Companies that need to factor their invoices are sometimes early stage and just getting going so they need some extra cash to keep the ball rolling. The owners go to the local bank and ask for a loan. Being an early stage company they don’t have historical profitability or real assets. What they usually have are personal assets, like home equity, or stocks to put in escrow, or even a well off friend or relative that will sign the loan as a “guarantor”.
So the bank processes the loan request and gives its approval. They have decided that the equity in the house is enough collateral to loan the money. At this point they are not basing the loan on the value of any business assets like accounts receivable.
If you will ever consider factoring invoices in the future, be aware of the UCC-1 financing statement. (read this) The banks as a normal course of business assign all the tangible assets of your company. What this means is, six months or a year later you are looking for more operating capital. You contact a factoring company and ask to finance the accounts receivables. We can’t because of a signed document that gives ownership of your accounts receivable to the bank. Access to capital has just become more complicated. Either the bank has to be paid off, or paid down a significant portion of the existing loan, or the bank has to “subordinate” the accounts receivable which effectively releases their ownership of it.
And beware, leasing companies, suppliers that offer credit terms, previous owner financed loans, all of these potentially will secure your invoices as collateral.
So when securing credit, ask about the UCC-1. Ask what collateral is being secured. If it’s not what you thought had been agreed to, tell them before going to closing.