Factoring Agreement: Definition & Common Terms

Small business owners who apply with an invoice factoring company will receive a factoring agreement outlining their rates and terms. This agreement should outline the agreed-upon rates, terms, and conditions to be followed throughout the factoring relationship. Factoring agreements usually last from between one and three years, at which point they can be renegotiated with the factor and renewed.

Key Parts of a Factoring Agreement

Most factoring agreements share multiple common features, which you should get to know before entering into the agreement. The factoring agreement template provided by HSBC can act as a great reference for business owners hoping to get familiar with the language before contacting a factoring company.

Key parts of a factoring agreement include:

• Advance rate: This is the percentage of the invoice the factoring company is willing to advance. For example, a $1,000 invoice with a 90% advance rate would result in a $900 initial advance.
• Factoring fees: This is the fee a factoring company charges as a flat rate or in increments of days, weeks, or months while the invoice is outstanding. For example, a fee of 1% for 30 days would result in a 2% fee during a 60-day period.
• Credit approvals, withdrawals, and disputes: The factoring company reserves the right to both approve invoices from particular debtors and reject them if they are not creditworthy. In some cases, the factoring company may change its stance on a particular debtor during a factoring contract, usually due to nonpayment or deterioration of credit.
• Invoicing and assignment schedules: This governs the way invoice assignment is handled, including the way a debtor is informed about the factoring relationships and the procedure for making payments.
• Obligations and interest: Obligations usually include additional fees for late payments on collectible invoices or violations of certain minimums. Interest may be charged in the event a debtor defaults, and the business must make payments directly to the factoring company for the advance.
• Payment of the purchase price of an account: After a debtor settles an invoice, the difference between the remaining capital and the fee will be paid out to the business. In the case of low advance rates, this difference can be as much as 20% of the invoice value.
• Representations and warranties: Like most financing agreements, your business must verify that it is solvent, free of liens and encumbrances, and there are no outstanding tax debts.
• Sale and purchase of receivables: Most factoring companies will require the sale of all receivables, which is known as contract factoring. For an alternative factoring arrangement that does not require factoring all invoices, consider spot factoring.
• Security interests and remedies: This usually covers stipulations like blanket Uniform Commercial Code (UCC) filings and personal guarantees, which help protect the factoring company in the event of a default.
• Termination provisions and events of default: Factoring agreements usually have a restriction of one to three years during which they are valid. After this date, they must be renewed, usually with the business and the factoring company entering a stage of negotiations 30 days prior to renewal.

Bottom Line

Interpreting a factoring agreement can be difficult for business owners who are factoring invoices for the first time. Most invoice factoring companies have a representative that is willing to walk you through and help you with every step of the factory agreement. For larger transactions and long-term contracts, it is always prudent to involve an attorney and an accountant to help review the agreement.