When small business owners need cash, one financing option is business factoring loans. Here’s what to know before agreeing to sign away your outstanding invoices.

What is Business Factoring?

Factoring is a type of business finance where a company sells its accounts receivables to an invoice factoring company (called a “factor”) at a discount. The factor lends the borrower a portion of the invoice (the business factoring loan) and then collects payment for the total invoice. The factor then sends the company the remainder of the invoice minus a fee.

How Does Business Factoring Work?

Before the factoring process begins, it’s essential to research and find a Factor willing toBusiness factoring loan accept your company’s accounts receivables. Although the application process varies by the Factor, you can expect the lender to require the following:

  • Proof of business ownership, such as a business license. Some Factors may require businesses to be legal entities, such as a C Corp or Limited Liability Company (LLC).
  • Your customers must be financially sound. Factors will look at the “quality” of your invoices, in other words, the business reputation of your customers.
  • Customer credit scores. Because invoice factoring companies collect money from your customers, your customers must have a good credit history and credit score.
  • The company’s profit margins. Factors may look at how your company’s profit margins compare to like-businesses in your industry.
  • Invoices must be free of liens. Often companies secure business loans by offering invoices as collateral. Factors do not accept invoices that are collateral for another loan.
  • Personal credit score. Factoring companies often consider the borrower’s personal credit history when making the lending decision.
  • Company documentation. Factors may also ask for the company’s articles of incorporation, Federal Tax ID Number, payroll tax information, and an accounts receivable aging report.

Typically, a Factor will fund your company 80% of the invoice—called the “borrowing base.” However, the borrowing base could be more (or less) depending on the terms of your contract. To obtain a business factoring loan, start by providing services or products to your customers and then create invoices for the customers to pay, typically with 30 to 90-day terms.

Before customers pay their invoices, your company submits the unpaid invoices to a factoring company. The factoring company then gives you a business factoring loan, the borrowing base. The Factor then sends customers a “notice of assignment,” informing them that the Factor will collect payments.

Once customers pay the invoice factoring company, the remaining balance—called the “reserve”—is transferred (minus the factoring fee) to your bank account.

Business Factoring vs. Business Loan

The differences between business factoring loans and traditional business loans are many, but the most significant is how the money will be used. Business factoring loans (similar to business lines of credit) are short-term loans and typically fund everyday operating expenses. These loans are based on your company’s unpaid invoices and can cover costs when cash flow slows due to late-paying customers. As we explained, invoice factoring companies pay your company upfront for your account receivables for a fee. Once the customer has paid the invoice (and the reserve refunded), the terms of the business factoring loan are completed unless your company chooses to use invoice factoring again.

A traditional business loan is usually for a significant amount of money and is mainly used for large expenses such as real estate, building improvements, or purchasing expensive equipment. Typically, lenders for business loans require excellent credit scores and collateral or personal guarantees from borrowers. If your company is approved, the lender will lend you a lump sum, which you agree to pay back (with interest) per the loan’s repayment terms. You must make predetermined monthly payments throughout the life of the loan, which can range from 10-25 years.

Types of Business Factoring Loans

There are two main types of business factoring loans, and they differ in who takes on the risk of payment.

  • Recourse Factoring. With recourse factoring, the borrower is responsible for payment if the customer does not pay the invoice. Because your company carries the risk, you can usually negotiate smaller factoring fees.
  • Non-Recourse Factoring. In a non-recourse factoring agreement, the invoice factoring company takes on the risk of collecting the customer’s payment. If the customer cannot pay for some reason, the factor takes the loss. Fees are higher for non-recourse factoring.

When Business Factoring Should be Used

Like a business line of credit, business factoring loans can supply immediate working capital to help cover a cash flow deficiency due to slow-paying customers. As long as your company meets the invoice factoring company’s requirements, the application approval is typically quicker and easier than a business bank loan. In addition, the loan is based on unpaid invoices, so if you have a steady customer base, invoice factoring could be an acceptable solution to a temporary or seasonal cash flow shortage.

The downside of business factoring loans is that they typically have numerous add-on fees, so you never receive the total amount of your invoices. In addition, your customers will be informed that a factoring company is collecting the invoice payments, which can make your customers unsure about your business’s survival. Also, you have no control over how the company deals with your customers, so your business risks getting a bad reputation for payment collection.

Have More Questions? Call Financing Solutions!

An alternative to business factoring loans is a business line of credit. A business line of credit also has a simple application process. It is a good finance option when your company needs cash flow for payroll, utility payments, and similar costs. The approval process is quick (a couple of days), and usually, the borrower does not need collateral or a personal guarantee. The best thing about a business line of credit is that it’s a revolving loan, which means once the money is paid back, it is available to borrow again without reapplying for a loan. Plus, you only pay interest and fees on the amount withdrawn.

Every business has unexpected financial emergencies. Planning for future cash flow shortages helps to ensure your company will survive to see another day.

Financing Solutions is an alternative lender offering an easy application process (it takes less than two minutes to fill out) and requires no collateral or documentation to get a written offer letter. Many other alternative lenders have a much longer application process and can be relatively expensive.

The founders of Financing Solutions have started and grown several companies together, so we understand how important it is to keep costs low. That’s why we don’t charge you to set up the credit line, and there are no maintenance fees. We don’t ask for personal guarantees, and applicants can receive a no-obligation offer letter the same day. We make approval decisions based on our decade of experience working with small businesses. Find out today why we have five-star ratings from the Better Business Bureau and Google. Also:

  • There are no costs to set it up or keep it in place
  • The easy 2-minute application online application
  • If approved, you’ll receive a same-day, no-obligation offer letter
  • The fastest setup, 48-72 hours
  • Once you have the line of credit, requests for funds are wired to your bank in minutes
  • You can use your line of credit whenever needed
  • Inexpensive when used (low fees)
  • There are no restrictions in place or collateral required
  • No personal guarantee is required, either
  • Financing Solutions is a leading provider of lines of credit
  • We are a reputable company with an A+ & 5-star rating
  • You can pay off the line whenever you are ready
  • The credit line is easy to renew and renews yearly
  • You have a secured account portal access 24 x 7

A line of credit is a reliable funding resource that’s available whenever your company needs it, without the heavy burden of term loan requirements. If you want to see if your small business would be approved and for how much, please fill out the no-obligation, 2-minute line of credit application here.