The decision to change factoring companies should be made only after carefully evaluating the pros and cons. Many business owners underestimate the potential complexity of switching finance companies. This oversight can lead to problems that could have been avoided with proper planning. This article explains how the process works, common reasons for changing finance companies, and the potential drawbacks of making the change. It helps you evaluate whether changing factoring companies is right for you. We cover:
- How do you move to a new factoring company?
- Reasons for changing a factoring company
- Problems when switching factoring companies
- Should you change factoring companies?
1. How do you move to a new factoring company?
The most challenging part of switching factoring companies is transferring operations from the old factor to the new provider. This transfer must be planned and executed carefully to ensure a smooth transition.
The outgoing and incoming factoring companies will have to contact your customers. Consequently, it’s essential that your customers understand the transition process and how it impacts them. Work with your new factoring company to develop a strategy to handle your customer’s expectations.
a) Customer touchpoints
The notice of assignment (NOA) that your current finance company provided will need to be replaced with the new factor’s NOA. This process involves two steps. The current factoring company will need to contact your customer to provide a termination letter. Once the termination is handled, the new factoring company will provide your customer with a new NOA.
The new factor will likely need to verify any invoices transferred from the current factor. The way this process is done depends on the relationship between the factoring companies. However, it’s best to assume your customers may be asked to verify invoices that the current factor has already verified.
b) Move to the new factoring company
Factoring companies transfer accounts in two ways. The simplest way of transferring accounts is a full buyout. If that option is not viable, the factoring companies may implement an ongoing buyout and transfer.
i) Full buyout
In a full buyout, the new factoring company takes over all the open invoices funded by your current factoring company. The buyout amount is calculated based on the total funds that have been advanced, along with any accrued fees.
One potential problem occurs when the funds required for the buyout exceed the amount the new factor can advance. There are two possible ways to solve this challenge. The new factor may choose to over-advance funds. The over-advance provides sufficient funds to cover the buyout and settle the account with the current factoring company. Alternatively, you may need to use the advance from new factoring transactions to cover the difference. This approach could impact your cash flow.
ii) Ongoing buyout and transfer
This type of buyout occurs when the new factor cannot do a full buyout from your current factor. The current factor keeps the invoices they have already purchased. The incoming factoring company purchases new invoices only. Customers are transferred to the new finance company as their invoices settle with the current factor. This type of buyout can be challenging as it could leave you without new funding until the customer transfers occur. Discuss this with your new factoring company to develop a contingency plan to handle this situation.
2. Reasons for changing factoring companies
Business owners are motivated to switch factoring companies if the finance company isn’t meeting their expectations. The most common reasons fall into three general categories.
a) The factor won’t approve your customers
A common reason for wanting to switch factoring companies is that the current factor cannot finance a customer’s invoices. This can be a problem if it involves a large customer that represents a substantial portion of your revenues.
Usually, this problem happens when the customer’s business credit does not meet the finance company’s criteria. However, that is not the only reason that a customer won’t be approved. Your factor may not want to finance invoices from a specific customer due to internal reasons that are unrelated to your company. Consequently, the client looks for a new finance company that can work with their customers.
b) There are service issues
Working with a factoring company that is not servicing your customers correctly can be a serious problem. It impacts your cash flow and your customer’s satisfaction with your business. Consequently, the client is looking to replace the finance company with a new factoring company that can manage customer relationships more effectively. This scenario emphasizes the importance of business owners performing due diligence when selecting a factoring company.
c) Their price is too high
Companies often look to change factoring companies to lower their financing costs. For example, the business may have outgrown its current financing proposal. Their volume may qualify them for lower fees. Consequently, they are paying higher fees than they would if they took their business elsewhere. Alternatively, they may look for a factor that specializes in their industry and is willing to provide more flexible terms.
3. Problems when switching factoring companies
Changing factoring companies is not simple and takes diligence. Your reasons for changing factoring companies must be carefully balanced against the challenges. The most common problems fall into four general categories.
a) The process can take weeks
Most factoring companies have a process to transfer accounts to a new provider. The buyout and transfer can often be done quickly and completed in a few days. However, the process can sometimes take weeks. During this time, both providers negotiate how to execute the buyout and how to settle accounts. Ask your provider to explain their process so that you can prepare accordingly.
b) You may be without factoring for some time
You may reach a point when your current provider isn’t able to finance new invoices, and your new provider isn’t ready either. This situation depends on how the transfer is structured, among other things. It’s best to prepare for this eventuality since it could happen. As a precaution, build an emergency cash reserve to cover expenses during the transition.
c) There may not be enough funds for a buyout
As described in section 1, most transitions are structured as full buyouts. In a full buyout, the new factoring company buys out the invoices that the old provider financed. During settlement, the new provider pays the current provider all advanced funds and accrued fees.
However, the new provider’s advance rate may not be enough to cover this total. Let’s say that you have a $1,000 invoice with the current provider and that your advance rate was 85% ($850). Additionally, you have accrued $5 worth of fees. Assume that the new provider also advances 85%. Their advance only covers the old factor’s $850 advance.
But what happens to the accrued fee? Who pays the remaining $5 fee to settle the transaction? In many cases, your new provider extends an over-advance. However, not every factor is comfortable providing over-advances. You may need to factor some new invoices with the incoming provider and use the proceeds from those advances to cover this fee. This situation impacts your cash flow.
d) Your customers need to be informed
Your clients are notified that you are changing factoring companies. They receive a release from the old Notice of Assignment and get a new one from the incoming finance company. Additionally, they need to work with the new factoring company to handle verifications. Some customers may be unhappy about this.
4. Should you change factoring companies?
The decision to change factoring companies is not easy and must be made carefully. You must evaluate whether your business is better off changing factoring companies or if you should consider alternatives. Please note we are not advocating any specific course of action. Rather, we suggest you make an informed decision.
a) Is the current challenge worth going through the process?
Switching factoring companies can be challenging even when things flow smoothly. Keep in mind that no business relationship is perfect. Determine if the situation is causing enough problems to merit enduring the process of changing providers.
b) Can the problem be fixed?
Evaluate if the situation with your current factor can be fixed. Can your issues or disagreements be resolved through negotiation? Sometimes, reaching a negotiated solution is more manageable than switching factoring providers. It also saves your customers from going through the new notification and verification process.
However, consider switching companies if the problem cannot be fixed. Sometimes, parting ways is the best course of action.
c) Perform due diligence methodically
Evaluate factoring companies carefully and perform substantial due diligence before making the change. Ask your new factor to describe the buyout process. Additionally, inquire if they have ever done a buyout with your current factor. Lastly, ask the new company to provide existing client references. Contacting references is an essential step to help ensure you choose the right company. You should switch companies only after you have examined all the information, evaluated the alternatives, and determined that changing providers is the best course of action.
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Disclaimer: This article does not provide legal or financial advice. Seek advice from a professional if you need it.