In my past few blogs, I shared some thoughts on how to get a bank loan these days. But what if your credit is bad or you just don’t want to go that route for some reason? In this blog and the next, I would like to share with my Greatland readers a couple of other ways to fund a business.
Today, lets look at factoring. Factoring is the selling of a business’ accounts receivable to a third party in order to obtain funding now. Often, the money can be received within 24 to 48 hours. Whereas factoring was once a sort of exotic idea, today it is a commonplace way for businesses of all kinds to get the capital they need without having to apply for a bank loan or sell a piece of the company to an investor. Literally billions of dollars in accounts receivables are factored every year.
Another nice thing about factoring is that it is a relatively easy and quick process, especially in comparison to getting a bank loan. Indeed, the factor cares little about your credit-worthiness and is really only concerned about the payment history of your customer. If your customer pays in full and on time, you are in business. Usually all the factor needs from you is proof that all services are complete or that all products have been delivered as promised. Once you show that, selling your invoice on that deal should be a breeze.
Even though the idea of factoring is easy to understand – you are owed money so you sell that “asset” to someone else – factoring is a still specialized way of getting money. It has its own language. Here are the key terms you need to know:
Account Debtor: Your customer. The one who owes you money.
Factor: the Company that is willing to buy the accounts receivables so as to provide businesses with operating capital.
Advance rate: This is the amount the factor will advance you on the invoice.
Verification: This is the process whereby the factor verifies that you have in fact provided a product or service for a customer and that the customer plans on paying the invoice.
Discount fee: The fee that the factor will charge you for the service
Obviously, factoring is not an idea that works for most startups because consistent accounts receivable must be in the pipeline for a factor to be interested. But for those more established companies that do have money owed to them every month, factoring can be a great solution. It can provide immediate working capital for inventory, payroll, improved facilities, projects, anything.
Really, the only downsides to this deal are:
- In return for that almost-instant cash, you must be willing to give up some of the money you are owed, to the factor (the discount fee), and
- You must be willing to have the company whose invoice you are selling learn of the sale; they will be paying the invoice to the factor and not you.
(For even more business tips and strategies, check out our podcast on iTunes, Small Business Success with Steve Strauss, Powered by Greatland.)