In the United States, invoice factoring is often viewed as the “financing option of last resort.” In this article I make the case that invoice factoring should be the first choice for a growing business. Debt and equity financing are options for different circumstances.
Two key turning points in the business lifecycle
Turning point one: a new business. When a company is less than three years old, the options for access to capital are limited. Debt financing sources look for historical income figures that show the ability to pay the debt. A new business does not have that history. This makes the risk of debt financing very high and greatly limits the number of sources of debt financing available.
When it comes to equity financing, equity investment dollars almost always come for a slice of the pie. The younger and less proven the company, the higher the percentage of equity that must be sold. The business owner must decide how much of his business (and therefore control) he is willing to give up.
Invoice billing, on the other hand, is an asset-based transaction. It is literally the sale of a financial instrument. That instrument is a business asset called an invoice. When you sell an asset, you are not borrowing money. Therefore, you are not going to go into debt. The invoice is simply sold at a discount from the face value. That discount is generally between 2% and 3% of the income that the invoice represents. In other words, if you sell $ 1,000,000 in bills, the cost of money is 2% to 3%. If you sell $ 10,000,000 in bills, the cost of money is still 2% to 3%.
If the business owner chose invoice factoring first, they could grow the business to a stable point. That would greatly facilitate access to bank financing. And it would provide greater bargaining power when it comes to equity financing.
Tipping point two: rapid growth. When a mature company reaches a point of rapid growth, its expenses can exceed its income. This is because the customer’s remittance for the product and / or service arrives later than the payroll and vendor payments need to be made. This is a time when the financial statements of a company can show negative figures.
Debt finance sources are extremely reluctant to lend money when a business shows red ink. The risk is considered too high.
Stock funding sources see a company under a lot of stress. They recognize that the owner may be willing to give up additional capital to obtain the necessary funds.
Neither of these situations benefits the business owner. Invoice factoring would provide much easier access to capital.
There are three main underwriting criteria for Invoice Factoring.
- The company must have a product and / or service that can be delivered and for which an invoice can be generated. (Companies before income have no accounts receivable and therefore nothing that can be taken into account.)
- The company’s product and / or service must be sold to another business entity or a government agency.
- The entity to which the product and / or service is sold must have decent business credit. That is, a) they must have a history of paying bills in a timely manner and b) they cannot be in default and / or on the brink of bankruptcy.
Summary
Invoice billing avoids the negative consequences of debt financing and equity financing for both young companies and fast-growing companies. It represents an immediate solution to a temporary problem and, when used properly, can quickly get the business owner to the point of accessing debt or equity financing on their own terms.
That is a much more comfortable place to be.