Funding is the lifeblood of every company, from bright-eyed startup to venerable industry leader. At various phases over the lifetime of your company, you may find that your cash needs change. While there are plenty of financing options available for businesses, small business invoice factoring — or its closely related sibling, invoice financing — can be one of the most practical. With these types of financing, your corporate and personal credit profiles might not be quite as important as the quality of your receivables; however, as is the case with any type of loan or financing, the more solid the borrower, the better the terms.
One of the most frustrating aspects for any business is the process of waiting to get paid. Between actual payment terms and late payers, you might bill for a service and not see that money for 30, 60 or even 90 days. Especially for companies that are dependent on their cash flow for survival — which most companies are — this can be crippling.
This common business problem is how invoice finance and factoring got their start. Invoice factoring is essentially a cash advance on your accounts receivable, financed by an outside lender. You’ll get the cash you need upfront, and when your customers pay their balances, you’ll net the total received, minus the lender’s fee. There are variations on how invoice factoring actually plays out, but that’s the basic template.
One of the main problems with invoice factoring, however, is that it’s not available to all companies. If you’ve just formed a brand-new startup, for example, you won’t have any accounts receivable to borrow against until your company is up and running. However, even in that case, there are ways to finance your business until you can switch over to invoice factoring, which hopefully won’t be too long after you open your doors.
In any event, invoice factoring is likely to be an important financing option for your business at some point in its life cycle, so you should understand how it works, what it costs and where you can get it. Here’s a look at invoice financing options for six types of companies, ranging from those who need it immediately to those who are planning for it in the near future.
When it comes to getting the best financing, you’re sitting in the catbird seat if you’re a business with five or more years of consistent revenue. After all, you have nearly everything that a lender is looking for, including:
With these types of financials, you can likely have access to any type of financing you would like.
Invoice factoring is certainly an option when it comes to generating financing for an established company. However, as an established business with good credit, invoice financing may be a more cost-effective option for you. The difference between invoice factoring and invoice financing is subtle, but it can save you money if you can qualify.
The important distinction between the two is this: with invoice factoring, you are selling your accounts receivable to a third-party; with invoice financing, you’re taking out a short-term loan using your accounts receivable as collateral.
Invoice financing involves taking out a short-term loan that you pay back after your accounts receivable come due. A simple example may make this clearer.
Let’s say you are owed $10,000 in payments over the coming month. You know that you’ll have $10,000 in 30 or 60 days, for example, but you need that cash flow now to finance your existing expenses. With invoice financing, you use that $10,000 as collateral, receiving about 80 percent in advance, or $8,000. When you finally receive full payment from the customer, you pay back the $8,000 you borrowed, plus an additional fee for the lender.
This type of financing is good for established businesses because it only works with proven accounts receivable and a reliable history of payback — two characteristics of large, established companies. In addition to making it easier to qualify for virtually any type of financing, these solid financial characteristics also lead to lower rates.
If you’re looking to take the path of invoice financing, your credit, while important, is not as critical as the quality of your receivables. Think about what you’re asking a lender to do. Essentially, you’re asking for a cash advance, and you’re not offering any of your current assets as collateral for that money. As you can imagine, lenders will want to make sure that your receivables are as good as gold before they hand over any money. For that reason, you should expect to provide plenty of documentation of your accounts receivable when you apply.
Invoice financing is a short-term process, one that rarely extends more than 30 or 60 days. This can make the fees that invoice financing companies take out seem very high on an annual basis. For example, you might see a monthly interest rate anywhere between 1 percent and 3 percent with invoice financing. On a monthly $10,000 transaction, that might only amount to $100 to $300; however, on an annual basis, that interest rate will be in the high double-digits.
As a well-established business, however, you’re likely to get rates that are towards the lower end of that spectrum. Lenders will reduce rates in exchange for a higher probability of getting paid back, so companies like yours are the exact type of businesses that are in demand.
As a long-standing business, it’s highly likely that you’ll qualify for nearly any type of financing that you can imagine. But again, when it comes to invoice financing, the most important thing for lenders is that your receivables are iron-clad. The longer you can show that your invoices get paid on a regular basis, the more likely you are to qualify for invoice financing.
