Most companies looking for factoring try to get the best rate by sending applications to as many factors as possible. While this approach can work, having many open applications is hard to manage. Ultimately, the process is time-consuming and doesn’t always work. Fortunately, there is a better way to get the best factoring rates. It involves a simple and methodical approach. In this article, we show you how to:
- Understand a factor’s perception of risk
- Understand how factoring rates work
- Find the best factor for your company
- Present your application
- Handle application problems
- Negotiate the best factoring rate
1. How factors evaluate risk
Before looking for a factoring company, you should learn how they work. Understanding how factoring companies evaluate risk is key to getting a term sheet with good rates. This knowledge allows you to negotiate terms while understanding their perspective.
Factors negotiate rates based on financed volume and the transaction’s overall risk. Your transaction risk is determined by your business, industry, and customers.
a) Your business
Factors examine your business to determine its risk and viability. The process is not scientific and often depends on the judgment of the underwriter. Underwriters usually review the following:
- Does the client get paid on time?
- Do customers underpay often?
- Does the company experience many chargebacks?
- Are assets pledged to a lender?
- Are taxes up to date?
- Is payroll up to date?
- Are there any bankruptcies?
b) Industry
Each industry has its own risk. Most industry sectors are considered to have “average” risk. However, there are some exceptions. In general, trucking and staffing are usually seen as having lower-than-average risk. These two industries have well-defined collection processes, and companies typically pay their invoices in full.
On the other hand, industries like construction and healthcare (third-party insurance) are seen as higher-risk industries. Payment disputes and underpayments are common. Consequently, some factors avoid these two industries, while others offer services but at a higher price.
c) Your customers
Ultimately, factoring companies care about the creditworthiness of your customers. Your customer’s ability to pay the invoice in full and on time secures the factor’s transaction. Clients whose customers have good commercial credit are seen as lower risk than clients whose customers have mediocre commercial credit.
2. How do factoring rates work?
Before starting the negotiation process, you should understand how factoring costs work. Most business owners believe that the factoring rate is the most crucial element of the factoring cost. Consequently, they focus their negotiation efforts on rate alone. In reality, this assumption is incorrect and often leads to expensive mistakes. The factoring cost is better determined by considering both the rate and the advance.
The combination of rate and advance gives you a “cost per dollar,” which is a more useful way of determining the actual factoring cost. The cost-per-dollar concept accounts for the fact that a “low rate” coupled with a “low advance” can have a high cost-per-dollar. Consequently, the lowest cost per factoring dollar is always the combination of lowest rates and highest advances.
Resources:
Typical factoring rates
How to compare factoring rates
3. The best way to find a factoring company
The best approach to find a factoring company is to research a few companies online and submit applications only to those that meet your criteria. Evaluate the companies carefully and collect two or three proposals. Managing more than three ongoing proposals is difficult. Here are some simple rules to remember:
- Specialty factors (in your industry) will provide you with better terms
- Larger factoring companies offer lower costs and rates
- Smaller factors are more flexible with risk but are also more expensive
- If it looks too good to be true, don’t believe it. Ask for details
- Always ask for references, preferably in your industry
- Always ask for a trial term (3 to 6 months)
4. How to present your factoring application
The image your company projects influences how finance companies view your application. Most small business owners make the costly mistake of underestimating this fact.
You may improve your financing terms simply by presenting a more professional corporate image. This effort usually reflects a well-run company. The logic of this strategy is simple: professionalism inspires trust. Trust lowers the factor’s perceived risk and gets you better terms.
Here are some tips:
If you can, type the application. Otherwise, use neat handwriting
- Fill out the application completely
- Don’t hide problems (more on this later)
- Include all the requested information
- Include a short professional summary
5. Handle problems and setbacks
Factoring applications routinely ask for background and company information. Finance companies use this information as part of their decision-making process. Negative information does not have to derail your application if you handle the situation correctly. However, clients sometimes try to hide negative information. Hiding information always backfires.
From an underwriter’s perspective, there are three types of applications. They have applications that:
- Disclose problems upfront
- Omit problems (and hope for the best)
- Don’t answer truthfully
Let’s handle untruthful answers first because those are simple. Applications where the applicant knowingly provides false information are always rejected.
Omitting answers to critical questions can be a telltale sign that the application is hiding some information. Factoring underwriters get notoriously suspicious when essential information is missing. This situation won’t usually cause an application to get rejected. However, the factor will have less in the transaction.
Lastly, there are applications that disclose negative information honestly and upfront. Fortunately, this happens in most cases. Most factoring companies see this positively because it often shows the client’s integrity. Factors often have a lenient view towards negative information as long as problems are disclosed upfront and aren’t insurmountable.
6. How to negotiate the best factoring rate
The factoring market is very competitive. This gives you some leverage and can help you negotiate excellent terms. This section shows you where factoring companies can be flexible. Most factoring companies are willing to provide concessions to clients who agree to minimum volumes, minimum terms, or both. You can negotiate these items.
a) Minimum volumes
Agreeing to a minimum volume commits your company to finance a minimum amount per month or quarter. Companies that agree to line minimums but don’t meet them incur a minimum fee charge.
Factors prefer clients with minimums because it guarantees a certain amount of revenue. Most factoring companies are willing to provide lower rates in exchange for agreeing to minimums.
Just keep in mind that minimum volumes can be a double-edged sword. You will incur the minimum fee if you don’t meet them regularly. Consequently, agree to minimums only if you are certain you can meet them.
b) Minimum terms
Agreeing to minimum terms commits your company to stay with the factor for a period of time. A common commitment is a one-year term. Factoring companies prefer clients that agree to term commitments. They bring stability to their portfolio. Most factors are willing to provide better rates to companies that commit to staying with them for a while. This should not cause a problem for clients, as long as you don’t stay with the factor any longer than you need to.
Get more information
Are you looking for a factoring quote? We can provide competitive factoring proposals. For more information, call (877) 300 3258.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.