Types of Invoice Financing for Small Businesses

Invoice financing is the process business owners rely on to borrow against unpaid invoices and receivables. The industry offers small business owners multiple options that include factoring, discounting, selective financing, spot factoring, and invoice auctioning. These types of invoice financing for small businesses have varying costs, terms, and requirements.

Invoice financing is part of a larger set of financing products that lenders refer to as asset-based lending. These lending solutions are defined by the collateral that backs these loans, which can include equipment, invoices, and real estate.

5 Types of Invoice Financing for Small Business

The five types of invoice financing are:

1. Invoice Factoring

Invoice factoring is the most common type of invoice financing for small business owners. Business owners must factor all of their invoices and the factoring company collects the invoice on their behalf. Small businesses can access up to $20 million in capital at a time with starting rates of 1.25% per 30 days.

How Invoice Factoring Works

Business owners that get invoice factoring must assign all of their outstanding invoices to an invoice factoring provider along with the collections process and customer relationship. The lender advances up to 85% of the invoice value to the business and collects the invoices from the customers. It then uses these invoices to repay the advance and returns the difference, less the fee, to the business.

Invoice Factoring Rates, Terms, and Qualifications

Invoice factoring offers the largest loan amounts and charges a discount rate only while the invoice is outstanding. Repaying the invoice early results in an interest discount, but lenders may charge rates with different monthly, weekly, or daily structures. It’s also easy to qualify because the lender has the invoices and collects them, the only major requirement is the minimum amount of factoring and annual revenue.

While most invoice factoring providers offer funding in under two weeks, the process and the time it takes vary by business. Some factoring providers specialize in certain industries, while others can work with multiple businesses. Most factoring companies will require a contract from the borrower to factor all invoices for at least one year, so business owners should decide whether factoring is the best solution now and in the long run before committing.

2. Invoice Discounting

Invoice discounting and factoring differ because business owners need not assign the invoice or the collections process to the lender. Here, business owners receive up to 85% of the invoice value from the lender and repay the funding when they collect the invoice. The 15% initial discount and the added discount rate per week is where invoice discounting gets its name.

How Invoice Discounting Works

In an invoice discounting transaction small business owners use the invoices to receive early payments from a lender at a discount. The business is still responsible for managing the collections process and keeps control of the customer relationship, which makes this type of invoice financing more accessible to most businesses. However, this accessibility has the added barrier to entry of higher minimum qualification requirements set by lenders.

Invoice Discounting Rates, Terms, and Qualifications

While businesses can keep control of customer relationships with invoice discounting, the overall financing amounts are lower and the total APR range is greater. This results from the larger risk that lenders take with this type of invoice financing and is also the reason they set higher minimum requirements. With control of the invoice collections process and prepayment discounts that lenders offer, business owners have more control over their total costs with invoice discounting.

Businesses that elect to use invoice discounting must meet a minimum credit score, time in business and annual revenue requirement. While the credit score can be a drawback, the lower annual revenue requirement makes invoice discounting one of the most accessible types of invoice financing for small business owners.

3. Selective Invoice Financing

Selective invoice financing is the easiest solution for small business owners to access. Business owners can choose the invoices they wish to borrow against and receive a revolving line of credit with weekly payments based on the invoice value. While it offers a small amount of funding, it’s also flexible, easy to access, and offers low revenue businesses a way to finance invoices.

How Selective Invoice Financing Works

Lenders connect to an applicant’s invoicing or accounting software and offer business owners the opportunity to select the invoices they would like to consider for financing. business owners can access a line of credit to draw on for financing based on the quality of the invoices and the overall amount outstanding. Lenders determine the quality of invoices based on past payments and overall credit history of the debtor.

Selective Invoice Financing Rates, Terms, and Qualifications

Selective invoice financing providers offer less funding than other types of invoice financing for small businesses. However, providers also require less annual revenue and offer revolving credit for business owners to draw on. Business owners must make weekly payments to repay the draw, and while rates are low, the overall APR of selective invoice financing is high. This is because of the short-term nature of these working capital loans.

4. Spot Factoring

Spot factoring is like invoice factoring but it enables small business owners to finance individual invoices, instead of factoring all of their receivables. While this gives business owners some added flexibility, it also increases the risk for lenders, which results in higher overall costs. Most invoice factoring companies offer spot factoring, but they are selective with the businesses they fund.

How Spot Factoring Works

Business owners select the invoices they wish to factor with spot factoring. Although business owners can select the invoices, these invoices must come from credible businesses in low-risk industries. Like with invoice factoring, the lender collects the invoice and uses the proceeds to repay the advance and returns any leftover capital, less a fee.

Spot Factoring Rates, Terms, and Qualifications

The overall cost of spot factoring is higher than invoice factoring because lenders perceive this type of invoice financing to be riskier. While the disclosed minimum qualifications are similar, most lenders and business owners report that qualifying for spot factoring is much more difficult than other invoice financing solutions. Lenders offer spot factoring to small business owners who already have a factoring relationship and established credibility.

5. Invoice Auctioning

Invoice auctioning is a recent market that has opened up for business owners needing to factor invoices. Invoice auction marketplaces offer invoice factoring, spot factoring, and invoice financing to small business owners. Instead of selecting a provider, individual factoring companies can bid on invoices, resulting in lower costs and lower minimum qualifications but longer funding times.

How Invoice Auctioning Works

In an invoice auction, a business selects the type of factoring it needs and uploads information about the invoices. The auction site approves the factoring request and displays it to outside parties which may include individual investors and factoring companies. The auction lasts for one to two weeks, during which investors can place bids on the invoices. Each subsequent bid lowers the costs for the business and improves its factoring arrangement.

Invoice Auctioning Rates, Terms, and Qualifications

Invoice auctioning provides a unique mix of costs, terms, and requirements for small business owners. It offers the same amount of maximum funding as invoice factoring, with a wider range of potential discount rates. However, it also has low minimum qualifications, which makes it more accessible than invoice factoring. This is because the marketplace attracts all kinds of business owners who hope to get lower invoice financing costs by auctioning their invoices.

Types of Invoice Financing Frequently Asked Questions (FAQs)

Is an invoice an asset?

An invoice is an asset because it represents work that a business already completed and can now collect on. Factoring companies help liquidate the value of an invoice through invoice financing, helping business owners convert this value into cash sooner. However, an invoice from a customer with poor credit will be difficult to factor.

How does supply chain financing work?

Supply chain financing refers to working capital for both buyers and sellers in the supply chain that helps unlock capital sooner for both parties. This provides both businesses with the liquidity needed to invest in more projects. Invoice financing and purchase order financing are both major products within supply chain financing.

Bottom Line

The five types of invoice financing are part of a much larger network of working capital solutions called supply chain finance. Small business owners should focus on selecting the financing solution that offers them sufficient capital and flexibility at the lowest cost. The types of invoice financing solutions for small business owners include invoice factoring, invoice discounting, selective invoice financing, spot factoring, and invoice auctioning.