Invoice financing typically covers somewhere between 70 percent and 90 percent of outstanding accounts receivable. Again, the longer you are in business and the more consistent your revenue history, the more likely you are to get approved at the higher end of this range. Generally, you can expect somewhere around 80 percent of your receivables value to be available for invoice financing.
If you’re not a fan of long loan applications, invoice financing might be a plus for you. In most cases, you won’t have to provide nearly as much documentation for invoice factoring as you would for a traditional loan. This is because the cash advance-like payment you’ll receive via invoice financing is collateralized by your accounts receivable, rather than other general company assets. Thus, to apply for invoice financing, you’ll likely need to provide these types of documents:
If your business also has a documented history of paying back loans on time, you may also want to provide that information to your finance company.
Invoice financing is a short-term solution. If you’re looking for a long-term loan, that’s a whole different product. Most invoice financing arrangements run 30 days or less, although in some cases they may extend to 60 or even 90 days. The bottom line is that you want to get into and out of an invoice financing transaction as quickly as possible, because you’re likely being charged a high interest rate and fees may compound on a daily basis.
Companies with good-to-excellent credit may not be the absolute cream of the crop when it comes to financing, but they are close enough that they can still likely qualify for nearly any type of financing, including invoice financing. As with more established businesses, invoice financing can be a good short-term option for upper-tier credit companies because it’s easy and relatively painless when it comes to documentation.
Invoice financing is a way to collect on your receivables before they become due. It can be a cash flow problem for companies to perform a service or sell a product and then not see the money from that transaction for 30 days or more. Invoice financing allows businesses to get paid right away for sales they make without having to take the short-term cash flow hit of waiting to get paid.
Rates on an annualized basis are very high for invoice financing. However, these types of financing arrangements rarely last for more than 30 days. You’ll often see invoice financing rates anywhere between 1 percent and 3 percent per month. As a cash advance-type fee for monthly services, this isn’t exorbitant, as it amounts to just $10 to $30 for every $1,000 financed. If extrapolated out, however, that translates to low- to mid-double digits on an annualized basis, so you’ll want to keep your financing transactions as short as possible.
With good-to excellent credit, you stand a great chance of getting approved for almost any kind of loan. However, your good credit, while helpful, isn’t the most important thing when it comes to qualifying for invoice financing. Rather, it’s the reliability of your accounts receivable. Yes, it’s great that you’ve paid all of your bills on time, and it’s something that lenders will take into account, but what’s more important regarding invoice financing is whether or not your customers are going to pay.
Essentially, with invoice financing you’re taking a cash advance on the good name and credit of your customers, as it is their payments that will pay back your invoice financing transaction. Your good-to-excellent credit may help you get a lower rate, but the longevity, reliability, size and consistency of your accounts receivable book are what will qualify you for invoice financing.
Invoice financing isn’t like a traditional loan, where you’re granted a fixed amount that you pay back in installments. The amount of invoice financing that you can get is based on the total accounts receivable on your books. Typically, you can get financing for up to 80 percent or so of your outstanding receipts, although the range might run from 70 percent to 90 percent. The more reliable your record of getting paid on time by your customers, the higher percentage of accounts receivable you can likely get financed.
The main document you’ll need to qualify for invoice financing is a large book of receivables. Your good-to-excellent credit will certainly not hurt you, but potential lenders will primarily be evaluating the likelihood that your customers will pay what they owe you in a timely fashion. To that end, you should first and foremost provide the following documents:
In addition to these primary items, it can only help to document the good credit history you’ve compiled at your business. Business tax records, account statements, balance sheets and income statements can all help document a minimized level of risk for your lender.
When it comes to invoice financing, the shorter the better, as annualized interest rates can be high. Generally, however, invoices are sent out and paid by customers on a monthly basis, so you can expect your invoice financing to run from 7 days to 30 days on average. In some cases, this can be extended to 60 or 90 days, but the longer you are financing your invoices, the more you’ll have to pay.
Companies with fair credit fall along the middle of the credit spectrum; their credit is not poor enough to block them from many lines of financing, but it’s not good enough for the best types of financing. Still, invoice financing can be a viable option for these types of companies, based on the quality of their incoming receipts.
In some instances, invoice financing can be the optimal choice for companies with fair credit because they may not be able to generate large, rapidly financed loans on the strength of their own credit alone. With invoice financing, as long as payments from customers are coming in regularly, financing can be had.
