Invoice factoring allows business owners to sell pending invoices to factoring companies in exchange for immediate cash. Generally, these factoring companies are the ones responsible for collecting payments from your customers. This means that your customers will pay their dues directly to the factoring company, not you.
However, the problem with this set up is that no business owner wants their customers and suppliers to know they are struggling with cash flow problems. If your business needs immediate funding but values confidentiality, you might want to check out confidential invoice factoring.
With the number of factoring companies in the market, it can be hard to choose the best one for you. Here are two things you need to look for.
Privacy is a concern among many small business owners. There are factoring companies who offer confidential invoice factoring. Instead of handing over your ledgers to factors, this type of invoice factoring allows you to remain in control of your accounts.
Most lenders run credit ratings before approving you of a loan. Once lenders check your credit, it takes a hit on your score and it’s going to be visible for other institutions that run your credit. Fortunately, most factoring companies are not concerned with your credit rating; some of them don’t even run credit checks. They’re more concerned with the credit rating of your customers since they’re technically the ones paying for the loan.
If privacy is a major concern for your business, make sure to ask potential lenders if they are going to run your credit and if the results are going to be visible in future credit reports.
2. Recourse vs. Non-Recourse Factoring
Before applying for invoice factoring, you need to know the difference between recourse and non-recourse factoring.
Recourse factoring is the most common type of invoice factoring. You’ll be held liable if any of your customers fail to pay their invoices. The factoring company has the legal right to demand repayment for the defaulted invoices. You can pay them back with cash or provide them with new invoices of the same value.
On the other hand, non-recourse factoring is similar to the recourse factoring, except you don’t have to pay back the factoring company if your customers default on the invoices. Many business owners automatically assume that non-recourse factoring strips them of their responsibilities if a customer doesn’t pay. However, this is not the case for most factoring companies. For non-recourse factoring, the reason for the default has to be insolvency, meaning a bankruptcy or closure. Furthermore, the insolvency must occur within the factoring period. While non-recourse factoring offer protection, it’s not as comprehensive as many people think.
When applying for invoice factoring, make sure to closely examine the contract before agreeing. It also helps to check the contract with a competent attorney. If you want to know more about invoice factoring, SMB Compass can help.