The Post-Banking Loan Factoring--an expensive way to get cash fast--is on the rise. But before you take the money, take a hard look at the deal.
Say you're a young startup--growing fast, but with little-to-zero positive cash flow--and you're straining to reach the next level or just to get through the end of the month. The bank-financing drought is showing no sign of letting up, and of course credit lines are reeled in tight.
What's the answer? For a growing number of startups, it is factoring. The practice involves a financing company, or "factor," advancing you money based on its buying your receivables at a discount; your customers pay the factor the full value later, when the bill is due. Factoring gets you cash in hand immediately--but at a steep price. Factoring fees are much higher than interest rates charged by a commercial bank. Fees are quoted by the month, so a typical 3 percent fee is actually the equivalent of a 36 percent annual interest rate.
Dealing with a factor can also be much more difficult than with a commercial bank. Banks are highly regulated, offer competitive rates and commoditized lending services, so entrepreneurs can, with few exceptions, easily anticipate the cost and terms of their small business loans. But factoring is very fragmented. Most factor financing is provided by smaller, unconventional lenders. It is much less regulated and the quality, reliability and integrity of factors vary widely.