by Bill Steele

Created on: August 25, 2008

Financing a business through factoring your receivables can be a good solution for a small business, and helps close the time gap between disbursing your funds to acquire your product or service, paying your establishment overheads, property costs and your staff, and receiving the cash from your customers. It could also give you more finance than you could expect to get from an unsecured overdraft.

But be careful. Consider:

It's expensive. Remember you are paying an administration charge for the facility as well as an interest charge on your borrowings which could well be higher than you would pay on a straight forward overdraft. The administration charge will be a percentage of sales, subject to a minimum so you end up paying for the service whether you use it or not.
They will probably promise you debt collection and credit control services, as "experts" in the field. Don't believe it. Their credit control interventions are likely to be intermittent only when they get worried and so clumsy that they will probably put your customers off your company.
They may well ask you to sign a personal guarantee. Don't. You will be told that factoring companies rarely enforce these agreements they use them only to make sure that directors assist with collecting the receivables in the event of failure. Don't believe that either. They have security over your customer receivables which should be more than enough for them.
They will definitely ask you to sign for a guaranteed minimum period. This means that you are tied in to them for that period whether their service is good enough or not. And they will expect to get their minimum administration charge for at least that minimum period, whatever happens to your business.

If it sounds like I speak from bitter experience, you are right. My business failed because the investor I was working with decided to withdraw his funding. We were half way through the factoring agreement, which meant that the factoring company attempted to extract from me under their guarantee the minimum administration charge for the remaining eighteen months, even though the business no longer existed. After some court action we agreed on a much smaller sum, but it was a nasty experience. I should have been much more careful in the early part of the process.

Aside from the unhappy way the whole thing ended, we were not happy with the way things were conducted. Customers did complain about the techniques used to collect outstanding debts, and the contacts we were given at the factoring company were not good at respomding to queries and sorting out problems. That does not necessarily apply to all factoring companies however.

Just be careful about what you are signing up front. Don't sign personal guarantees. There should be no need as their lending is secured on your debts, and where debts go bad there will probably be recourse to you in any event.

If you do decide to go down this financing route, good luck. When your business is more established, pay them off as soon as you can.

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