Invoice factoring is an excellent funding solution that allows businesses to sell their outstanding accounts receivable to a factoring company for immediate working capital and, in most cases, transfer the credit risk of nonpayment onto the factoring company. It is an effective and reliable financial service that brokers and ISOs can use to help their clients while creating a continuous flow of commission income.
However, there are reasons why a business may be unable to factor their invoices. Recognizing these barriers to successful invoice factoring will help you avoid marginal leads that waste your time and resources. Here are some of the barriers that can hinder invoice factoring.
Incomplete Information
A prospective client who is uncooperative and secretive may not be a good lead for invoice factoring. You should look out for signs of fraud, such as mistakes, typos, and discrepancies in the documentation. A legitimate client will be able to send you all the required information and documents in a few emails, without errors or delays.
Prior Liens, Open Judgements, and Lawsuits
Prior tax liens, all asset liens, and open/ pending judgments prevent the factoring company from having a senior UCC-1 lien position on the prospective client’s assets. The factoring company must be in a senior position as a condition for funding, which is not possible if assets have a lien or are already pledged as collateral. It may also imply that the prospective client is not meeting mandatory tax requirements or already has another business funding source, but things may have gone wrong somehow. Negotiating with tax authorities like the IRS and other funding sources such as banks, factoring companies, or merchant cash advance (MCA) companies can be lengthy and difficult, especially if there is an open balance owed. Lawsuits can create many issues and negatively impact the viability of the business.
If you are working with clients in the construction industry, you should ask if they have the ability to issue payment and performance bonds. In the event that your potential client has a bonding line, they have already pledged their accounts receivable and the proceeds thereof to the bonding company. A factoring company will not be able to purchase the accounts receivable that have a bond in place as the bonding company has a superseding first lien on those accounts receivable.
Industry Type or Location
Some industries are considered high-risk (or even illegal) and may not qualify for factoring. This applies to certain geographic areas as well.
Client Customers with Poor Credit
Clients that have customers with poor credit or spotty payment histories, such as late payments or unpaid invoices, may not qualify for factoring.
Low-Profit Margin on the Invoice/Project
There needs to be a sufficient profit margin in an invoice/project to enable the client to pay the related cost of goods sold as well as cover fees for factoring the invoice. Invoices or projects with gross profit margins below 15-20% may not qualify for factoring.
Low Invoice Value
Factoring companies typically require a minimum invoice value to cover the cost of the factoring transaction and make a profit. If the invoice value is too small, it may not be able to qualify for invoice factoring.
Goods or Services Invoiced Before They Are Provided
Some companies bill their customers before providing goods/services. This may not be an acceptable practice for invoice factoring transactions. The invoice factored must be for work or services that have been completed and accepted by the client’s customer (account debtor). Sales must be final without offsets or chargebacks.
Inability to Verify Invoices
Invoice verification helps the factoring company ensure the validity and accuracy of the invoices being factored and also prevents fraud. Invoice verification is typically done through an online vendor portal, via email, or through a Verification Letter (aka Estoppel Letter) sent by the factoring company to the account debtor, which they are required to sign and return. Without proper invoice verification, a factoring transaction may not move forward.
Direct-To-Consumer (DTC) Sales or Other Sales Issues
Sales must be business-to-business (B2B) and creditworthy for the accounts receivable to be eligible for factoring. Many businesses try to sell their products or services DTC, and some businesses may have both DTC and B2B sales, so check for any prospective client’s sales that may be DTC.
Consignment and guaranteed sales, which are sales that are subject to any contingency other than normal returns in the course of business for quality or delivery issues, are not eligible for invoice factoring. Prospective clients with retail customers experiencing high levels of returns, chargebacks, sales allowances, or large sales deductions may result in the account debtor’s payments not satisfying the amount advanced to the client. This may necessitate a reduction in the advance rate or jeopardize the viability of the invoice factoring program.
Questionable Client Background
Excessive litigation, unfavorable media coverage, and a poor reputation in their industry may indicate a higher risk for operating and financial difficulties. Prospective clients that are contentious and difficult to deal with may not be worth the hassle of doing business with.
Transaction Has Unusual Features, Trends, Size, or Frequency
Unusually large transactions, a few large single-invoice sales, increasing volume in a declining economy, a significant increase in sales to a new customer, and significantly more generous credit terms may be indications of potential problems. Transactions that are unusual for a prospective client’s profile or significantly different than past history and industry norms and a sharp increase in sales volume that is not consistent with past history, sales, and marketing programs, and industry and economic conditions may indicate falsified sales.
If the transaction seems to be too good to be true, it probably is. Unrealistic assumptions and projections not supported by past history or expected trends in the industry or economy and documentation that shows no past due accounts are warning signs.
Recognizing the barriers to successful invoice factoring will help financial brokers and ISOs identify marginal leads and save time for themselves and the factoring company they work with. There are many prospective clients who have been turned down by banks and other traditional lenders because of a lower allocation of capital to high-risk loans that are still viable candidates for invoice factoring. Spend your time identifying and developing viable clients to build your business volume.
Capstone is a leader in customizing business funding plans for businesses in a wide range of industries and circumstances to help them meet their working capital needs. For more information on how to join Capstone as a broker and referral partner, call us at (212) 755-3636. You may also visit our Broker Resources page to learn more.
