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Invoice Factoring for Contractors, Is It Worth It?

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Factoring, as a form of contractor financing, has a long-established history. It is, fundamentally, the business of buying accounts receivable at a lower face value, the invoice amount received is less because the factoring company assumes the risk of and delays in the collection and the possibility of a loss on the accounts receivable purchased if unpaid. Under a typical factoring agreement, the factoring company purchases a contractor’s billing invoices at a lower cost in exchange for a security interest in the receivables owed by other parties as a payment of these invoices. The factoring company notifies your customer, thereby securing the factoring company’s right to payment. Through this transaction, the contractor gains a short-term working capital and the factoring company manage the receivables and collections. On payment, the factoring company generally pays a percentage of the payment to its client, retaining the remainder for service fees.

Most contractor factoring companies allow you to manage cash flow by getting paid faster than waiting 30, 45 or 60 days. Your suppliers get paid quickly, and since this is the case, you have more ammunition when negotiating the best pricing for having a stellar payment record. In many cases, the ability to avail price breaks and get better material pricing has made up for the cost associated with invoice factoring.

The difference between factoring and a business loan is when you factor your invoices your subcontractor/supplier credit line is used as a leverage, not yours. Business loans’ criteria is  solely based on your assets and the ability to pay them back. When an invoice is submitted for factoring, your potential for growth is based on your credit worthy subcontractor/supplier and it is almost unlimited. The more credit worthy subcontractor/supplier you sell to, the higher your credit line becomes.

In 2018, factoring is often viewed as a source of last resort financing, preferred by companies often on the verge of insolvency that are incapable of benefitting from traditional forms of financing. Factoring is relatively common in various disciplines of the contracting industry. In fact, there has been a recently discovered flaw in the factoring activity. For an inexperienced and underprepared contractor, it may come with significant risk, such as doubling payments or paying even when contractual protections otherwise would allow the withholding of contract funds. There are steps that every wise contractor should take to protect itself from additional costs arising from downstream factoring.

Know who you are dealing with: Factoring companies often do not identify themselves as such. Depending on other facets of their businesses, they may insinuate that they are a bank, financial institution, lender, capital resource, asset solution, or some other financial related term. If a contractor receives a notice interposing a new entity in the payment process with a subcontractor/supplier, a factoring company may be involved—irrespective of the name of the entity or the type of business it represents.

Evaluate subcontractors/suppliers who factor invoices carefully: At a minimum, there are many inconveniences for a contractor when its subcontractors/suppliers have factored their invoices. Procedures for payment processing must be modified as a new party is now involved, and special steps may need to be taken to keep contractual protections in place. Such events and activities involve additional time and a potentially disruptive change from standard practices. The fact that a subcontractor/supplier is factoring its invoices certainly could be an indication of serious financial issues. A contractor should cautiously evaluate all subcontractor/supplier who is factoring its invoices and determine whether the added burden and risk is worth the value that the subcontractor/supplier otherwise provides, and, where appropriate, limit the opportunities to work on future projects with the contractor.

Know the limits of your contract terms: Contracts often contain clauses by which one party (or both parties) are prohibited from assigning any contractual rights or obligations to a third-party without the consent of the other party to the contract. The goal of such clauses is to ensure that contracting parties know who they will be working with. However, by law, such clauses are futile to the extent that they prohibit or restrict assignment or need the consent of the company required to pay. While anti-assignment clauses can be a valuable tool to provide permanence during and after completion of a project, despite their limitations.

Understand the risks of paying the wrong party: Once a contractor has received proper notification that a right to payment has been assigned and that payment is to be made to the factoring company, the contractor may only discharge its obligation by paying the factor. These notices should be taken seriously, as once it is received, paying the contractor directly will not release the debt—only paying the factor company will. A contractor may at times overlook the significance of this notice and discover that they have paid twice, and attempt to collect the overpayment from the primary contractor.

Know your rights and the implications of your statements: Generally, a factoring company’s rights are subject to all terms of the agreement between the contractor and the subcontractor/supplier and any defense or claim in recoupment. However, this is not the instance where a subcontractor/supplier has made an enforceable agreement not to assert defenses or claims. There is no prerequisite that such an agreement be made in writing, and factoring companies have been known to seek to obtain an agreement during a telephone call (which may be on a recorded line). Meticulously read any document that a subcontractor/supplier or factoring company provides to guarantee that no rights or defenses are inadvertently waived by any action or lack thereof. Contractors should be careful on their declarations on the telephone to a factoring company representative.

This article is meant to provide the fundamentals on invoice factoring and its advantage and disadvantages. If possible, a contractor may wish to avoid subcontractors/suppliers who factor their invoices altogether. If that is not viable, a contractor should be very vigilant in protecting itself to avoid the risks that arise when a factoring company takes on the right to payment of your subcontractor/supplier.

Andrea Hughes

Posted In: ACCA Now, Management, Money

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