Essentially, with invoice financing, a lender will look at how much customers owe you and will pay you a significant portion of that incoming revenue before it ever arrives. When customer payments do finally arrive, you pay back the amount your were advanced, plus a fee, to the invoice financing company. Typically, you’ll then repeat the whole process again with the following month’s receipts.
No matter what your credit situation is like, your eligibility for invoice financing is likely to depend primarily on the consistency and reliability of your accounts receivable. As a company with only fair credit, you may not qualify for the best terms with a straight loan. However, invoice financing is usually still available as long as you have a reliable book of business, particularly one that is recurring.
The amount you can receive through invoice financing is based strictly on your accounts receivable. Unlike a traditional loan, which is funded for a strict dollar amount, you’ll receive a certain percentage of your accounts receivable through invoice financing. Typically, you can expect to finance about finance about 80 percent of your receivables, on average. So, if you hold a $100,000 book of receivables in a given month, you can expect to receive about $80,000 in invoice financing.
The primary documentation you’ll need when applying for invoice financing is proof of a solid book of receivables. What lenders will look for is a consistent pattern of regular invoices being sent out and paid in a timely basis. Documents that can help demonstrate this include the following:
If you want to qualify for invoice financing when your company has only fair credit, you’ll need this documentation to be strong. You can provide additional information about your business, such as your balance sheet, profit and loss statement and credit report, but they may not do much to advance your cause. Regular and consistent payments from your customers are the key to success here.
If you’re looking at invoice financing as your funding solution, you’re generally looking at a 30-day term. Some invoice financing can run longer, to 60 days or 90 days, but generally both lenders and borrowers stick to a 30-day schedule, in line with monthly receivables.
If your company has bad credit, you may struggle to find financing for your business. If you are still in business but you have a bad credit history, it means that you have financed your growth through either too much debt or a series of loans that you have failed to pay back. These are the types of credit characteristics that lenders tend to avoid as much as possible. If you find your company in this situation, you may find that invoice factoring is the solution, rather than invoice financing.
Invoice factoring for companies with bad credit can still be problematic. However, it can be easier to obtain for some companies because it puts the finance company in the driver’s seat. With invoice financing, a lender has to trust that a business will collect its accounts receivable and forward payment to the lender. With invoice factoring, the lender itself is in charge of collecting the outstanding debts and then paying them to the issuing company, less the agreed-upon fee.
For companies with bad credit, this can be a more palatable arrangement for a finance company because the money is paid to the lender first; lenders don’t have to worry that companies will use accounts receivable to fund ongoing operations before they pay a fee to the lender.
Accounts receivable factoring rates are typically higher than with invoice financing, in part because the lender has to do more work. Whereas an invoice finance company might charge between 1 percent and 3 percent per month, an invoice factoring company will likely charge somewhere between 2 percent and 4.5 percent per month. The silver lining for companies with bad credit is that credit history isn’t generally as important in determining the financing rate as is the quality of your receivables. Even if your company has defaulted on a few loans, if you can show a reliable stream of paid-in-full invoices over the years, your might garner a rate near the lower end of that spectrum.
Eligibility for invoice factoring depends on your credit history and the type of accounts receivable you have, with the latter being more important. While you might not get approved for a straight business loan as a company with bad credit, as long as your customers consistently pay in a timely fashion, an invoice factoring company will likely take interest. Remember, on an annualized basis rates for invoice factoring can get pretty high, so many finance companies are interested in this type of business — if it seems likely that they’ll get paid back in a timely fashion.
With invoice factoring, you can often finance a higher percentage of your receivables than you could with invoice financing. Whereas with the latter you might be able to finance about 80 percent of your receivables, on average, with invoice factoring, that percentage might jump up to 90 percent. Part of the reason for this is that the invoice factoring company will be the first one that gets paid by your customers.
It’s always a struggle to get financing with bad credit, so the more items you can put in the “reliable” and “dependable” columns on your application, the better. An advantage for bad-credit borrowers when it comes to invoice factoring is that your accounts receivable history is more important than your prior credit history when it comes to getting approved. To that end, anticipate providing this type of information to your lender:
Your lender may also want to take a look at the following:
If your company has both bad credit and a poor history of receivables collection, your options might be limited. However, if you’ve got a number of long-standing customers that always pay their bills on time, you’re likely to find an invoice factoring company willing to work with you.
