Small businesses owners are the unspoken heroes of the American economy. These entrepreneurs and risk takers set out to change the landscape of an industry or do what they love. But finding extra cash flow to pay off unexpected costs or weather late payments from clients is one of their biggest issues.
Getting extra money from traditional banks and lenders tends to take too long, in most cases, and is not efficient for their bottom line. Fortunately, there are several routes small business owners can take to receive funding for expansion, growth and improved liquidity. One of these avenues is invoice factoring, which allows small businesses to sell unpaid invoices to a third party for immediate cash, giving them immediate working capital to help bridge a funding gap created by slow-paying customers or clients.
This is the most effective solution for small operations and is also one of the most obtainable. It allows business owners to access money quickly without accumulating new debt, which can be risky and, more often than not, force small businesses out of business.
How it works:
- The company sells its unpaid invoices to a third party lender, usually a small business capital provider such as Par Funding.
- The third-party lender verifies the invoices and then infuses the small business with a payment of up to 90 percent of the value, the same day.
- Customers then make payments directly to the factoring company, which will return the balance of the paid invoices minus a fee, when all invoices are collected.
Here are the pros, when considering invoice factoring:
- Get Unsecured Financing: Invoice factoring is unsecured financing, so it doesn’t require an asset, such as real estate or inventory, which the lender can seize if you fail to pay.
- Gain Immediate Capital: It can provide fast cash, so capital is available immediately to cover a funding gap.
- Use an Alternative to Traditional Banks: Invoice factoring provides an opportunity to secure financing for companies that may have a difficult time acquiring capital from a traditional bank due to a lack of collateral, a below-average personal credit, or a limited operating history.
- Create Better Cash Flow: It can also enable companies to keep loyal customers on longer payment terms without stifling cash flow.
Here are the cons to consider when deciding whether invoice factoring is the best option:
- Consider the Fees: There are nominal costs associated with application and processing fees to consider, including credit check fees and late fees, if a client is past due on a payment. These late payments can trigger an increase in the annual percentage rate, which may increase the annual cost of borrowing money.
- Weigh the Third-Party Involvement: The invoice factoring company will collect on the invoices directly, which means the client will no longer pay you directly for the invoices in question.
- Question Clients’ Creditworthiness: Clients with poor credit or a history of late or missed payments may not be approved for the financing. So the creditworthiness of your customers will come into question.
- Know What Happens if Invoices are Unpaid: Similarly, there is no guarantee the invoice factoring company will ultimately collect the unpaid invoices and, if the clients do not pay them, you may be required to buy back the unpaid invoice or replace it with another one that is worth as much or more.
In the end, invoice factoring is the most viable solution when a business is in a cash crunch and doesn’t have the luxury of time. However, it is not the same as working with a collection agency to get paid for delinquent invoices. So, it’s important to consider whether your clients will be deemed reliable and financially stable enough to pay back the invoice factoring company, before deciding which invoices to sell them.
But with employees waiting to be compensated, supplies to be bought and rent to be paid, small business owners may ultimately find that invoice factoring gives them greater stability and liquidity, as they continue to grow or scale.
By Joseph Laforte, Par Funding
About the Author:
As the director of sales at Par Funding with more than 20 years of finance industry experience, Joseph Laforte is one of the small business industry’s most distinguished and accomplished leaders. He has steered the company through various market shifts and industry changes, and led Par Funding to unprecedented growth. Since 2013, Par Funding has helped more than 5,000 clients, assisting small and mid-size businesses access working capital when it matters most.