Factoring vs. a bank loan

They both put cash in your account, which is why they get compared. Almost everything else about them is different, and the differences matter most to the businesses that need the money soonest.

The difference underneath everything else

A bank loan creates a debt. You borrow a sum, you owe it, and you repay it on a schedule whether or not the work you borrowed against ever gets paid for.

Factoring sells an asset you already own. The invoice is money your customer owes you. You sell it, at a discount, to get paid now instead of in 30, 60 or 90 days. Nothing is borrowed and there is nothing to repay.

Every other difference on this page follows from that one.

Who gets looked at

A bank underwrites you: your trading history, your credit, your accounts, your assets. A business that has been running for eight months, or that grew fast last year and looks lumpy on paper, is a hard file for a bank no matter how good its customers are.

A factor underwrites your customers. The question is whether the companies that owe you money pay their bills, because they are the ones who will settle the invoice. A new business hauling for a broker that has paid on time for a decade is a straightforward file.

This is why factoring is common among companies in their first year and among companies growing faster than their balance sheet suggests they should be.

How long it takes

A bank loan is weeks, sometimes months: application, financials, underwriting, committee, documentation.

Factoring is set up once and then runs invoice by invoice. The setup is days rather than weeks, and after that each invoice is verified and funded on its own without a new approval.

What it costs, and why comparing the two is hard

A loan is priced as an annual interest rate plus whatever fees the bank charges to originate it.

Factoring is priced as a fee on each invoice — a percentage of the invoice value, usually tied to how long it takes the customer to pay.

Converting one into the other is where most comparisons go wrong. A 3% fee on an invoice that settles in 30 days is not “3% a year”, and it is not “36% a year” either, because you only pay it on the invoices you actually factor and only for the days they are outstanding. The honest comparison is what each one costs you in dollars across a real month of real invoices, which is a calculation rather than a rate card.

What happens if the customer does not pay

On a loan, nothing changes. You still owe the bank.

On a factored invoice it depends on the agreement. Under recourse factoring the invoice comes back to you if the customer never pays. Under non-recourse the factor carries that risk, usually for a higher fee and usually only for specific reasons like the customer becoming insolvent. This is the single most important thing to establish before signing with anybody, and it is worth asking in exactly those words.

Limits

A loan is a fixed amount. If you land a contract twice the size of anything you have done before, the loan does not grow with it.

Factoring moves with your invoicing. More work sold to creditworthy customers means more that can be factored. It is one of the few funding arrangements that gets larger as the business does, without a new application each time.

Which suits which business

A loan tends to suit a stable business buying something specific and long-lived — premises, a building, an acquisition — where the repayment schedule can be matched to the return, and where there is enough history to get approved at a good rate.

Factoring tends to suit a business whose problem is timing rather than solvency: the work is done, the invoice is out, and payroll is on Friday. Trucking, construction, staffing and any other trade where customers pay on terms and wages do not.

Plenty of businesses use both, and there is no contradiction in that. They solve different problems.

What to ask before you sign either

• Recourse or non-recourse, and what triggers a buy-back
• Whether there is a minimum volume, a minimum term, or a monthly minimum fee
• What happens if you want to stop
• Who talks to your customers, and what they say
• Every fee, not just the headline rate: wire fees, verification fees, account fees, and what happens to invoices that pay late