Financing Without Borrowing
Other alternative financing options for small business owners
In today's world we can't escape the doom-and-gloom press, and the constant reminders about the bad economy and tight credit. But here's the good news. There are a variety of alternative funding sources that can replace or complement bank financing. These alternative sources of funds work well for companies with no prior credit, less than favorable credit, or inadequate credit lines.
One alternative is Factoring, or accounts receivable financing. Factoring is the process of selling your outstanding receivables in order to get immediate payment; instead of waiting for a customer to pay in 30, 60 or 90 days. Factoring is not a loan. So the approval process is based on the quality of your customer, not on your own credit rating. Factoring helps new companies with tight working capital, growing companies who need additional cash to take on new or larger clients, and established companies who want to limit the use of their bank credit line in order to protect their credit rating.
Factoring is common in Europe and Asia, and becoming more popular in the US. This is an industry that's seeing more competition. So Factors are starting to compete for your business, which is causing discount rates to fall.
The process includes three steps. First, you sell an invoice to a Factor. Second, the Factor sends you the advance, which is typically 80-90% of the dollar amount of the invoice. And they hold back a 10-20% reserve. Third, when the Factor receives payment from your customer, he releases the reserve less the discount.
Here's an example with an 85% advance rate, and a 3% discount on a 30-day invoice. You sell a $1,000 invoice, and receive $850 within 24 hours. When your customer pays the invoice within 30 days, you get an additional $120 and the Factor retains a $30 fee. So at the end of 30 days you get $970 for a $1,000 invoice.
Typical Factoring clients include: media buyers, high school tutoring, doctors and medical device manufacturers, architects, engineers, construction GCs and sub-contractors, building suppliers, security firms, custodial firms, pest control, temporary staffing, all types of manufacturers, machine shops, printers, and printing suppliers. In fact, any company with commercial invoices and credit-worthy customers can be an appealing candidate for a Factor.
Discount rate is a primary consideration when evaluating an offer. The average discount across all business categories is about 3% for a 30-day invoice. This fee may be tax deductible as a business expense, but always work closely with your accountant to stay on top of any changes to the tax laws. It's easy to find offers touting rates as low as 1%, but be careful. It's critical to calculate the Effective Rate. Many low rate offers include a variety of fees that drive up the actual cost.
There are a variety of options from spot to relationship. Spot provides the most flexibility. Relationship involves a higher level of commitment, but the higher volume allows you to negotiate a lower discount. Keep in mind that Factors are more flexible than banks, and more willing to negotiate.
Phyllis Brown is Principal at Capital Consulting Group that helps companies save time and money by finding the best factor to meet your business needs.