The factoring industry is in need of a facelift. While the concept of selling unpaid invoices to someone who has the cash up-front has been around for centuries, modern-day financial services present companies with a slew of different options to access capital. Meanwhile, factoring has developed a reputation for lacking transparency, under-cutting businesses with high fees and using harassing collection tactics.
But factoring, otherwise known as accounts receivables (AR) financing, can play an important role in the health of a company, particularly small businesses. As companies struggle to manage longer payment terms, traditional banks will often turn away young firms for lack of solid credit history and assets to underwrite a line of credit or other loan product. AR financing can provide the working capital necessary to stay afloat while a company builds up revenue streams.
Jack Stieber, president of American Receivable Corporation, said companies can find success with their factoring strategies if they find the right partner, placing the emphasis on customer relationships for the AR financing world. What's important to recognize, he told PYMNTS, is that factoring is a link that supports business growth until a company is solid enough to seek bank financing or fund invoices themselves.
"For most banks, a startup must be somewhere profitable before they can get a line of credit," he said. "But if they use a factoring program properly, it can help them grow – and we let them grow as much as they want."
Steiber added that American Receivable helps companies with the collections process and provides credit checks to support business growth, all with the understanding that that client will eventually move on to access bank financing a few years later.
"That's what factoring is here for," he added. "It's bridge financing."
The factoring industry would see opportunity in collaborating with lenders, too. Stieber said traditional lenders will often refer their small business customers to a factoring company like American Receivable if rejected for a bank loan, or if bank financing is not enough for a company's working capital needs at the time. A company may be able to access a $100,000 line of credit to invest in equipment or marketing initiatives, but as B2B payment terms lengthen, accessing a way to secure financing for unpaid invoices can be instrumental in survival, particularly in the first few years of operation.
Unfortunately, because factoring is frequently considered a means to a bank loan end, many factoring companies take the "get it while you can" strategy with their small business customers, which is why factoring has developed such a negative reputation in the market.
Stieber explained a few of the ways a factoring firm can gouge customers, such as burying hidden rates and fees in contractual agreements or strong-arming firms into staying.
For instance, a business that notifies a factoring firm of plans to exit the relationship in, say, 90 days might be cut off during that time period. But if that company has to wait 90 days for bank financing to come in, a lack of receivables financing can be deadly – and can force that business into another yearlong contract with the factoring firm.
In other cases, some companies will bury in contractual terms that the rate on an initial $200,000 factoring agreement will be charged every month thereafter – even if those companies do not utilize that agreement.
A positive customer relationship is imperative to helping firms avoid those pitfalls and to help repair the reputation of the industry, said Stieber. Flexible contracts and transparency into rates and fees are key, as is the understanding that one day, a business will become profitable enough to exit, self-fund or use bank financing. Close customer ties can foster longer-lasting relationships, he noted, but parties should go into agreements with the understanding that the point of factoring is to help a business grow.
As the factoring sector grapples with its complicated reputation and history, and as state and federal regulators in the U.S. begin to focus on small business borrower protections, the industry is also enduring the FinTech disruption faced by other segments of small business finance – and financial services overall.
Stieber said when he and his partner began the company four decades ago, all processes were manual and paper-based. Software integrations with platforms like QuickBooks have enabled faster gathering of information about a potential business client and faster decision-making times.
While he said he misses the in-person relationships that were traditionally developed in years past, customer ties remain the focal point of a business operating in a space where trust can be limited.
"Everybody can nickel-and-dime a customer to death," Stieber said. "There are a lot of factoring companies out there with up-front charges, initiation fees – but a good factoring company is going to let you grow. If you're really positive with your customers, they will grow, which will affect your bottom line, and their bottom line – and that's what it's all about in this business."