Invoice factoring is a short-term financing solution, like its cousin invoice financing. Typical invoice factoring terms run for 30 days, although you may be able to use factoring finance for 60-day and 90-day receivables as well.
If you’ve made it through the first few years of business to the point where you are cash-flow positive, congratulations! Many businesses can’t get out of the startup phase to the point where invoice factoring becomes a possibility. From the perspective of lenders, this makes your business more attractive, and less risky, than it was when it was a startup. However, you’re still not quite at that golden point where you can get nearly any type of financing without any problem at all. Invoice factoring can be an option at this stage, but in terms of flexibility, interest rates and terms, your best bet at this stage may still be an SBA business loan.
The Small Business Administration is not a lender per se but rather a matchmaker. Borrowers need access to capital but might still have trouble qualifying for good loans from major banks; lenders want to offer loans but often find smaller businesses too risky. What the SBA does is offer to guarantee 85 percent of the value of any loan provided through its program, thereby protecting creditors from default and providing capital to small businesses.
To be able to provide this type of guarantee, the SBA has a list of restrictions as to which types of businesses can qualify for the program. Typically, startups won’t qualify for an SBA loan, but businesses with a few years of experience are in the sweet spot. Invoice factoring can be an option, but some lenders might charge much higher rates since cash flow can still be sporadic.
Unlike loans offered directly from banks and finance companies themselves, SBA loans have a very specific rate schedule — and it’s fairly low. Larger loans with shorter maturities earn the best rates. Currently, the rate for loans of more than $50,000 with terms shorter than seven years clocks in at the prime rate + 2.25 percent. Longer-term loans trigger an additional premium of 0.50 percent. Lenders are allowed to tack on an additional 1 percent for loans between $25,000 and $50,000, and an additional 2 percent for loans smaller than $25,000.
In many ways, small business financing via an SBA loan sounds like a dream come true for borrowers. Rates are moderately low, and qualification is made easier thanks to the SBA loan guarantee. However, at the end of the day, you’re still applying for a loan through a bank, meaning your business will have to qualify on its own merits.
Beyond having strong financials, the SBA has a list of minimum basic requirements that all borrowers must meet to qualify for the program. In the most general sense, the requirements are that you are truly a “small” business, that your business idea and method of execution are solid, and that have the financial wherewithal to pay back what you borrow. Additional requirements include the proviso that you cannot obtain other types of financing and that you have your own personal financial stake in the business.
For the SBA, most companies that have $1 million or less in annual revenue qualify as a “small business.” However, for certain larger industries, this limit can skyrocket as high as $41.5 million. Still other industries are defined by the number of employees rather than their revenue. In those cases, businesses with between 100 and 1,500 employees are generally considered “small.”
As with so much of the SBA loan program, loan limits are defined. However, for most small businesses, there’s no need to fear a limited loan amount. The SBA authorizes loans all the way up to $5.5 million, so unless your business is really booming, you’ll fall well under the top limit.
While you shouldn’t ever borrow more than your business really needs, the fact that the SBA can authorize high-limit loans can make them a more flexible option than invoice factoring. With invoice factoring, you’ll likely only receive somewhere between 70 percent and 90 percent of your incoming receivables; with an SBA loan, you can borrow enough to cover your cash flow throughout the year.
Of course, as with any loan, the amount you can get is not always necessarily what you should get. Always consider your free cash flow, net income and capital expense needs before you decide on the size of loan you want.
Applying for an SBA loan requires extensive documentation because you are essentially passing through two reviews. First, you’ll have to meet the standards of the SBA itself. Then, you’ll need to get approved by a lender. Basically, anything you can provide that demonstrates you’re a good credit risk should be included in your loan application. The SBA itself requires the following documents, at a minimum:
When you put together your loan application, think about how you are representing your company from the perspective of the lender. Although you may be somewhat established, you’re still not necessarily the ideal candidate for a lender, so the strongest financial picture you can present, the better.
Just like the interest rates, the terms on SBA loans are also well-defined. The longest possible term for an SBA loan is 25 years, but those are only allowed for real estate transactions. Typically, an SBA loan will run between five and 10 years.
