The scenario is of an emerging business that comes to a factoring company to find additional working capital. Much earlier on they secured a line of credit from a bank. Over time the business has been utilizing the line of credit but never paying it down. Now that it’s time to look at invoice factoring the line of credit is getting maxed out. In order for the factoring company to finance the accounts receivable the bank has to subordinate their hold on the A/R. Usually this means paying off the bank entirely in order to achieve first position on the invoices. To be perfectly clear – you cannot use the same asset (accounts receivable) for collateral with two lenders.
Here is the fundamental question; can the business afford to take the income coming in from completed work to pay off the bank in order to start factoring? In other words over the past two years you have used up $100K on a line of credit. You now have $500K in good A/R, plenty to pay off the bank. But you are essentially paying off in one day a debt that took two years to accumulate. That $100K paid by the factoring company to the bank gets collected by the factor. Can your business do without the use of that $100K?
Companies that properly prepare for this event can make it. Those striving to meet day to day needs probably cannot. Typically banks will ask a troubled company to “term out†a used up line, creating a term note to be paid off in regular monthly installments, with interest.
The number one killer of a small business is lack of capital or access to it.