When you apply for a loan for your business at the bank, they analyze your past performance to make a credit decision.
First they consider the Owner’s Credit score and report. If the Score is below their established threshold, this will usually disqualify you. Then they will ask how long you have been in business? If for less than 2 years, they will consider you a Start-Up, and you will be disqualified. If your business has experienced losses at any time over the last 3 years, again you will be disqualified. All these factors, and others the banks use, are considerations which are looking to the past in order to attempt to predict your future performance.
With factoring you can overcome these constraints, as we look more to the credit quality of your customers to make a decision. This is opposite to the banks’ strategy, as it is forward looking.
I’m sure you’ve heard of people and businesses that get into financial trouble due to excessive debt. For individuals it is usually with their credit cards. For companies it is with a bank loan or line of credit.
With factoring you can avoid these pitfalls, because factoring is not debt, it is simply accelerating receipt of money that is already rightfully yours, as you have already delivered the product or service to your customer, and are waiting to get paid.
Some factoring companies even provide “non-recourse” factoring, meaning they advance you the cash, and then take on the “risk of non-payment” on the part of your customer, therefore releasing you of the responsibility to collect.
In this low interest rate environment, banks need to charge more fees for their services because they make very little money on loans. If your business is tight on cash, probably you are incurring frequent overdraft and other fees.
I had a client that was being charged over $1,000 monthly in fees by the bank, a lot more than the factoring fees once we started funding their invoices. By improving your cash flow with factoring, you can avoid many of the bank fees.
Here’s an example to demonstrate how focusing on the cost can lead to lost opportunities.
Let’s say you have a business with Sales of $100,000, and a Gross Margin of 30%, or $30,000, and you have an opportunity to grow your Sales to $200,000, high growth of 100% If you can fund this growth with your own working capital, you will now generate $60,000 in Gross Margin.
However many times you internally generated funds are not sufficient to fund such high growth. If you sell to other businesses and have B2B accounts receivable, many times factoring can provide the funding you need to grow at a high rate.
Let’s say the Cost of factoring the additional $100,000 in Sales is 5%, or $5,000. So now at the higher level of Sales of $200,000 your Gross Margin will be $55,000, that is $60,000 less the $5,000 for factoring.
Now I ask you: Which do you prefer? a Gross Margin of $30,000 or $55,000? of course the answer is obvious, but the point of the message is that sometimes you focus on the $5,000 cost, and loose the opportunity of making and additional $25,000 in Gross Margin.
Sometimes factoring is criticized for being expensive. If you compare the cost with traditional bank financing this is true. However I would suggest that this is a mute point as companies using factoring are mostly those that do not qualify for bank lending.
On the other hand, crowdfunding somehow is not subject to this criticism, even though it is much more costly than factoring. Just one fact is enough to demonstrate this: Did you know that you will pay the company promoting your crowdfunding on their portal 10% of the funding received? This is more than double the cost of factoring.
There are 2 kinds of crowdfunding: Equity and Debt. With Equity you are actually selling part of your business to the investors. Why would you want to do that at an early stage of your business, when it is not worth much? Also when you have outside investors owning part of your business, this will put a big burden on your time, with the reporting requirements they will impose on you.
With Debt crowdfunding, not only will you have to pay the company promoting your deal a 10% fee, but you will also have to pay the Debt providers a handsome return on their money, probably over 15% per year.