One of the great things about account receivable factoring is that you may be offered a term sheet (a document listing all the details involved in the financing) in as little as 24 hours. It’s a welcome departure from the slow loan application process normally used by banks.
Duration of the Financing
Even the most ardent advocate of factoring admits that this method of financing should be only temporary. It’s to be used only as needed. However, some lenders may ask for an extended period of time for factoring so that they actually get a decent return on their investment.
This is called a lock up period, and it can be devastating if you’re required to use factoring for a year or two when you only need it for a few months.
But with some companies, spot factoring which only involves a one-time deal and a single invoice may also be possible.
Advance Rates and Fees
In factoring, you get an advance as a percentage (more or less 80%) and then the rest is forwarded to you minus the factor’s fees when the customer finally pays in full. So to have a viable budget plan, you’ll need a definite idea of the advance rates and the fees. The AR factoring term sheets must explicitly state how much you’ll be getting.
The problem here is when advance rates differ depending on the credit-worthiness of your customers. If advance rates are different each time, what determines the final advance rate?
The fees may also be affected if your customers don’t pay on time. You may have to shoulder the penalties as well, so you’ll need to know the fees involved.
And you also need to know what will happen if your customer refuses to pay. Usually, you may have to return the advance money you received along with additional interest. In non-recourse factoring, the factor doesn’t hold you accountable if the customer declares bankruptcy. But it’s usually a different matter if the customer refuses to pay because of a dispute with your company.
Factors are usually in charge of collecting fees from your customers. While this may be regarded as a convenient service, it may also be an area of concern. Some factors may employ collection methods which may not sit well with your customers.
Some term sheets specify the kind of letters factors send out to customers when collecting payments, and the frequency of sending out these letters are specified as well. Sometimes the factor may even incorporate your own letterhead or logo on the collection letters so that your customers are unaware that you’re using a factor as a collection agency.
AR factoring term sheets specify every important detail so that you avoid disagreements and confusion later on. The best term sheets try to anticipate every possible contingency so that there’s a planned response for every scenario. Having a factor as backup is often great, but to forge a lasting relationship you need to come up with AR factoring term sheets that are fair to all parties involved.