With advance factoring, a factoring company pays a business a percentage of future receivables in advance, typically between 75% to 90%. The arrangement between the seller and the factoring company is kept confidential. Hence, the responsibility of collecting on the receivables remains with the small business. This option is rarer than traditional invoice factoring and usually exists in niches like publishing.
How Advance Factoring Works
A business that wants to factor receivables will be assessed by the factoring company for creditworthiness. If the business gets approved, both it and the factor will agree on an advance rate based on invoice value. The factoring company then provides the advance but does not take possession of the invoices, relying instead on a blanket Uniform Commercial Code (UCC) filing to secure the advance.
Lenders that offer advance factoring don’t require invoice assignment. Instead, the small business will be responsible for collecting the invoice from the customer. This gives the business more privacy about its financing but also places a larger burden on the business for collections. If customers cannot make payments, the factoring company will hold the borrowing business responsible for repaying the advance.
How the Size of a Factoring Advance Is Determined
Factoring companies we reviewed rely on multiple criteria to determine the size and percentage of invoices they are willing to advance to borrowers. These criteria include the industry, customer creditworthiness, aging reports, and debtor creditworthiness. In addition to this, factoring companies rely on a degree of familiarity with a business and its customers.
Generally speaking, low-risk industries will get better terms, such as higher advance rates, than high-risk ones. For instance, businesses that supply services will receive higher advance rates than those that supply products. That’s because service-based businesses are less prone to disputes, making them less risky for the factor to deal with.
The creditworthiness of a business’s customers is also a key part of a factor company’s determination of the advance rate. It’s also a key part of the factor company’s determination of whether your invoice should even be funded. While a poor personal credit score won’t prohibit funding, lenders do rely on credit history to inform their decisions. A low score may mean the factoring company offers lower advance rates or higher factor fees, which is the amount the factoring company charges to advance funds.
The evaluation of debtor performance and the familiarity of the factoring company with a particular business is the final consideration. Businesses must pay on time with few or no missed payments for a factoring company to feel comfortable lending.
Advance vs Maturity Factoring
Advance and maturity factoring are considered the two pillars of factoring transactions. Advance factoring is the more common solution, which offers small business owners payment before an invoice is due. With maturity factoring, the collections process is handled by the lender, but the small business only receives payment when the customer pays its invoice. Another way to think of maturity factoring is like an outsourced collections department for your business.
What Is Full Advance Factoring?
Full advance factoring is a rare form of factoring that offers small business owners the entire invoice value as an advance. This means that a $10,000 invoice may have a 3% fee and the business owner immediately gets $9,700. Invoice factoring companies consider this a major risk so this kind of advance is reserved for business owners that have very reliable debtors like major corporations and a long history of on-time payment from those debtors. For more small business owners, full advance factoring, won’t be an option.
Pros and Cons of Advance Factoring
Advance factoring is an option for small business owners who want to factor invoices but hope to avoid their customers being contacted. It typically offers lower advance rates, and the small business will usually be responsible for any unpaid invoices. Rather than collecting directly from customers, the small business handles the collections and repays any debt to the factoring company.
While the lower advance rates and higher fees are a major disadvantage for small businesses, there is also the added burden of collections. Small business owners looking for this niche solution must have better credit scores and higher business revenue than most businesses that are comfortable with traditional invoice factoring.
Advance factoring is a niche solution for small business owners who want to factor invoices but hesitate to hand over customer interactions to a lender. Business owners must meet higher requirements to qualify and will usually receive lower overall advance rates for their invoices. However, it’s an option for small business owners struggling to qualify for other types of financing.