What is Invoice Factoring? Is it a good idea?

Invoice Factoring Piggy Bank

Creative agencies differ from other businesses because they grow from artistic talent. The nature of creative agencies, especially when they are young and/or on the smaller side, is experimentation, trial and error, and research.

Unfortunately, not all of these agencies have the cash flow to invest in their businesses and provide resources for new creative talent. Often, budding agencies find themselves working paycheck to paycheck between clients.

That’s where invoice factoring comes in to provide sturdier financial capabilities. It is the process of selling unpaid invoices to a third party (at a discount) in order to receive money sooner than when the client agreed to pay. Then, depending on the agreement, the client will either pay the third party directly, or pay the agency who then passes the money on to the factoring company.

Invoice factoring can benefit smaller agencies who feel stagnated by the lack of steady cash flow. But don’t be fooled. It is not for everyone. Before your agency decides to pursue a factoring company, you need to do your research.

A Brief History of Invoice Factoring

For those of us who didn’t graduate with a degree in finance, invoice factoring is sort of like the payday advance store next to your local pharmacy; except it is more legitimate, more professional, and involves less interest.

Say you design a website for your client: SEO optimized, custom graphics, mobile friendly, the whole package. Satisfied with your work, you send the client a sizable invoice (for tips and tricks on designing those invoices, click here). She then has a certain number of days, usually 30 depending on the contract, to pay you back.

In the meantime, your agency continues to rack up daily expenses: new projects, software subscriptions, employee paychecks, rent, and more. If you work at a small to medium sized agency, it makes a huge difference whether she pays you on day 5 or day 25. With new clients it is especially hard to predict when they will pay up.

Factoring invoice was created as a solution to problems like this one thousands of years ago. Ancient Romans and Mesopotamians sold promissory notes at local markets so they could, well, survive and feed their families. It really blew up in popularity during colonial times when the shipping and receiving department slugged pathetically behind the demands of the economy.

About 20 years ago, before the internet changed the financial world, only large companies with hefty price tags on their invoices used factoring. Back then, factoring was an involved process, and not worth the time and money of smaller businesses.

The financial world of 2017 has flipped this paradigm. It is now generally considered that factoring is most beneficial for small businesses. And, According to the Office of Advocacy, 99.7% of U.S. employers firms are small businesses (defined as 500 or less employees).

Today, online factoring companies make it possible to have cash from your invoices in less than 24 hours. Agencies no longer have to be geographically close to a factoring company to use their services. More opportunities for cash flow in small businesses means a healthier U.S. economy as a whole.

Besides having more cash to spend in your pocket, there are other reasons to use invoice financing to bolster your business.

The right reasons to use invoice factoring

As the Notorious B.I.G. so infamously said, mo money mo problems.

The purpose of factoring is not to give you a surplus of cash, although some factoring companies may try to convince you of that. The purpose is to meet your immediate cash needs so you can sustain your business with less worry. Here’s how factoring can help you creative agency. 

The bank side of factoring:

  • You don’t have to waste time on applying and waiting for bank loans.
  • You don’t have to worry about not qualifying for loans.
  • Doesn’t affect your credit (as long as the client pays on time).

The client side of factoring:

  • Factoring companies can evaluate the credit of your customers for you.
  • You can collect data on how long it takes your customers to pay without actually having to worry and wait.
  • Helps with client relationships by lessening the stress of constantly reminding them to pay you.

The business side of factoring:

  • You don’t need an elaborate business plan to prove the factoring company the legitimacy of your business.
  • You can focus on growth without wasting time adjusting your budget.

As a start-up or small business feeling bogged down waiting for money, invoice financing probably sounds like a foolproof option for you. Unfortunately “foolproof” doesn’t exist in the business world. It has several risks you need to consider.

Possible risks of invoice factoring

Can you trust your client? Can you trust the factoring company?

Although beneficial for newer companies, it may not be the right time for invoice factoring if you don’t know your clients very well.

There are two types of invoice factoring: recourse and nonrecourse. Recourse factoring is less expensive, and means that you as the business owner take responsibility if the client doesn’t pay. If this happens, you not only lose the money owed by the client but you also must pay the factoring company a hefty fee. Nonrecourse factoring is more expensive upfront, but means the factoring company assumes the debt 100%. If the client doesn’t pay, it’s not your financial problem.

When you don’t know the history of your clients and you choose recourse, you may find yourself in more debt that you would have been if you didn’t use factoring . Newer companies who don’t know their clients very well may consider nonrecourse factoring for this reason. But can these new businesses afford the extra fee? A more wallet-friendly choice may be to wait and build a repertoire with clients.  

For more established agencies, choose clients who historically pay on time. It’s better that you take unpaid invoices into your own hands.

The fact is that factoring is worth pursuing if the conditions are right (steady clients, low fees) and not worth it if you are unsure about the ability of your business to pay back possible debt.

How to choose a factoring service

Although the internet provides more options for invoice factoring, it has also made factoring companies more competitive, and therefore more expensive. For as many trusted factoring companies on the internet, there as twice as many that are just out for your money.

When looking for factoring companies, look for reliable on-time payments, low and unwavering fees, and good customer service.

Here are three factoring companies with high praise (taken from consumeraffairs.com and fundera.com):

1. BlueVineBlueVine is highly rated for quick responses to customer questions. The first transaction with BlueVine takes less than 24 hours, and subsequent transactions are processed in less than an hour. Upfront pricing, no hidden fees, and the ability to integrate with your current accounting softwares are among the benefits of factoring with BlueVine.

Their Advice: “A business line of credit is a smart financing option to any entrepreneur for a key reason: it can help you prepare for unexpected turns in your business… A business line of credit is perfect for businesses with seasonal sales cycles and monthly cash flow fluctuations. It’s also ideal for businesses that typically have unpredictable, or “lumpy,” cash flow, or need to invest in their business in order to grow.” Learn more.

2. FundboxDesigned specifically for start-ups and small businesses, Fundbox is one of the only trusted factoring companies that will give you 100% of your unpaid invoice upfront, with 12 weeks to pay back the charged fee.

Their Advice: When you choose a factoring company to give you a cash advance, the factor takes over collecting your unpaid invoices. This can cause all kinds of misunderstandings and confusion. Customers may wonder why a strange company is calling and asking for money—they may think it’s some kind of scam. They might even think your business is in financial trouble. Who needs all that drama? Fundbox’s cash flow lending solution lets you handle your customer relationships and keep collecting on your invoices.” Learn more.

3. Triumph Business Capital. One of the oldest and most trusted factoring companies on the market. Due to its connection with a large bank, Triumph has competitively low costs. Customer service experience consistently ranks high as well.  

Their Advice: Worried about your credit? No problem! Invoice factoring is primarily based on the quality of your customers’ credit, not your own credit or business history. While most banking institutions look at the same documentation we do, our focus primarily on the quality of your customers. Don’t let the successes and failures of your business journey stop you from getting paid.” Learn more.

At Bric, we commit ourselves to fostering the creative process in the agencies we work with. That is why we research things like invoice financing. We want you to focus on the work you love. Meanwhile, we spend our time searching for ways to expedite growth in your agency. If you’d like to talk more, feel free to contact us here. Happy creativity!