The Balancing Act of Factoring Invoices

In past articles I have addressed the need for understanding your client’s business as well as having a consistent set of policies and procedures to ensure you effectively manage the risk of factoring invoices.

However, what happens when you run across those out of the box deals that do not fit nicely into your company’s comfort zone?

Instead of immediately throwing these deals away you might want to consider some adjustments you can make to mitigate the risk.

Although we all like to fund deals that are in our sweet spot in terms of size and industry, I have found that some of our best success stories were with clients in industries that we never would have imagined funding. Some past examples include speech therapists, a startup that refurbishes calculators and sells them to school districts, specialized welders and a company that only cleans out storage space units. I didn’t read about any of these types of companies when I was writing our business plan several years ago.

So what step should you take before funding the out of the box type of client?

Before I get into any general methods that we employ at our company let me preface it by mentioning there are several fantastic factoring experts that will gladly assist you (typically for a fee) in your quest to become an invoice factoring company or broker. Before we opened our doors we worked with several seasoned factoring professionals and their input was worth their weight in gold.

First let’s start with clients who have only been in business for a short amount of time. This is a very common occurrence in factoring since banks will not usually lend to startups unless they have a rock solid business plan and sufficient collateral to back the loan. Startups can be in well seasoned industries such as transportation or apparel or be in a unique industry like some of the ones I mentioned earlier. One of the biggest challenges with trying to fund a company that has been in business for only a few months is their lack of historical results. They typically do not have any financial statements yet alone an account receivable history with their customers.

Several questions need to be answered when trying to fund startups. Do they have any past experience in their industry? What are the typical payment speeds of their customer? If your client doesn’t have any past history in their current venture this should raise a red flag. Obviously you will need to thoroughly verify every invoice to ensure the product has been shipped or the services have been completed.

A note to new factors, verifying invoices is one of the most difficult jobs that any factor has to perform. In many cases you will have to interact with an accounts payable person who basically feels this is just extra work for them for which they get no real benefit. This isn’t always the case but be prepared.

Many times the verification process isn’t always black and white. Several years ago we funded a few invoices with an apparel manufacturer that sold to one of the largest clothing stores in the country. When you called the 800 number to verify the invoice the only thing they would tell you was that the goods were received in the warehouse and would be inspected in a week or two. You as the factor have a client looking to get their advance yesterday since they have several more orders and desperately need the cash. How do you handle this one? I’ll save that answer for a future article about the joys of invoice verification.

Back to startups, what options do you really have when there isn’t any account history to use during your evaluation? Here are a few suggestions:

• Start with a lower credit limit. Since your client’s payment history with their customer is limited have your proposal start with a smaller credit line with the option to increase as conditions are satisfied. Typically you will want to see a clean payment history over a specified period of time to satisfy your risk tolerance. This is usually a tough sell since the client will want to fund every invoice they produce regardless of any contractual limit. In many cases you may lose the deal to another factor with a higher risk tolerance than yours. Experience has taught us that most startups have unrealistic revenue expectations and in most cases fund less than they originally forecasted.

• Setup a separate reserve. Many factors call this a rainy day type fund to have in the event of some unforeseen occurrence. This can be accomplished several ways including withholding advances, rebates or simply having the client write a check for a specified amount. We have found the most effective way is to withhold a portion of the client’s rebates until they reach the agreed reserve amount. This method allows the client to fund their invoices in a normal day to day fashion without feeling the upfront hit to their cash flow.

These are just a few simple suggestions you can use when thinking about funding new clients. There are several other methods to perfect your security interest including estoppel letters, liens and specific contract language that experts in this industry can advise you in greater detail. At the end of the day it comes down to balancing your risk and selling it to the prospective client. You’ll win a few and lose a few but most important is that you stay in the game.

Don D’Ambrosio is the president of Oxygen Funding, Inc., an invoice factoring company located in Lake Forest, California. Don has over 25 years experience working in the commercial and residential finance industries. He previously served as Controller of a commercial insurance agency and as Chief Financial Officer of a publicly traded mortgage company. He can be reached at 949-305-9300 or don.dambrosio@oxygenfunding.com.