At some point, all businesses suffer from growing pains resulting in a cash flow shortage.
Additionally, every company has clients who pay slower than the agreed-upon payment terms. This often results in vendors or suppliers breathing down your neck for payment. When you’re feeling these pains, a great solution for immediate and positive working capital is invoice factoring, especially in construction.
What is Factoring?
Going by many names like AR financing or receivables financing, invoice factoring is a financial process where a factoring company will purchase a business’s unpaid invoices at a discounted rate or for a factoring fee. The factoring company will then pay, or advance, the business a percent of the invoice upfront. When the invoice is fully paid, the factoring company will then return the remaining percent to the business minus a factoring fee. The benefit is that it is better to receive a majority of the invoice amount quickly than risk missing payments during the wait.
Factoring is most often used to fund the expansion of rapidly growing businesses. You have to go through a moderate underwriting process, but most of the focus is on your client, their creditworthiness, and their ability to pay.
Factoring is flexible. It’s there when you need it for your next project, and most of all, it doesn’t generate debt or long-term obligations, which can weigh down the balance sheet. And with options like single invoice (spot) factoring or volume factoring you can pick the perfect amount of working capital for your needs.
Factoring offers fast working capital. When you sell your invoice to a reputable firm, you’ll get working capital as soon as 48 hours for your completed work. Meanwhile, the factoring company waits to be paid by your client. It can really be that simple.
Other Financial Options May Be Enticing But…
Traditional lines of credit from a bank can be economical and are a great option. This usually applies to many larger firms with solid cash flow. However, young, smaller companies, companies with cash flow struggles, or those in the construction industry are likely to be considered “unbankable.”
>> READ MORE: Why Banks Hate Working with Construction Businesses
If you are fortunate enough to get a line of credit, you may find they’re capped and often cannot grow with your firm. This leaves you tied in a knot trying to figure out how to fund your growth.
If you don’t know much about them, Merchant Cash Advance loans sound great up front. With little to no menacing underwriting, you can get quick cash! But here’s the catch…
MCAs frequently come with hidden fees. Plus, they’re often very expensive, they draft directly from your bank accounts, and they add debt to your company. In many cases, you could find yourself stacking MCA loans on top of one another just to make ends meet. This can result in outrageous and crippling interest fees that could kill your business.
All Factoring Companies are NOT Created Equal
Factoring is, in fact, often a better solution. But it’s important to recognize all factoring companies are different. Do your homework before engaging a factoring firm. Understand the products they offer and know what to expect about how they operate.
Basic questions to ask when considering factoring:
- “Do you offer recourse or non-recourse factoring? What is the difference in pricing?”
- “Do you offer spot factoring?”
- “Do you require our company to factor all invoices? Is better pricing available for contract or volume accounts?”
- “Do you have a monthly minimum? If we do not meet that minimum, how much will I be charged?”
- “What happens if my debtor is not willing to work with a third party?”
- “What are ALL the fees I will be paying?”
>> IN-DEPTH READING: How to Choose the Best Factoring Company for Your Business
Possible “Additional Fees” When Factoring
Quotes or term sheets can be complicated. Look under the hood for hidden fees. Only a few factoring companies offer a one-time rate based on the invoices you fund.
Many factoring companies will at least charge a startup or origination fee, underwriting fee, and early termination fee. But there might be others. Here is a list of common fees that can be part of the agreement:
- Origination Fee
- Underwriting Fee
- Late Fee
- Termination Fee
- Wiring/ACH Fee
- Due Diligence Fee
- Annual Review Fee
When you are assessing a factoring company and get a quote, don’t be afraid to ask if there are any other charges or “hidden fees”. Be sure to read over your term sheet and contract thoroughly and add up all the fees before making your final decision.
>> IN-DEPTH READING: All Factoring Fees You Must Understand About
We will be the first to tell you that factoring is not a perfect fit for every business. Over the past 25+ years, we have worked with thousands of construction businesses in different lifecycles and financial situations. Some were a perfect fit at that minute, others were a perfect fit… just not at that moment. This being said, knowing if invoice factoring is a fit requires an assessment call. Give us a call at 865-670-2345 or schedule a meeting. We will be happy to assess the possible fit of your construction business.
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