Borrowing Trouble

Factor It In

Question: My partner wants to factor the accounts receivable of our temporary-help agency. Is that a good idea?

Answer: Your new and growing agency pays your employees before your clients pay you--the classic cash-crunch condition. A factoring company buys your client receivables from you as you bill. Your clients pay the factor when the bill is due. The factor looks to the payment ability of your customers, not you. You have to be solvent, not creditworthy. In effect, you "borrow" on your clients' credit.

Your partner has a good idea if you have strong profit margins; stable, fixed costs; and enough administrative capacity to handle new sales. Unlike bank lines of credit, there is no required annual payoff, and factor financing can keep pace with rapid sales growth.

The good news: Factoring is both unregulated and entrepreneurial. Factors deal where banks fear to tread. The bad news: Factors are expensive, and their contracts are mostly one-sided. The factor will "advance" you a percent of each invoice; the remaining "reserve" balance, less the factor's "discount," is paid to you when your customer pays the factor. If you receive an 80 percent advance on money you would normally collect in 60 days and pay a 4 percent discount, your annual interest is 30 percent [(0.04/0.8) x (360/60)]. Can you give up 4 percent on invoices and remain profitable?

Get proposals from at least three factors. Understand the contract completely. Is there a minimum invoice size, a minimum monthly volume, an administrative or setup fee, or other interest or penalty costs? How long are you locked in with the factor? Who eats the bad debts? When and how are reserve balances paid to you?

Factors operate nationwide; start your search with the Yellow Pages. Ask your bank which factors it deals with. Call your trade association for factors interested in working with your industry. Check out the Edwards Directory of American Factors (Edwards Research, $199, 617-244-8414) or the Commercial Finance Association's Web site (

George M. Dawson ( is a small-business consultant and author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Dearborn, $16.95, 800-621-9621). Send him your financing questions at

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This article was originally published in the April 1999 print edition of Entrepreneur with the headline: Borrowing Trouble.

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