What to Know Before Signing a Factoring Agreement

Sadie Keljikian, Express Trade Capital

If you plan to work with a factor to fund your business, it is vital that you do thorough research prior to signing anything. Obviously, it is important to be educated before signing any legally binding document, but the ongoing nature of trade financing solutions makes them the perfect trap for hidden fees and requirements.

Before you sign on the dotted line, here are some important questions you should ask your prospective factor:

What percentage of my invoice values will I receive in advance (i.e. what’s my advance rate)?

The percentage that you receive as an advance on your invoices is called an “advance rate.” Typically, factoring companies provide up to 80% of the total value when they receive an assignment. It is important to know your advance rate up front so you can predict available cash flow based on receivables.

What is the minimum sales volume required by the factor?

This is one of the primary points in determining whether the factor will accept your application or not. Most factors have a minimum sales volume for clients to ensure that each relationship will be profitable.

You should know that unfortunately, if your sales volume is low, your rates will be higher than that of a comparable business with higher sales volumes, even if it doesn’t keep you from successfully signing a factoring contract. Factoring is still a labor-intensive industry with high overhead so each client has to have enough volume or high enough rates to justify the cost of acquiring a new client.

What fees (beyond the standard rate charged on each factored invoice) will I incur during my contract?

Most factors include fine print in their agreements, which often contain the dreaded “hidden” fees that many have come to expect from banks and financial institutions. These can include termination fees if you end the agreement before the contract is up, annual minimums charged on a monthly basis, credit check fees, misdirected payment fees, invoice modification fees, and a myriad of other miscellaneous charges.

Occasional fees are to be expected, but if they seem excessive or confusing to you, there’s a chance that the factor is unopposed to taking advantage of less informed clients.

Does the factor perform credit checks in house? Is there a fee for credit checks?

All non-recourse factoring companies require a credit check of all customers whose invoices are factored. Since a non-recourse factor provides credit protection on their client’s receivables, the factor needs to know the payment habits and financial soundness of the end customer (i.e. the debtor on any assigned invoice). Credit worthy customers receive credit protection and are therefore considered non-recourse receivables. Non-approved accounts are not insured and therefore they are called “with recourse” because the factor has recourse to their client if the receivables fail.

Ask your factor if they insure your receivables (i.e. are they recourse or non-recourse factors) and, if so, whether they charge a fee for providing credit checks on your customers.

What varieties of factoring does the company offer?

It is very useful to know what types of factoring the company in question offers for a number of reasons. First, it is important to find out if your factor offers recourse factoring, non-recourse factoring, or both. This will determine whether you will be responsible should any of your customers declare bankruptcy without paying all of their factored invoices.

Once you’ve established recourse vs. non-recourse, you want to find out if your factor can adapt services to suit your needs. Practices like spot factoring or selective factoring are helpful if you find that you only want to factor a handful of your receivables. Bottom line, it helps to know if those options are available from the onset.

Does this factor have experience with businesses in my industry?

While it isn’t necessarily crucial to your relationship with your factor, you might be surprised what a difference it can make if your factor has experience in your industry. Each industry has its own unique structure and potential difficulties to consider and when you bring a financial institution into the equation, so it helps if they’ve dealt with the difficulties specific to your industry. Some factors specialize in certain industries. Where possible, try to work with a factor who specializes in and knows your industry.

What is the maximum credit line that will be available to me?

Depending on the factor, there may or may not be a flexible limit on the credit line they can offer you. Typically, a factor is either a department at a bank, or has a close relationship with one or more banks. This allows them to offer substantial credit lines, provided that your customers have good credit. Some smaller factors, however, can only offer limited hard caps on cash lines due to limited access to funds. Ask before you sign to determine if the factor is suited to meet your financial needs.

In general, it is important to research the business with whom you are working, particularly when your sensitive information is involved. The best practice is to familiarize yourself with the factoring industry in general, that should inform any questions you might need to ask in order to be prepared to sign anything. Also ask for references to ensure that other clients have been satisfied with their experience. Use your instincts and do your homework. Your diligence will be rewarded.

Click to learn more about our trade financing services.

Contact us to learn more.