There’s an old saying in the financial world that banks only lend money to people or businesses that don’t need it. While that’s an oversimplification, to a large degree it’s accurate. This is because lenders aren’t in the business of losing money, and people or businesses that are desperate for money are often a risky bet. So it goes with startup companies, which by definition have no operating history and no proven ability to pay back loans.
This fact means that startups are more or less in their own category when it comes to raising capital. Unfortunately, it’s particularly difficult for startups to obtain invoice financing, as they don’t have any collateral yet to finance. Before startups can get to the point where they are invoicing clients for their services, they need startup loans to turn on the lights, hire the right people, lease office space or do whatever it takes to get the business up and running. For startups, the first step before undertaking invoice factoring is to find an alternative source of funding, such as Seek Business Capital.
Since startups don’t usually qualify for traditional business loans with big lenders, you’ll want to work with an alternative option like Seek Business Capital. These types of companies can fund startup loans online in a matter of hours, with initial application responses taking just minutes. Since this area of financing is devoid of more traditional lenders, businesses like Seek understand how to work with startups and can even provide specialized business consultants to talk you through the process, either over the phone or in an office.
As an unproven borrower, you should be prepared for the fact that any loans you take out will carry higher rates than you could get as a large, established business. Don’t take it personally — all loans are simply a mathematical calculation of risk and reward. Since there’s no way around the fact that statistically you are a higher risk to a lender, you’ll likely have to pay for that risk in the form of a higher interest rate.
Of course, it’s not always a negative that you can’t work with larger, more impersonal banks. Specialized lenders or finance companies can often be more flexible in the terms they offer to newer borrowers. After all, no one wins if a company is squeezed so tightly by its financing terms that it goes bankrupt. So, take a chance and negotiate with your financing to see if there’s any type of promotional or startup rate that can help get you off the ground. Seek Business Capital, for example, can sometimes offer a 0% introductory APR for certain borrowers, although the rate may become variable after the promotional period expires.
Eligibility for any type of financing can be a roll of the dice for startup companies. Lenders are risk-averse, so they’re looking for borrowers that can easily pay back what they borrow. From the perspective of a lender, consistent cash flow and a long operating history are the bedrock of a strong borrower. These are not characteristics of a startup company, so it can be harder for them to qualify for traditional loans.
Of course, this doesn’t mean that startups have no access to funding. Every company that exists today was a startup at some point, so obviously some type of funding is available. You’ll just have to pick the right lender to work with and provide the right documentation to show that you’re not an extreme risk to default on your financial obligations.
One thing that can help in your quest for financing is to map out your business plan. For most businesses, this is an essential step in starting a company anyway, as it outlines your path to success and profitability. From the perspective of a lender, however, it may well be critical. Lenders don’t have any financial information to base a loan decision on, so you’ll have to prove your ability to pay back your loan in other ways.
With a solid business plan in place, your next step is to make sure your personal finances are in tip-top shape. With no business financials, your lenders will look to the next-best thing, which is your personal finances. You’ll no doubt face a credit check so lenders can examine your past financial history. If you’ve got a long history of paying back debts on time — and if you don’t have a lot of outstanding debt — you’re likely to have a better credit score. If not, take the time to improve these areas before you apply for your financing.
The more flexible your lender, the more likely you can get approved for a startup loan. A company like Seek Business Capital can help you not only obtain a startup loan but can work with you in developing an invoice factoring plan as your company gets rolling.
Although it may be harder to qualify for a business loan as a startup, you might be surprised how much you can get if you do qualify. Seek Business Capital, for example, finances requests of as much as $500,000 if you can qualify. However, you shouldn’t necessarily expect to qualify for this type of loan if you have absolutely no financials backing up that type of amount. Smaller loans will always be easier to get, so apply for just the amount you need to get off the ground. Remember that while it may seem like a windfall to receive a loan in the high six digits, you will still have to pay that money back. If your business can’t realistically afford payments on a large loan, you’re doing yourself a disservice by requesting more than you pay back.
