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Resources | Finance and Lending | September 8, 2022

Invoice Factoring is Broken – Here’s How It Can Be Saved

Factoring companies are known for high fees and confusing contracts. Fintech is changing this practice to help your business when financing options are limited.


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Factoring companies are known for high fees and confusing contracts. Fintech is changing this practice to help your business when financing options are limited.

If you’re a small to mid-sized business, you might have noticed how banks act like they’re doing you a huge favor by even talking to you. You’re really lucky if they give you even a sliver of financing.

So, what do you do if you can’t secure a bank line of credit or an asset-based loan? You might turn to family, friends, credit cards and other means to access the working capital you need to run and grow your business. When that’s not enough, invoice factoring is often the only option left.

Factoring companies — which advance cash based on your uncollected invoices — know this, and many of them try to capitalize on that advantage. Fortunately, innovative fintech solutions now leverage technology to compete with these services, creating an entirely new approach to factoring that can save your business time and money.

Here’s why you should consider replacing traditional invoice factoring with a more modern solution.

What is invoice factoring?

If your customers are other businesses, you probably don’t receive point-of-sale payments. Instead, you most likely send the customer an invoice and wait 30, 60 or even 90 days for accounts receivable to realize that cash. This delay can seriously impact your cash flow and leave you without the working capital you need to sustain or expand your business operations. If you’re an early-stage business, you might not qualify for financing, such as a business loan from a bank, to bridge this cash gap.

Traditional factoring companies, also called “factors,” help address these financing and cash flow barriers. Factors essentially buy your outstanding invoices for 70% to 90% of the invoice total upfront and then give you the remainder, minus factoring fees (typically 1%-5%), once your customer has paid them the invoice. Here’s how it works:

  1. You create an invoice (totaling $1,000, for example) for your customer and hand it over to the factor.

  2. The factor has a 5% factoring fee (in this case, $50) and advances you 80% of the remaining amount ($760) within a few days.

  3. The factor communicates directly with your customer and receives payment from them within 30 days.

  4. Once payment is received, the factor gives you the remaining 20% ($190).

You get the cash sooner, so you can pay bills on time and boost working capital. Plus, factors are usually more concerned with your customers’ credit histories than yours, which can mean a simpler approval process. However, this solution has several drawbacks.

What’s wrong with invoice factoring?

Factoring is now considered the payday lending of business funding. But it’s not the practice of factoring that is responsible for this bad reputation — it’s the factoring companies themselves. This is because:

  • Factors are notorious for charging hidden fees. The service’s initial APR might seem attractive, but with additional charges — from transaction fees to credit check fees — you could be paying 36% APR and have no idea how you got there. With a recourse factor, you may have to buy back unpaid receivables.

  • Factoring agreements are confusing, often by design. Fees and other terms are hidden within legalese that is intended to benefit the factor and keep clients locked into the agreement.

  • Factors interfere with your client relationships. Once you’ve sold an invoice to the factor, it decides how to collect invoice payments. Your client relationships could suffer if the factor inundates your customers with robocalls or suddenly introduces unfamiliar processes.

  • Traditional factoring companies are known for inefficient processes. Factors promise quick upfront payments but are typically bogged down by legacy systems, paperwork and manual processes.

The factoring client usually has limited financing alternatives. Traditional factoring companies know this and don’t feel the need to provide more cost-effective or transparent solutions.

How does invoice factoring need to change?

What would invoice factoring look like without the antiquated, often predatory practices of traditional factoring companies? Ideally, factoring would empower entrepreneurs to grow their business with a transparent, cost-effective and efficient process.

The following graphic illustrates what traditional factors offer today versus what factoring could look like:

chart comparing traditional invoice factoring with what modern invoice factoring could look like

Rather than luring clients in with an attractive APR and hitting them with complex, hidden fees, a new model would maintain an appealing APR with a surprise-free, simple fee structure. Factoring terms would use transparent language and make it easy for clients to end an agreement. Clients would also continue owning customer relationships.

Factoring can become a more valuable, appealing financing option for small to mid-sized businesses through three critical steps. First, factors should clearly define their cost structure upfront so that clients know what they are getting into. Second, factors should simplify contract language so both parties understand the terms and misinterpretation is avoided. Lastly, factors should provide a detailed statement of every single thing a client is charged. That way, clients can accurately assess whether factoring is an affordable option for working capital shortages.

A modern alternative to traditional invoice factoring

Factoring will inevitably change. With new market players putting pressure on the entire industry, factoring companies that refuse to evolve will go out of business. Where factoring services once filled financing gaps for early-stage businesses, now, innovative fintech solutions are filling gaps created by traditional factors.

One such innovation is invoice discounting or early payment programs, which boost your cash flow by giving your customers an incentive for paying early. Some programs even offer dynamic discounting — the earlier a customer pays, the bigger its discount and the sooner you have access to the cash. Programs like this also cost substantially less than factoring services and give you more control over the whole process.

chart comparing invoice factoring with early payment discounts

Early payment programs like C2FO’s use an online portal to make setting up and processing invoice discounts faster and easier. If your margins are too tight to afford the cost of a discount, you can also opt for solutions such as C2FO’s CashFlow+ Card. This gives you early payment in full, no discount required.

Turning receivables into cash flow quickly and conveniently has the potential to transform your business. As a working capital solution, factoring remains valuable — it just needs to be brought into the 21st century. Modern providers, such as C2FO, fix traditional factoring by making contracts simple and transparent, minimizing costs and using technology to increase efficiency and flexibility.

If you’re considering an invoice factoring service or have already signed an agreement with one, contact our team to see how much you could save with C2FO.

This article was updated September 8, 2022, and originally published October 3, 2019.

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