The decision to use factoring to improve your cash flow is important. But choosing the best factoring company can be difficult. The market is full of factoring companies that offer a confusing number of options. It can be hard to tell who will work best for you.
However, the success of your business depends on making the right choice.
In this article, we discuss how to compare factoring companies. Basically, there are seven key questions that you need to ask the factor. Then compare answers to these questions and determine which factor is the best fit for you. By the way, if you are not familiar with factoring, you can learn more here.
#1 How long has the factor been in business?
One of the first things to do is evaluate if you are working with a new factoring company or an established factor. This evaluation is critical because your company is usually better off working with an established factor.
Running a factoring company is difficult and requires careful risk management. Most new companies have not been around long enough to demonstrate long-term management of their portfolios. One of the worst outcomes would be for your factor to go out of business.
You want to work with a factor that has been around for at least five years. However, more experience is better.
This does not mean that every young factoring company is a bad choice. But if you do work with a new company, it does mean that you must dig deeper and research the management of the company. If the company is new, you want to make sure that the owners and underwriters have industry experience. An easy way to determine this is to review the profiles of key managers via LinkedIn.
#2 Does the factor have clients in your industry?
Most factoring companies claim to be generalists. They advertise that they can work with businesses in any industry as long as they are dealing with solid invoices for delivered products/services. For the most part, this claim is true.
However, you are always better served if you work with a company that is familiar with your industry and has active clients in it. Every industry has its own invoicing practices – and nuances. Working with an experienced company helps you avoid issues.
Determining if the factor works in your industry is simple. Ask them to provide references in your industry. If you decide to work with this factor, contact those references before making a final decision.
#3 Is the factor comfortable with your sales volume?
Most factoring companies claim that they can work with clients of all sizes. Their advertising may even say that they can handle clients from $5,000 to $5 million. As you can imagine, managing a $5,000 client requires a different set of skills than managing a $5 million client.
While they can probably fund accounts in the range they advertise, clients in the factor’s comfort zone are probably getting the best service. The comfort zone is that “sweet spot” where the factor has the majority of its clients.
In our previous example, the factor that works with clients from $5,000 to $5 million may have a sweet spot of $250,000. This means that most of their clients generate $250,000 in monthly sales. These clients usually get the best terms and services.
You can find out their sweet spot easily by asking them. Most factoring companies are happy to tell you about their comfort zone.
#4 Does the factor require minimum factoring fees?
Some factoring companies charge a minimum factoring fee. With minimums, your company commits to factoring a certain regular volume (monthly or quarterly) in exchange for better rates. If your factored volume falls below your required minimum volume, the factor charges you an additional fee. This fee ensures that the factor derives a minimum amount of revenue from your company.
Minimums, however, can be a double-edged sword. While minimums can lower your cost if you meet them, they can also be expensive. Unless you are certain your company will meet the minimum commitments, it’s best not to use them.
#5 Does the factor require a long-term commitment?
Some factoring companies operate on a yearly agreement. If you want to break the contract, the factor usually asks you to pay an early termination fee. These fees can be hefty and are put in place to discourage companies from early termination.
Try to negotiate a six-month engagement with an automatic extension. This strategy gives you enough time to set up the factoring plan and put it into practice. It also gives you a window to leave the factoring agreement if it has outlived its usefulness.
#6 Are the factor’s advance and fee structure competitive?
Part of the process of selecting a factoring company is ensuring that its proposal is competitive. Most business owners think that the cost of factoring is determined only by the rate. This thinking is incorrect. The cost of factoring is determined by the advance, the rate, and other fees.
The best way to evaluate proposals is to calculate the “all-in” cost per dollar. For a detailed explanation, learn how to compare factoring rate proposals. Also, here is some information on typical factoring rates.
#7 How is the factor funded?
Lastly, you should know how your factoring company is funded. Just like your business, most factors need funding to operate. Usually, sources of funding include owners assets, bank financing (e.g., a line of credit), and market instruments.
Unfortunately, there is no “best” way to finance a factoring company. All methods have risk. You just have to evaluate how they answer this question and decide if you are comfortable with that. In general, companies that have been around for a while – see question #1 – have a stable source (or sources) of financing.
For more factoring resources, consider reading our article “How to Choose a Factoring Company.”
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