1. Current financial condition – The company may be too new, meaning there are is not enough historical financials and tax returns to qualify for an institutional bank line, or a company has come out of a slow period so the balance sheet shows a negative net worth or may have delinquent tax issues.
Using accounts receivable as collateral for factoring only requires that the account debtor (customer) is creditworthy and has the ability to pay the invoice.
2. Growing too fast – After a long period of marketing for new business, the company is taking off. New orders are coming in faster than the cash flow can cover the operating costs. A bank line pegged against the recent past income will not suffice. Going ahead with a small bank line could potentially cut off the ability to secure additional financing. A loan too small to help is the worst decision to make when experiencing a steep growth curve.
Factoring is a “grow with you” relationship. As long as there are invoices to creditworthy customers, a company can go from zero to sixty without having to reapply for a larger line.
3. Investor fatigue – The company might be venture backed and are now well into revenue stage. Covering operations is not building shareholder value and the cost of using investment dollars to pay bills is prohibitive. Investment capital is extremely hard to get and very valuable and should be held to pay for expenditures that will increase the likelihood of an eventual exit strategy.
4. Speed – Factoring can be quick to set up and get started. With minimal paperwork required compared to other forms of commercial financing, a sufficient factoring line can be set up within 10 business days and then subsequent funding of an invoice is typically within 24 hrs. Many business owners are completely unfamiliar with factoring and so by the time someone mentions it as a potential funding solution they need to move fast.
5. Discipline – A credit line from a bank can in some instances be potential trouble for accompany without the discipline to use it correctly. Ideally a business takes money from the line and then replaces with incoming payments from customers. Too often a company will slowly chip away at the line without any strategy to pay off the outstanding balance that was used for various purposes.
With invoice factoring, each invoice submitted and funded is its own transaction, therefore when a customer pays the invoice, the indebtedness is retired without any long term net liability. There will never be a day where a loan will one day come due. Some companies rely on the factoring company to supply this discipline as part of the process.