Account receivable factoring has become a new favorite of small businesses these days. The reason for this is simple—they can’t get a bank loan. There are simply too many possible reasons why, as a small business owner, your bank loan application will be rejected.
Take a look:
- The bank doesn’t want to take the risk. You can’t really fault them for this kind of attitude, especially after the last recession. And the problem here is that small business loans are inherently riskier than large business loans. Small businesses have a higher loan default rate. The failure rate of small business is also quite high. In fact, for new companies less than 2 years old, the failure rate is close to 66%.
- You’re asking for too little. Banks consider loans of less than a million dollars to be small, and too often, they turn down business loan applications that fall below $250,000. The reason for this is because for them it costs the same to process a $50,000 loan and a $1 million loan. And obviously they stand to profit more with a $1 million loan.
- Your business has poor or no credit. Banks will take a look at your personal credit as well as the credit score of your business. And if your credit score isn’t high enough, then it’s a no go. Your credit score is an indication of your ability to pay back a loan, so a low score here doesn’t look good for you. (In account receivable factoring, however, your credit is actually quite irrelevant, because it’s your customer’s ability to pay that they’re interested in.)
- You don’t have collateral. In factoring, the accounts receivable may be seen as collateral. In traditional bank loans, that’s not going to be enough. This is why in so many approved bank loans for businesses, homes and cars may have to serve as collateral. Usually, your business should have some collateral such as real estate or expensive equipment.
- Your business cash flow is weak. For banks, they want to see that you have enough cash flow so you can cover the monthly payments and the overhead including the payroll, office rental, and inventory.
Ironically, this is the reason why you wanted a working capital business loan in the first place. It’s also one of the problems that factoring solves, because you immediately get your money instead of waiting 30 to 90 days for the customer to pay the invoice.
- Insufficient documents. Quite a few small business owners who are trying to get a loan for the first time seem to think that they can just waltz into a bank, fill out an application form, and then get the loan. The truth of the matter is that it can take many weeks.
And that’s if you prepare the necessary documents right away. The very long list of documents includes articles of incorporation, contracts, leases, and any permits and licenses. Then you also need a written business plan, and financial statements or projections. Plus, you also need your personal and business credit reports, tax returns and bank statements.
There are so many reasons why you can’t get a bank loan and this is why account receivable factoring is a much better option—it’s more likely that you’ll the financing you need as long as your customers have good credit.