Factoring, also known as AR financing, has a history reaching as far back as Mesopotamia, where producers and merchants employed mercantile agents to manage the sale and delivery of goods in return for trade credits. It was later adopted by ancient Romans, gained popularity through the Middle Ages, and deployed during the colonization of North America. While factoring has been around longer than most of us can grasp, the cash flow solution remains somewhat opaque to many business owners and financial professionals.
LSQ has helped businesses obtain billions in working capital since its founding in 1996, and we’ve likely heard every misconception about factoring that exists. Here we’ll shed light on some of the most popular myths we’ve heard over the years by counting down the top five, separating fact from fiction along the way.
The truth is that alternative lending companies, including those that provide factoring, called factors, are willing to take on more financial risk than traditional lenders. Meeting the distinct needs of businesses that don’t fit the conventional mold requires additional flexibility in how factors approach timelines, terms, and conditions.
Factors do business within the same ecosystem and often partner with bankers, turnaround experts, and other financial professionals likely to get “first looks” at companies seeking to obtain working capital. Most factors, including LSQ, do not compete directly with traditional lenders. Instead, they serve a percentage of the businesses that do not meet the bank’s lending standards. This leads factors to be more flexible and creative in how they structure a credit facility to provide access to liquidity.
Factors don’t exclusively focus on assets and liabilities. They also take into account the business’s customers’ credit data and future opportunities, which benefits small and medium-sized businesses (SMBs) two-fold. The first and most obvious benefit is that a company can leverage dealings with larger enterprise organizations to obtain working capital and increase funds available as they scale. Secondly, factors help mitigate the risk of bad debts by reviewing and determining the creditworthiness of client customers, promoting a healthy flow of working capital.
Our take: Flexibility is a primary feature of factoring.
A large part of LSQ’s client base consists of businesses either unable to meet stringent loan requirements or turned off by the lengthy application process innate to traditional lending. Factors assess creditworthiness in a manner designed to get working capital to small-to-medium-sized businesses (SMBs) more easily and quickly without requiring covenants, down payments, or fixed assets as collateral.
Factoring is indeed an excellent tool for savvy startups, and there are numerous venture capital and private equity firms that have leveraged it to their advantage. This myth, however, likely has to do with the fact that financing is often difficult to acquire for startups and young businesses— creating a subsegment of underserved entrepreneurs.
When you’re starting out, you need enough capital to make payroll, pay taxes, utilities, rent, inventory, advertising, and equipment— the list goes on. Not to mention having enough cash on hand to fill larger orders, chase new opportunities, and expand your offerings. But this scenario isn’t specific to startups; every organization to some degree has these or similar financial considerations to manage. The difference is that startups are rarely approved for sufficient financing from traditional lenders due to insufficient assets and operating history.
Factoring’s methodology lends itself to the circumstances and obstacles experienced by startups. This has led to many startups crediting factoring’s accessibility and scalability to their success. The somewhat symbiotic relationship between factors and young businesses could be the source of this myth.
Our take: Factoring may be niche, but it’s not that niche.
It’s not that factoring is exclusively for startups, but that it is exceptional at providing growth-enabling capital at a point in time when traditional funding is not an option. A startup is typically asset-light with little operating history, almost certainly disqualifying them from conventional financing during a critical stage of their business life cycle. Factoring works well to fill this funding gap for a fixed or indefinite amount of time.
Businesses can be deemed “unbankable” or not creditworthy by traditional lenders. As unfavorable as these terms may sound, they aren’t the end all be all for companies looking to boost cash flow, and it certainly doesn’t define them as being in poor financial health. Like startups, many SMBs fail to qualify for bank financing and discover factoring through research or referral.
Given that factoring leverages unpaid accounts receivable to help businesses get paid faster— it simply doesn’t add up that factoring would serve a failing business very well. Without quality debtors and outstanding accounts receivable, an SMB would not meet the two most vital requisites to obtain working capital from a factoring company.
Our take: Factoring often helps “unbankable” businesses, but it can’t save a failing business.
Being unable to obtain bank financing doesn’t disqualify a business from acquiring working capital. Factoring has proven itself an ideal solution for many SMBs that have been turned down for traditional financing. However, if a company isn’t earning sufficient revenue or its customers show a history of defaulting on payments, factoring would be impractical and likely inaccessible.
With ever-advancing technologies and increased competition, factoring has come a long way from the days of clients faxing invoices and verifying funds over a landline. Today’s landscape of factoring-related products and services offers businesses diverse, well-designed, real-time cash management solutions.
Modern factoring platforms can intake electronic files to provide up-to-date aging reports, collection reports, and other payment data to help companies digitally manage cash flow. Another consideration to take into account are limitations on funds available. It’s important to have funding that scales with you so you don’t suddenly outgrow your factor and need to establish a new funding relationship at an inopportune time.
Because the initial need is cash-based, services provided by alternative lenders tend to become an afterthought. Still, prospective clients would be wise to learn the services included to compare and determine if there are additional benefits to consider. Back office services, including invoice verification, cash posting, and collections are frequently available or included.
Our take: Technology and increased competition has modernized factors and created a diverse landscape with distinct offerings.
There are numerous aspects factoring providers can focus on and invest in to provide clients unique solutions and experiences. For example, LSQ bakes in cutting-edge technology and dedicated services that enrich client experiences and reduce the need for additional resources in non-revenue-generating segments of the business. In addition, we provide facilities up to $50 million (the highest in our industry) to afford clients peace of mind that we can support a variety of growth patterns.
What would any list about factoring be without addressing the proverbial elephant in the room? Is factoring more expensive than traditional financing? Yes, but it’s also less expensive than a merchant cash advance— a multi-billion dollar industry. Factoring is a financial tool, and like all tools, there are instances where it’s the best option, and instances where it isn’t. When considering factoring, it’s important to evaluate the cost of capital and what your business can achieve with that additional cash to determine the potential opportunity cost.
It’s estimated that 60% of invoices in the U.S. are not paid on time ; and with U.S. days sales outstanding (DSO) averaging 50 days , it’s no wonder many businesses prefer getting paid in near real-time for a nominal fee. They may want to put those funds to work immediately and reinvest in a new product or service, or perhaps they need to staff up for a big contract or make payroll. Others may simply prefer increasing the predictability of their cash flow.
Our take: Know your opportunity cost.
Businesses that factor their accounts receivable have determined that the opportunity to quickly grow and generate more revenue for their intended purposes is worth the terms outlined by their factoring provider. While alternative lending can cost more than traditional financing, businesses can utilize the capital to successfully manage their objectives without increasing debt.
Many industries, including manufacturing, oil and gas services, and transportation, find that alternative lending is the ideal solution given their circumstances. For others, like staffing and consulting firms, factoring’s ability to quickly advance on unbilled receivables, such as time cards, can serve as a long-term solution to payroll funding.
We hope this post helps clear up some of the myths you may have heard about factoring. To learn more about LSQ and how we can help your business— Contact Us.