How To: Factor

Get money to grow! Here's a little-known financing tactic even start-ups can use.
Magazine Contributor
7 min read

This story appears in the November 1998 issue of . Subscribe »

When Buddy Pope needed working capital to grow his young company, Recon Services Inc., his banker suggested he sell some of his invoices to get cash quickly. Pope turned to Dallas-based American Receivable Corp. That was 19 years ago. Today, the Garland, Texas, entrepreneur still sells his accounts receivable each week even though his business, which reconditions steel for oil and chemical companies, has more than tripled in size.

Like Recon Services, many companies sell their products and services without getting paid in advance. But they need cash to pay their employees and suppliers, often before customers pay the invoices. One way to get that cash is to sell their accounts receivable to a third party, called a factor, which pays a percentage of the invoice (known as an advance rate), often within 24 hours.

"Factoring keeps the cash flowing," Pope says. "Customers--especially big companies--want to pay in 45 to 60 days. [By factoring,] I get cash every week without loans or lines of credit."

Most companies don't stay with a factor as long as Recon Services has, says Jack Stieber, a partner at American Receivable. "Our average client stays three to four years; some come back periodically," he says. "We lose a lot of clients to banks [once they qualify for lines of credit and other forms of financing], but banks also refer a lot of business to us."

Businesses that get their payments right away, like restaurants and retail stores, don't typically use factoring. However, a wide range of companies, from manufacturers to consultants, can benefit from this technique. Factoring is especially appealing to start-ups that can't qualify for traditional bank financing and to fast-growing companies that need cash to keep growing or to take advantage of discount prices from suppliers.

Here are nine tips for successfully dealing with factors:

1. Understand the costs. Factoring can be an expensive source of financing. First of all, you get only a percentage of the face value of each invoice--usually 75 to 90 percent right away, depending on your industry. You'll get most of the rest after your customer pays the bill. A factor typically charges a 2 to 6 percent fee, called a discount fee, on an invoice due in 30 days.

Some factors increase the rate the longer the bill goes unpaid--for example, 3 percent if paid in 30 days, 4 percent in 60 days. The lower the amount of receivables you sell, the higher the rate. Some factors may also decide to tack on additional charges, such as audit fees, collateral-maintenance fees and upfront points.

2. Understand the basis on which the factor buys your receivables. Factors buy your receivables based on the creditworthiness of your customers, says Stieber. That's why start-up companies can factor even if they can't qualify for bank loans that require a three-year track record. "We've even [bought receivables] of companies that have major tax liens or are in Chapter 11 [bankruptcy reorganization]," he says.

Bankers who can't make a loan to a business customer sometimes refer him or her to a factor. Pope says his bank also did factoring, but he found a better deal with American Receivable just by shopping around.

3. Find a factor that matches your size and industry. "Many [factors] specialize in certain industries or sizes of business," says Lillyvette Montalvo, president of Star Capital Inc., a Birmingham, Alabama, factoring brokerage that helps businesses find the right match. "I can help companies with $5,000 to $25 million in monthly receivables."

American Receivable's minimum is typically $10,000 a month; however, the company sometimes considers clients with smaller receivables.

4. Understand the length of your commitment to a factor. Many factors require you to sell all your accounts receivable to them for a minimum of six months or a year. If your cash-flow problems are temporary, this commitment can be burdensome.

5. Use factoring to your advantage. Smart entrepreneurs take advantage of the fact that they're getting their money within 24 hours. "[Take the factor's advance rate] into account when setting your budget and prices," Montalvo says, "just as you do when you accept credit cards. Also, many entrepreneurs use that money to get discounts with their vendors for paying their own bills sooner. That offsets some of the cost of selling their invoices."

6. Let the factor help you improve your business. A factor can become an advisor. At American Receivable, Steiber says, "we run Dun & Bradstreet credit checks on prospective customers and stay on top of their late payers. That enables small-business owners to concentrate on growing the business."

7. Recognize who is responsible for receivables collection. Factors buy receivables either with or without recourse. With recourse means that if a bill can't be collected, it will be returned to the seller. Without recourse means the bad debt is the responsibility of the factor. But invoices must be for top, creditworthy companies to be sold without recourse, Stieber says. Also be aware that if a receivable is sold without recourse, the factor may become quite aggressive in collecting its money, which might harm your relationship with a large customer.

8. Once you have an ongoing relationship with a factor, negotiate for better terms. Most factors are flexible with good clients. They're often willing to negotiate terms of an ongoing factoring commitment, such as reducing the discount fee or waiving additional charges. However, few will change the advance rate, because it's based on your customer's reputation and reliability, not yours.

9. Realize you may or may not outgrow the need for factoring. Just as Pope continues to sell his receivables to American Receivable every week, many small-business owners work with factors long after their companies get a line of credit or other financing.

Fast-growing companies often find their lines of credit too small for their needs. "We're almost like an American Express card: no preset limits," Stieber says. "[The ability to factor] depends on the size and creditworthiness of your clients."

There are several ways to find factoring companies. Look in the Yellow Pages under "Factors," or ask for referrals from other entrepreneurs in your industry, bankers, accountants and other professionals. Factoring brokers can help find a niche factor if your business is too small for well-known factors or has special needs, Montalvo says; other business owners in your industry can recommend factoring brokers. You can also search the Internet; many factors and brokers have Web sites.

Whatever method you use to find a factoring company, connecting with the right firm and using factoring wisely is an excellent way to grow your new business without debt.

Good Questions

Get answers to the following questions before doing business with a factor:

1. Does the factor require a minimum dollar amount of monthly accounts receivable?

2. What will the advance rate be?

3. What are all the fees charged? What is the interest rate?

4. Must you sell the factor all your receivables?

5. What is the length of your agreement?

6. Does the factor buy the accounts receivable with or without recourse?

7. Will the factor help you check the creditworthiness of potential clients?

8. Will the factor monitor existing customers' creditworthiness and help track the aging of receivables?

9. How long does the factor hold reserve money after an account receivable has been paid?

Jan Norman has specialized in small-business coverage for 10 years. Her new book, What No One Ever Tells You About Starting Your Own Business (Upstart Publishing, $17.95, 800-245-2665), is now in bookstores.

Contact Sources

American Receivable Corp., (800) 297-6652,

Star Capital Inc., (888) 421-STAR,

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