How to Qualify a Factoring Prospect by Asking Three Simple Questions

It’s a factoring broker’s job to deliver companies with cash flow issues to the appropriate funding source. Although this task sounds easy enough, in reality, it’s not always so simple. Picture this scenario:

You have a client in need of cash flow who has been in business for a year, has three large customers and gets paid in less than 30 days. Eager to help this entrepreneur get the cash he needs to expand, you refer this small business owner to one of your factoring partners immediately.

The factoring company tells you that they are interested in pursuing the lead, and they’ll have an update for you as soon as they reach out to the prospect. The next day, you get a phone call from the factoring firm telling you that they are no longer working the deal.

Has this ever happened to you? If you answered yes, then I have some good news for you. There’s a simple way to drastically reduce the chances of the above situation ever happening again. All you have to do is ask three key questions before referring a lead to a factor.

#1: Have Your Receivables Been Pledged as Collateral to Another Lender?

The answer to this question can dramatically change how a factoring company views a prospect. Simply put, if the answer is ‘yes,’ the deal just got less interesting.

In order for a factoring company to purchase invoices, it uses the company’s accounts receivables as collateral. If the business owner has a loan (or is working with another factoring company), then that lender has most likely already filed a UCC-1 and claimed the borrower’s accounts receivables as collateral. (NOTE: A UCC-1 is a legal document that a creditor files to give notice that it has an interest in the personal property of a debtor.)

Discovering that a potential factoring candidate has a UCC-1 is problematic for a new factoring firm because it cannot fund on invoices if another entity is already entitled to them. In some instances, a factoring firm can structure an agreement where the previous lender is willing to release its ownership rights on the receivables, leaving them clear for the new funding source to use as collateral.

#2: Do You Owe Any Past-Due Taxes?

If your prospect answers ‘yes’ to this question, the next thing you need to ask is by how much? In general, a business that is behind on its taxes is not a good thing. However, how much or how little it owes will give the factoring company a better idea of how invested it would like to be in the deal.

When the IRS learns that a business is behind on its taxes, it files a lien on the company’s assets, including physical assets (property, computers, fax machines, etc.) as well as liquid assets (bank accounts, accounts receivables, etc.). This is the IRS’s way of getting a business owner’s attention because if the owner doesn’t pay the IRS what is owed, the next step is to levy on those assets.

When the IRS goes through with the levy, it claims the accounts receivables and other assets to compensate for the back taxes. In this situation, a factoring company cannot fund because the accounts receivables no longer belong to the factor. In other words, when the IRS levies on a company’s assets, all of the payments for the receivables which the factor initially purchased now go to the IRS instead of the factor. Translation – The factor never gets paid what it’s owed.

There are some situations in which the prospect, factoring firm and IRS could arrange a payment plan when taxes are past due. However, in general, if a company owes the government money, the risk level is usually too high for a factoring firm to want to stay involved.

#3: Who Are Your Customers?

Factoring brokers should pay very close attention to how their prospects answer this question because there are a couple of “entities” that simply cannot be factored. In a nutshell, the accounts receivable factoring model works best when smaller, less-established companies are selling to or providing services for larger, creditworthy companies. As such, a factoring firm is able to extend credit to the smaller entity, which may have little or no business credit history, based on the fact that its customers are financially sound enough to pay their bills in a timely manner. This ideal factoring model breaks down any time the above conditions are not met.

The most common factoring deals that get turned down immediately because of who they bill are companies that are paid by private consumers and extremely slow-paying clients. For the latter example, it’s important to note what the standard industry payment terms are to determine if the customer is a slow payer. For example, in the medical staffing industry, it’s typical to see net-60 terms, whereas in another industry, net-60 might be considered too past due to purchase.

Incorporating these questions into your initial information gathering process will help you weed out some of the less desirable deals before you approach a factoring company, saving you, your prospect and the factor some time and effort. It will help the referral process run more smoothly, and it will help you better understand your clients’ current financial state so that you will be better equipped to help them with their cash flow.

Nikki Flores is a Consultant Liaison for PRN Funding, LLC, which is an extraordinarily focused niche player in healthcare factoring.

PRN Funding exclusively factors the accounts receivable of companies that sell goods or provide services to healthcare providers.