail and Some Succeed.

Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.

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