Invoice factoring can help small business owners save time, access funding without collateral, finance growth, and receive large amounts of capital quickly. However, there are sometimes drawbacks like reduced control over invoice collections, the stigma of alerting customers to a factoring relationship, the high overall costs, and a reduction in profits. Each of these factors should be evaluated when determining if invoice factoring is right for your business.
Pros of Invoice Factoring
Small businesses that apply for invoice factoring can save the time they would usually spend on gathering loan documents, collecting signatures, and providing additional information by submitting an invoice factoring application. Small business owners can apply for factoring in as little as 10 minutes, whereas a traditional loan can take weeks of back and forth.
Doesn’t Require Hard Collateral
Invoice factoring does not require hard collateral. There is no equipment, real estate, or inventory to pledge as collateral for funding. This allows a small business to both receive invoice factoring and use assets as collateral for additional forms of funding to scale more quickly.
Good for Growth
Invoice factoring is also good during growth periods. While lines of credit are usually good early on and term loans can provide a necessary boost in cash for things like renovations, invoice factoring can scale with a company. Most invoice factoring companies can offer up to $10 million or more in funding per month, which is difficult to get with any other form of financing.
Provides Immediate Cash Inflow
Invoice factoring is already quick to set up, but once it’s set up, small business owners can receive cash in as little as 24 hours after submitting an invoice. This is money that can be reinvested in the company and used more productively to serve customers, hire staff, improve internal operations, and attract new clients.
Has Low Minimum Requirements
Invoice factoring has low minimum requirements, which are usually restricted to annual revenue. This means a small business owner with poor credit or those with a short time in business can qualify for funding. Invoice factoring is one of the most accessible forms of financing for newer businesses and more established businesses struggling to get funding.
Cons of Invoice Factoring
Can Have Stigma Associated With It
Your customers will be notified that you have factored their invoices. In industries where this is not common, there can be a certain stigma associated with the process. Small business owners may worry their customers might think that they’re not creditworthy or unable to manage their funds. If this is a concern, we recommend discussing it with the factoring company to understand how they handle customer communications.
Reduces Control of Customer Relationships
Your business will have less control over the invoice collection process since most factoring companies will handle it on your behalf. This can mean that in situations where you might give a customer a little more leeway or put on a little more pressure, the factoring company may behave differently. However, in most factoring contracts, the factoring company is responsible for representing your best interest in the collections process.
Has High Overall Costs
Invoice factoring companies have relatively low rates, but the total cost of factoring invoices over the course of a year can exceed an annual percentage rate (APR) of 50%. Invoice factoring companies don’t like to refer to an APR because they are unlocking existing capital rather than lending you money. It also doesn’t include the value of services they provide, such as collections, which makes it difficult to compare to other financing solutions.
When you factor invoices, you’re essentially getting paid less than you would have if you waited for a customer to settle the invoice directly. This leads to a reduction in profitability, which early in your business may be almost unnoticeable and well worth the cost. However, once your business is more mature, losing 5% to 10% of every invoice can eat into profit margins substantially.
Depends on Customer Creditworthiness
A major benefit of invoice factoring is its low minimum requirements, which means factoring companies rely on the creditworthiness of your customers. In this case, your customer may become less creditworthy or may prevent you from getting access to factoring altogether because they have a history of paying invoices late or not paying them at all. This lack of control over qualification is unusual in financing. It’s typically the borrower’s creditworthiness that’s most important.
Small business owners evaluating the pros and cons of invoice factoring should consider the benefits and drawbacks in the context of their business. Small business owners can always stop factoring invoices or slow down the number of invoices they factor as the business matures if some of the drawbacks begin to outweigh the advantages.