What is Factoring?
Factoring is not a loan, but rather the sale of a company’s accounts receivable at a discount to a third party, known as a factor. The factor then owns the outstanding invoices and collects from the customers. The factor earns a profit from the difference between the discounted rate negotiated to buy the receivables and the full invoice amount collected from the customer.
How Does Modern-Day Factoring Work?
In addition to more traditional factors, today there are online factors that use technology to make the process easier and more streamlined. Nevertheless, the following will apply whether the factor works online or offline.
- Contract with a factor: If your business and your invoices qualify with the factor, you and the factor will sign a financing agreement. This agreement will establish the maximum amount you can be advanced and will specify which invoices you want to factor.
- Your customers will be notified: The factor will usually send what’s called a “notice of assignment” to those customers whose invoices you are factoring. The notice is to let them know your company has chosen to have the factor collect their outstanding invoice(s).
- You will receive an advance: Depending upon the factor, the industry you’re in, the invoices, and other risk factors, you will receive an advance between 70-90 percent of the value of the factored invoice(s). Again, there are exceptions, so you should make sure you understand the specific terms before you sign an agreement with any factor.
- Your invoices are collected: Once the factor collects payment for the agreed-upon invoices, they will pay the remaining balance owed to you, minus their fees. Every factor is a little different, and as mentioned above, the discount rate varies depending upon a number of factors, so make sure you understand the specific terms.
Many factors prefer to specialize in specific industries where they are familiar with the common industry practices. With that in mind, you may want to look for a factor that specializes in your industry.
There are Two Types of Factoring: Recourse and Non-Recourse
Before you agree to factor any of your invoices, you need to be aware that there are two types of factoring:
- Recourse Factoring: This type of factoring agreement requires that you will pay the factor for any invoice he or she is unable to collect within a reasonable amount of time. This is the most common form of factoring in the United States.
- Non-Recourse Factoring: The factor assumes all the risk for uncollected invoices in this type of factoring arrangement. As a result, the fees associated with non-recourse factoring are usually higher.
A Short-Term Business Loan as an Alternative to Factoring
Factoring could be a good way to access capital to overcome short-term cash flow needs, and it’s also standard practice in many industries. It’s not a viable option for businesses that don’t bill on invoice or are in an industry a factor might not be interested in.
If you have a healthy business and don’t want to engage with a factor, OnDeck offers small business financing with a simple application, a quick answer, and fund availability often within 24 to 48 hours of approval.
What type of loan makes sense for your business?
Financing options to help you grow your business
If you’ve ever heard the adage, “It takes money to make money,” you must be a small business owner. Fortunately, there are more small business loan options available today than ever before—you just need to know where to look and what to look for. You don’t need to be a financing expert to build a successful business, but you do need to consider all the business loan options available to determine which one is best to meet your business need.
Unsecured Small Business Loans
An unsecured business loan is simply a loan from a lender that does not require any form of collateral from a business or a business owner. This is based solely upon the creditworthiness of the applicant.
Many small business owners are interested in a loan for their business but don’t have the specific collateral a bank may require, such as specifically-identified real estate, inventory or other hard assets. Fortunately, there are lenders like OnDeck that do not require that their loans be secured by specific collateral, relying instead on a general lien on the assets of the business. These may be good options for many businesses.
Secured Small Business Loans
Banks generally prefer secured—rather than unsecured—business loans. Secured loans are loans that are backed with some sort of collateral like real estate, equipment, or other valuable business assets the bank can seize and sell if the loan is not repaid.
Banks (or other lenders that require specific collateral) commonly determine what they refer to as the loan-to-value ratio of your collateral based upon the nature of the asset. In other words, your banker may allow you to borrow against 75 percent of the value of appraised real estate or 60 percent to 80 percent of the value of what they call ready-to-go inventory. Because lenders might consider their loan-to-value ratios differently, you’ll need to ask any potential lender how they intend to set that value.
Small Business Loans for Different Industries
As a business owner, your needs may be industry-specific such as ordering kitchen supplies upfront or bridging cash flow while you wait for insurance reimbursement. At OnDeck, we understand and we offer tailored loan options (with multiple loan types, amounts, and repayment terms), so you can get a loan best suited for your industry and business. Here are some of the most common industries we work with and the small business financing options available to them.