Factoring plans can provide many of the benefits associated with a line of credit. However, they are much easier to qualify for than conventional financing. Most factoring companies have fairly simple requirements to qualify. The following is a list of the main requirements to qualify for invoice factoring.
1) You must operate a business
Factoring companies can provide financing to businesses only. Most factors prefer that your business be formalized. Your company should have a corporate structure such as a Corporation (Inc.) or Limited Liability Company (LLC). This requirement allows factors to easily differentiate business assets from personal assets.
2) Your business must have commercial or government clients
Factoring plans provide financing by allowing you to sell your accounts receivable to a factoring company. Factors can buy your invoices only if your clients are commercial companies or government entities. Unfortunately, factoring companies cannot buy low- quality invoices. Those are best referred to a lawyer or collections professional.
Note: Factoring companies cannot buy invoices due from retail customers.
3) Your client’s commercial credit must be good
The most important benefit of factoring is that it provides funding based on the credit quality of your invoices. Factors will only finance high-quality invoices that are very likely to be paid on their due date. Factoring companies determine the credit quality of your invoices by checking the commercial credit of your clients.
Federal and state government invoices are assumed to have good credit. However, there are some exceptions to this rule that vary between factoring companies.
4) Your profit margins must be above 10% to 15% (varies)
Due to its cost, factoring works best if your profit margins are reasonably high. For larger companies, profit margins of 10% to 15% work well. For smaller companies, a margin of 15% or more works best.
5) Your invoices must be free of liens or encumbrances
You can only finance invoices that have not been pledged as collateral to other institutions. Keep in mind that it’s common for financing institutions to file an “all assets” lien when providing any type of funding. These liens encumber your invoices.
If your accounts receivable is pledged as collateral, the other finance company needs to agree to a subordination before the invoices can be factored. Tax liens and judgement liens can also encumber accounts receivable. Such liens need to be resolved before your invoices can be funded (see the next section).
6) If you have tax problems or a tax lien, you must have a payment plan
Factoring companies can finance invoices that are encumbered by a tax lien (usually an IRS lien) under certain circumstances:
- You must have a payment plan
- The taxing authority must be willing to subordinate its position on the receivables
- Alternatively, your company can just pay the liability, which removes the lien.
7) You should not have an open bankruptcy
While some factors offer bankruptcy financing (e.g., debtor in possession financing), it’s an expensive and complex solution. Most factoring companies will only finance companies that don’t have open bankruptcies.
8) Your personal background must show you have good character
Factoring companies examine your background as part of their underwriting process. They don’t expect clients to have a perfect background. However, they need to ensure there are no serious issues. These determinations vary by factoring company.
9) You must be able to provide basic company information
While the credit of your customers is the most important criteria for a factoring company, it is not the only one. Your company must be able to provide some basic information. Some requirements vary by industry, but here is a general list:
- Government-issued identification
- Articles of incorporation (or similar document)
- Accounts Receivables aging report
- Payroll tax information (if you have employees)
One last point
Note that each factoring company is different and has its own specific requirements. However, this guide should give you a good idea of what you need to have in place to qualify for an invoice factoring line. If you are looking for factoring, here are some useful application tips.
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