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Invoice factoring can be useful if you’re struggling with cash flow because you rely on revenue from other businesses. Most small businesses can qualify, since factoring companies typically consider your client’s credit rather than your own. But it’s one of the most expensive types of business financing out there. And it could compromise your relationship with your customers.
Invoice factoring is a type of short-term business financing, where businesses sell unpaid invoices at a discount to a factoring company. This type of advance is available to business-to-business (B2B) and business-to-government (B2G) companies that have invoices from $10,000 to $10 million due within 30 to 90 days.
Because factoring companies buy a small business’s invoices up front, they aren’t technically lenders. Instead of paying interest, factoring companies charge a fee that’s typically equal to a percentage of your total invoices. This means you won’t ever receive the full value of your invoices with this service.
Factoring might be an option if you’ve struggled to qualify for financing from traditional lenders due to cashflow problems, the industry you’re in or your credit rating.
Sell all of your invoices to a factoring company over a period of time.
Sell only the invoices you choose over a period of time.
Sell individual invoices in a one-off deal.
This is a popular choice for companies that are expanding and want a long-term solution for their invoice factoring. With whole turnover factoring, businesses are typically required to sign up for at least 12 months of factoring on all invoices they receive during that period. Since you're signing up for the long haul, many factoring companies often charge lower fees for whole turnover financing.
Selective invoice factoring lets businesses choose which invoices they want to factor and which they'd like to handle themselves. It allows companies to account for a number of factors that can affect income — such as the time it takes individual customers to pay invoices, peaks in trading and unique agreements with specific customers.
Like whole turnover factoring, selective also usually involves a year-long contract. However, it gives you the option to choose which invoices you finance and when. These features make this brand of factoring a sound option for small businesses that deal with a diverse array of clients and customers. But it can be more expensive.
If your company needs income quickly, possibly to cover a one-time payment or meet the monthly payroll, you might consider spot or single factoring. This is for when you’re looking to access the funds from one invoice or a single load as quickly as possible.
Keep in mind that the speed of this type of invoice factoring is reflected in the costs, which are the highest out of these three choices. The short period makes this type of invoice factoring less profitable for the lender, who may charge you weekly or even monthly for just a few hours of work.
While the factoring process can vary depending on your business’s industry, it typically follows these steps:
In many cases, the factoring company handles the invoices after you sign up. However, some allow you to maintain that relationship with your client.
Advance rates range from 80% to 95%, though you could see rates as low as 50% and as high as 100%. However, factoring companies have minimum and maximum invoice values, usually between $10,000 and $10 million — though these limits can get higher.
Many factoring companies require you to sign up for a contract that lasts between six months and one year. In that case, you’d repeat this process several times. Others offer spot factoring, which allows you to renew your contract as needed each month.
The main cost of invoice factoring is the factor fee. This fee is typically a percentage of your invoices’ total value. How this works depends on the fee structure your factoring company uses.
Say your small business had $100,000 in unpaid invoices from a project with the Department of Transportation (DOT), due within 60 days. You got another contract with the DOT but needed the funds from the first project to get started.
Here’s how your advance and costs might break down if you signed up for invoice factoring:
Advance rate | 90% |
How much you get up front | $90,000 |
Factor fee rate | 0.5% per week over 60 days |
Factor fee cost | $4,286 |
Other fees | Advance fee of 1% |
Total cost | $5,286 |
How much you get back | $4,714 |
It depends on the factoring company. Most companies offer recourse factoring, where it’s your business’s responsibility to pay back the invoice should your client fail to pay up. Others offer nonrecourse factoring, where the factoring company absorbs the cost.
A few offer a combination of the two, where you’re responsible for paying some of the invoices if your clients don’t pay, and the factoring company covers the rest.
While nonrecourse factoring might sound like it’s less risky for your business, it’s also more expensive. If your clients have a history of late payments, you might want to consider another type of working capital financing.
Most factoring companies have flexible eligibility requirements. Unlike business lenders, factoring companies usually aren’t concerned about your revenue or personal credit score.
Instead, factoring companies more often consider:
Not sure if factoring is right for your business? Weigh the pros and cons of working with a factoring company.
Not as much as other financing options. Factoring companies are largely unregulated in the US, which means fewer laws limiting how much a company can charge or how it discloses its fees.
Generally, trade organizations oversee the industry, including the International Factoring Association, the Commercial Finance Association and the Independent Factoring Standards Association. These organizations set standards for best practices among factoring companies, though they aren’t legally able to enforce them.
Considering factoring your invoices? Watch out for these common mistakes small businesses make:
No. Invoice financing uses your business’s unpaid invoices as collateral for a loan, while invoice factoring involves selling your invoices to another company. With invoice financing, you repay the loan plus interest over time.
Invoice payment flexibility | More flexibility. You get to pick and choose which invoices to finance and when. | Less flexibility. Invoice amounts are typically advanced in the order received. |
Cost | Monthly rate (usually between 3 and 5% that depends on the amount of your invoices. | High fees (as much as 15% of invoice amount) for selling a single invoice, lower fees for long-term commitments. |
Retrieving payment | Your business usually deals directly with the customer for repayments. | The factoring company will usually have a debt collection service retrieve payments on your behalf. |
Confidentiality | Private. Customers typically won't know you are using a financing company. | Less privacy. Customers will be aware you are using a factoring company when contacted about payment from the third-party. |
Invoice factoring might be useful if your B2B or B2G business has cashflow problems due to unpaid invoices. Especially if you’re in an industry that struggles to qualify for traditional business loans.
But it’s not cheap. And you might have to sign a contract that lasts anywhere from six months to a year. You can learn how it compares to other options by checking out our guide to business loans.
What's the difference between invoice discounting and factoring?
Generally, there is none. Many companies use the terms invoice factoring and invoice discounting to refer to the same type of financing.
Do I have to factor all of my company's invoices?
It depends on the company, but often you can choose which invoices to factor. However, you likely need to have invoices that meet the company’s minimum value requirements.
Can startups apply for invoice factoring?
Sometimes. Factoring companies are generally more willing to work with newer businesses than lenders — as long as you have enough unpaid invoices. Check with the company’s eligibility requirements to make sure your business qualifies.
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