All business loans, from short-term financing to invoice factoring, requires evidence of creditworthiness. As a startup, your business won’t have detailed financials, so you’ll have to rely heavily on the quality of your business plan and your own credit history to get approved. You should expect to provide these documents, at a bare minimum:
As a startup, your potential lenders may ask for additional documentation, including a business license (if applicable), information on competitors and whatever else the lender needs to feel comfortable with the loan. The more flexible the lender, the more willing they may be to work with you even if you have shortfalls in documentation.
Startup business loans are not the ideal market for most lenders. However, if you have a good concept that should be cash-flow positive in short order, you might find that lenders are more eager to work with you in anticipation of future business. Once you get your business up and running, other financing options, from invoice factoring to lines of credit, may be in your future. Lenders that can establish a good relationship with you from the start may figure that they’ll be first in line for your future lending needs, so they may be more willing to work with you from the offset if you have a viable business plan.
Still, you shouldn’t expect to get great terms on your very first startup loan. You should anticipate that your loans will be shorter-term in nature, as lenders take on more risk if they extend loan maturity dates. You may also get relatively high rates until you have demonstrated the ability to pay back your initial loans.
Invoice financing and invoice factoring are two sides of the same coin. Both offer a way for businesses of all sizes to get short-term financing based on the value of their receivables. To help you understand which type of financing option might be the best for your business, take a look at these common questions regarding both invoice financing and invoice factoring.
Invoice factoring is a way to get a cash advance out of your accounts receivable. Rather than waiting 30 days or more to get paid on your existing invoices, an invoice factoring company will buy your receivables and give you most of their value upfront, with the balance — minus a fee — coming after customers make payment.
Under invoice factoring, a third-party lender actually owns your receivable accounts. When customers make payment, it goes to the invoice factoring company. The remaining 10 percent or so of your accounts receivable balance is then forwarded to you, less, the invoice factoring company fee.
Invoice factoring can cost between about 2 percent and 4.5 percent of your monthly accounts receivable balance. Before you sign a factoring agreement, however, verify that there are no hidden fees.
Invoice financing is a way to get a cash advance for your outstanding accounts receivable. It operates somewhat like invoice factoring, but with invoice financing, you still deal directly with your customers, rather than handing off collections to a third-party finance company.
Invoice financing is similar to invoice factoring, but it works more like a loan. Rather than buying your receivables portfolio outright, a lender will use your receivables as collateral for a cash advance. When your receivables get paid, you will pay off the cash advance, along with the invoice factoring company fee.
Invoice finance isn’t as risky for lenders as invoice factoring, as invoice factoring companies are responsible for tracking down customers and coaxing payment out of them. As a result, invoice financing is generally less expensive than invoice factoring. You can expect to pay about 1 percent to 3 percent for invoice financing.
When you hire an invoice factoring company, you will no longer have to worry about chasing down outstanding balances from your customers. One of the main invoice factoring services provided is collection. Customers pay the factoring company directly, and then you net the proceeds, less any fees. There may be a hidden cost in this transaction, however, as you are putting a third party between you and your customer. This may cause confusion among some customers, who may prefer dealing with you directly regarding their payments.
With traditional loans, improving your credit score is the primary way you can increase your chances for approval and get a better interest rate. With invoice finance and factoring, personal and business credit scores are not as important as the quality of your receivables. What makes a “quality receivable?” A history of on-time payments and a full and recurring revenue book are two key elements to getting the best possible invoice finance and factoring rates.
Invoice financing and factoring are both less risky than general loans because they are priced off a known quantity, which is the amount of incoming receivables you have. Since lenders won’t finance the entire amount of your receivables, you have some wiggle room in case some of your customers are stragglers when it comes to paying on time.
Of course, any type of borrowing involves risk, and there’s always the chance that more than 10 percent or 20 percent of your customers fail to pay on time the month that you are financing or factoring your receivables. In that case, problems can happen. For starters, you may have to come up with another way to pay back your lender. Perhaps even worse, this will count as a major black mark when it comes to your next round of financing or factoring, as no lender wants to work with a borrower that has defaulted. Even if you don’t lose your financing in the future, you may face a higher interest rate.
All types of business loans involve some level of risk. When you borrow money, you’re usually making a promise to pay back money that you don’t yet have. If something goes wrong with your business plan, you may end up defaulting on your loan. In some cases, the loan itself may prove crippling, with the required monthly payments sapping your business cash flow to the point that you can’t properly run your business.