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Companies faced with a cash-flow squeeze and slow paying customers can quickly find their own credit ratings at risk and difficulty securing a credit line or loan. Receiving an advance against invoices or accounts receivable from asset based lenders called factors can be an optimal solution for securing cash needed to grow, when you don’t quite qualify for a traditional loan. Many don’t realize that factor financing can be a good source of capital for high growth or start-up companies. The factor advances most of the invoice amount, usually 70-90 percent, after reviewing the credit-worthiness of the billed customer. When the bill is paid, the factor remits the balance, minus a transaction (or factoring) fee. If you are going to consider factor financing, it is important to understand the different options. In non-recourse factoring, the factor accepts specified risks around the debtor's failure to pay. In other words, the credit risk has shifted to the factor and if the debtor (your client) does not pay, you are not required to pay back the factor for the advance against the factored invoice. While this might sound like a great option, non-recourse factoring is very expensive and the factor becomes the aggressive collection company pursuing your clients. The factor takes over all rights to pursue the customer for payment. This includes the right to take legal action. In recourse factoring, the factor does not take on the risk of bad debts and the credit risk remains with you. Put another way, the factor will be able to reclaim their money from you if the customer does not pay. Whether you refund the advance or not, you will still have to pay the fee and interest. Recourse factoring is cheaper than non-recourse factoring and may have fewer requirements concerning your customers and your systems. When choosing recourse factoring, it is important to protect your company against credit risk, since you retain the credit risk of non-payment. In the event your customer goes bust or just doesn't pay, you are ultimately responsible for any funds advanced to you by the factoring company. If you sell on open credit to your customers, there will be times when you are concerned about repayment. If you don’t want to be on the hook for all the credit risk, trade credit insurance may be an option. Trade credit insurance insures manufacturers, traders and providers of services against the risk that their buyer does not pay (after bankruptcy or insolvency) or pays very late. The trade credit insurance premium will be based primarily on the credit profile of the customers you are insuring against. The trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75- 95 percent of the invoice amount, but may be higher or lower depending on the type of cover that was purchased. Before deciding what the best option is for your organization, do your homework, ask questions and get referrals. Robyn Barrett is founder and managing member of FSW Funding, formerly Factors Southwest LLC, specializing in factoring financing for small to mid-size companies. For more information, visit www.fswfunding.com.
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