The information technology (IT) industry is extremely competitive, with a number of small and medium-sized firms aggressively competing for customer contracts. Because of the heavy competition, only the smartest and toughest survive in this industry. An IT company and its finances need to be managed carefully to succeed. Many companies fail at this point. IT companies are usually started by technology-savvy people with little knowledge about management – or accounting. Before long, most tech companies run into cash flow problems that, in the worst cases, may ultimately cause companies to fail.
Is venture capital the solution?
Technology companies in need of financing instinctively look for venture capital. Working with a VC is great if they also provide management advice and industry contacts. However, venture capital is not always the best solution to a company’s financial problems. As a matter of fact, other solutions offer flexible financing without requiring you to surrender equity.
For example, many small IT companies have heavy regular expenses. IT payroll is always expensive. They also have equipment expenses and other overhead costs. The challenge is that most clients pay for IT services in net-30 to net-60 day terms, so you must be able to run your company while waiting for customer payment. Unless you have capital reserves, you will run into problems. Slow payment is one of the most common cash flow problems that haunt IT companies.
Two common solutions
Two common solutions to this problem include trying to negotiate quick payments from clients or seeking bank financing. Actually, many clients are willing to pay sooner for a discount in order to increases their profitability, so it’s to their advantage to do so if they have the funds. The problem with this strategy is that it’s not reliable. Clients can delay payments at any time if they choose.
Bank financing can also work well – if you qualify for it. Remember, most banks have stringent requirements and only fund companies with solid financial reports and substantial assets as collateral. These hurdles can be a problem for start-ups and young companies who do not meet these criteria. Fortunately, a solution is available to small and mid-sized companies that can solve working capital problems created by slow-paying corporate clients: factoring.
Factoring: a better solution
Factoring solves cash flow shortages through a simple solution in which you partner with a factoring company to fund open invoices from creditworthy clients. Once you complete your work, or stage of a project, you send an invoice to your client. The funding company finances the invoice, which provides you with immediate funds to cover corporate expenses. The transaction closes once your client pays the invoice in full. Learn more about “What is factoring financing?”
Gain tactical and strategic advantages
Financing your invoices can provide you with both a tactical and strategic advantage. From a tactical point of view, your cash flow improves because you do not need to wait up to 60 days to get paid. But, more importantly, you can use factoring to offer terms to qualifying clients, allowing you to grow your business. You can do the work and then capitalize on the invoices by financing them. If you have had to turn away business because you could not afford to offer terms, financing your receivables is the right solution for you.
From a collateral perspective, factoring companies are financing your invoices. Consequently, your clients, who pay your invoices, must have solid commercial credit and a track record of paying on time. Also, your invoices cannot be encumbered by liens – a challenge for companies with existing business loans because most loans will encumber your receivables as collateral.
The qualification criteria for factoring are fairly simple. Also, the facility can be deployed quickly – in as little as five days. As a result, receivables factoring is an ideal solution for technology companies with cash flow shortages because of slow-paying clients.