In business, companies often face financial challenges. especially in the construction industry. From handling large projects with extended payment terms to managing seasonal fluctuations, the need for reliable cash flow is paramount. Traditional financing options like bank loans or lines of credit may not always be accessible or quick enough to meet these demands. This is where alternative financing from factoring companies comes into play, offering an alternative solution that can provide immediate financial relief and ongoing support.

What is a Factoring Company?

A factoring company provides financial services by purchasing your outstanding invoices at a discount. This transaction provides your business with immediate funds, which can be crucial for maintaining operations without the wait typically associated with client payments. Unlike traditional lenders that offer loans, factoring companies buy your receivables, thus providing cash without increasing your company’s debt load.

With over 353 factoring companies currently operating in the US, the factoring industry has become a significant component of business financing, offering a robust alternative to traditional credit solutions. This prevalence underscores the trust and reliability businesses place in factoring services, especially in sectors like construction where cash flow is critical.

How Do Factoring Companies Work?

The Factoring Process:

The process that a factoring company uses to assess then send funds to a business is a relatively simple one:

  1. Pre-Approval/Application: After a general “fact finding” call and you both agree you are a good fit for factoring, you will be asked to send a few basic documents and forms to become a client.
  2. Invoice Submission: Your company completes a job and issues an invoice to the client. You then also submit the invoice to the factoring company.
  3. Verification and Advance: The factoring company verifies the invoice and “advances” a significant percentage of its value (typically 70-90%) to your business within 24-48 hours.
  4. Client Payment: The factoring company waits for your client’s payment according to their normal payment terms.
  5. Balance Payment: Once the invoice is paid in full, the factoring company sends the remaining balance to you, minus their fees.

Why Factoring Companies Work Well for Construction Businesses

Factoring works well helping many industries but it can be particularly supportive for those in the construction trades:

  • Project-Based Billing: Factoring can be especially beneficial in dealing with the project-based billing cycles of construction, where payments can be delayed until project milestones are reached.
  • Handling Retainage: Construction contracts often include retainage – holding back a portion of the payment until project completion. Factoring can work with these arrangements by providing funds during project milestones, ensuring constant cash flow.

Benefits of Using a Factoring Company for Construction Financing

Factoring can offer several advantages over traditional financing methods like bank loans, particularly for construction businesses:

  • Quick Cash Flow: Enables companies to maintain continuity and liquidity without the wait for client payments. This benefit is crucial because it is typical in the construction industry for accounts receivable payments to take 30-90 days. When construction companies have multiple projects overlapping or limited numbers of contracts, these cash flow gaps can significantly impact their ability to operate efficiently, pay bills, or take on new projects.
  • Easier Qualification: Since factoring companies focus on the creditworthiness of your clients rather than your company, it is generally easier to qualify, even with less-than-perfect credit.
  • No Collateral Required: Unlike secured loans, factoring doesn’t require physical assets as collateral, which is beneficial for new or growing companies without significant capital assets.

Industry-Specific Challenges and Factoring Solutions

Construction businesses often face hurdles with traditional financing. Common push-back of banks and other lenders can be due to the cyclical nature of the industry, high project costs, and payment disputes. Factoring addresses these challenges effectively:

  • Credit Issues: Construction companies dealing with credit issues or have minimal history can still receive funding. The approval process looks primarily on the credit of the customers and not construction company.
  • Flexible Funding: Factoring provides a flexible line of funding that adjusts with your invoicing, ideal for the fluctuating workload of construction projects.

Case Studies and Real-World Applications

For instance, a mid-sized subcontractor specializing in masonry faced delays in payment that threatened to halt their operations. By turning to factoring, they were able to receive 80% of their invoice value upfront, allowing them to meet payroll and take on new projects without interruption. This case, detailed on the CapitalPlus website, showcases how effective factoring can be in addressing industry-specific financial challenges.

Comparing Factoring to Other Financial Solutions

Factoring stands out particularly well when compared to other popular options for construction businesses like bank lines of credit or Merchant Cash Advances (MCAs):

  • Bank Lines of Credit: Often require extensive credit checks and collateral which might not be feasible for new or expanding companies.
  • Merchant Cash Advances: While quick, MCAs can carry high costs and risks, especially if the business’s cash flow is unstable.

Transparency and Fee Structures in Factoring

Transparency in fee structures is crucial. Prospective factoring clients will (if working with a reputable factoring company) understand all fees, including service charges, processing fees, and any potential additional costs. This transparency ensures that businesses can make informed decisions and maintain trust in their financial partnerships.

>> LEARN MORE: All Factoring Fees & Contract Terms You Need to Know

Additionally, it is important to note that because factoring involves the purchase of invoices rather than the provision of a loan, factoring companies are generally not subject to the stringent state and/or governmental regulations and compliance issues that burden traditional lending institutions. This regulatory flexibility can often result in quicker processing times and fewer bureaucratic hurdles for businesses seeking immediate cash flow solutions.

What’s Next?

Factoring companies offer a practical financing solution for businesses, helping them navigate the financial complexities of the industry. With faster access to funds, less stringent qualifications, and no requirement for collateral, factoring can be a pivotal resource for maintaining and growing your construction business.

Now that we have answered the question “what is a factoring company?” you now hopefully have the understanding how make the best financial choice for your business. Next steps? You need to know how to pick the right factoring company for your construction company. And if you have questions, reach out. We will be happy to help you assess your situation for fit.

Curt Powell VP of Sales

About the Author:
Curt Powell — VP of Sales
Joining the team in 2016, Curt serves as the Vice President of Sales at CapitalPlus Financial Services, a direct lender based in Knoxville, Tennessee focusing exclusively on the construction industry. During that time he has walked thousands of business owners through the financing options to find the best solution for their needs.

Curt is a member of The International Factoring Association, The Association of General Contractors, and the Construction Financial Management Association.

CapitalPlus was established in 1998 providing over $1 billion in factoring funds empowering thousands of construction companies all over the US.

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