If you are considering factoring your receivables, you are probably already aware of its benefits. But other things are essential to know before you sign on the bottom line with a factoring firm. The most important is this: not every factoring firm is the same! Not only does every company have its own procedures and requirements, but some also have more experience in certain industries and factoring methods than others. Here is a list of questions you should ask before signing a factoring contract.
1. How many years has the company been in business?
Over the years the factoring industry has grown considerably as more and more people realize factoring is an excellent method for increasing cash flow. However, with the increase in popularity of invoice factoring, many new and inexperienced companies have also appeared. Be sure to learn the level of experience of any potential factoring firm; if the company is new, what factoring experience have the people had before starting or joining this firm?
2. Is this company an intermediary or the factor who will be providing your funds?
A great many firms in the factoring arena today are actually intermediaries and not factors themselves. These companies might be brokers trying to attract customers for other firms. Some companies act like they are the factoring firm but in reality they have little or no funds of their own to buy invoices. The potential problem with such companies is that they cannot make their own decision and have to follow the dictates of its funding partners.
However, make no mistake – working with a factoring broker can be a very good choice, as long as they present themselves as being a broker and not an
actual funding source. Good brokers will not only have many good factors to whom they can refer you, but they will tell you quite early that they are not the funder, and will connect you with a factor who is a good match.
3. What are their discount terms, and what other fees are charged? Are there any hidden fees?
A good factoring firm makes its income from the discount terms it charges, not add-on fees. While some items such as wire fees, application fees and other similar charges are common and normally act as a reimbursement for a factor’s out of pocket expenses, beware of unusually high charges for these common fees. Some companies offer (and brag about) very low discount rates, but in reality overcharge for these and other fees, hidden and otherwise, which actually makes the cost of factoring higher than those with reasonable fees.
You are better served to find a factor with an easy to read contract with clear, understandable wording about its rates, fees and service charges. Read the contract thoroughly; if the discount terms are worded in a way you can’t easily understand, be careful! Be absolutely sure there are no hidden charges that will surprise you at any point of time during your factoring relationship.
4. Do they have factoring experience in your specific industry?
Unless they specialize in one specific industry, most factoring firms accept clients from a variety of industries. It is to your advantage to find a factor who has worked with other companies in your industry; previous experience will help them understand your business and customers better. However, this should not be the only basis by which you select your factor, as a good factoring company will quickly learn about your industry.
5. Can I factor a few selected invoices or customers, or do I have to factor everything?
This is the most important thing to discuss after the cost to you. Sometimes you may want to factor all or most of your receivables, but on other occasions you might just need to factor selected invoices or customers. Either way, you need to have that flexibility and freedom to decide just how much you need to factor. It is important to ask the factoring firm about their minimum number of invoices and/or volume that must be factored every month. Some factors will require you to factor all your ARs, especially if you’re a smaller company; if that doesn’t work for you, keep looking.
6. Is there a term contract or can you stop factoring at any time?
In many cases factors will require that you factor for a specific length of time, such as 6 12, 18 or 24 months. It is better for you if there is not a term contract, meaning you can stop factoring any time you choose. But when a term contract is required, which is common, find out first what the stipulations are for leaving the contract early, or if it can even be done.
Usually release clauses include some penalties which can be quite costly or difficult to work with, so be very clear what will be required if you feel you want out. Also, will you actually need and want to factor for the full length of the term? If you only need to factor for six months, signing a two-year contract may not be in your best interest. Also, if you find the factor is just not meeting your needs after a few months, being locked in to a long term contract can make for a very long haul.
7. Is there a monthly factoring minimum?
If your company is smaller, be sure that the minimum monthly factoring volume (if one is required – better for you if it is not) is not more than you can produce. For example, if you have a minimum monthly requirement of factoring $35,000 but during some slow months you only have $25,000 to factor, what happens? In this situation, your monthly minimum discounts – how much the factor makes – must reach a certain threshold. If it doesn’t, you must make up the difference between the factor’s monthly minimum and how much you actually paid.
8. Ask when they make their UCC security filing.
It is very common practice for factoring firms to file a UCC (Uniform Commercial Code) security interest on your company before providing you with the funds. The main purpose of this filing is to be in first position in a bankruptcy court should your company fail; it also alerts other factors and financial institutions that the filing company has a prior interest in your receivables. Factors should not file a UCC right after you apply, but some do in order to keep other factors from taking an interest in your account; after all, they haven’t given you any funds yet and have nothing at stake!
If you find a factor has done this and you don’t wish to work with them,demand they immediately terminate the UCC filing if you wish to apply to other factoring firms; it will have to be done anyway for another factor to fund you. It can be done quite easily and quickly by the factor who filed it.
9. How much of a line of credit will you be given to start, and can it be increased later?
Be very clear how much invoice volume you can have outstanding; in other words, how much can you factor at a given time? If you have very slow paying customers and/or large invoices, this is especially important. You need enough of a line to keep up with your sales, or you will have invoices sitting idly by you can’t convert to cash. If you need your credit line increased, when will it be increased, and what is necessary for that to happen?
10. Will they provide professional references?
Some factors will provide references to current or past clients; many others will not, citing confidentiality concerns which are legitimate. Good factors will do all they can to protect their clients’ privacy, as you no doubt will want them to do with yours. However, sometimes a factor will have a relationship with certain clients who are willing to give a reference.
If this is the case, contact those references and ask about their experience with the firm. How long they have been factoring? Has factoring with this company been a good experience overall? If they had to do it all over again, would they? f not, what would they do differently? This information can help you understand what working with this factor will be like for you.
Choosing the right factor for your company is an important decision towards the financial success of your business. It is important that you make the correct and best possible decision. Factoring can be a long term association that the two companies share, and you want it to be positive for you, your company, and the factor.
Author Reed Corry
Managing Member and owner of Allegiant Business Finance, LLC, www.allegiant1.com. He founded Allegiant with Jana Blackburn, Operations Manager, in 2003. His background includes experience in financing and managing early stage companies as well as turnarounds. Prior to his banking career, Reed was employed as a professor of accounting at Seattle University and was employed as a Certified Public Accountant. Mr. Corry is a graduate of the University of Washington and holds an MBA from Seattle University. Check out Allegiant’s Factoring Guide for some more really helpful information.