In the realm of business financing, Invoice Factoring is often perceived as the “last resort” option. However, in this article, we argue that Invoice Factoring should actually be the first choice for growing businesses, while acknowledging that Debt and Equity Financing have their place in different circumstances.
Two key inflection points in the business life cycle highlight the limitations of traditional financing options and the advantages of Invoice Factoring.
Inflection Point One: A New Business
For businesses that are less than three years old, accessing capital through traditional debt financing becomes challenging. Lenders typically require a history of revenue to assess the capacity to service the debt, which a new business lacks. This high-risk scenario severely limits the availability of debt financing sources.
Equity financing, on the other hand, often involves giving up a portion of the company in exchange for investment. The younger and less proven the company, the higher the percentage of equity that may need to be relinquished. Business owners must carefully consider how much control they are willing to sacrifice.
In contrast, Invoice Factoring is an asset-based transaction that involves selling invoices, a business asset, at a discount. Unlike borrowing money through debt financing, this approach doesn’t create additional debt. The discount typically ranges from 2% to 3% of the invoice value. Whether selling $1,000,000 or $10,000,000 in invoices, the cost of money remains consistent at 2% to 3%.
By choosing Invoice Factoring as the first financing option, business owners can propel their companies to a stable point, making it easier to access bank financing in the future. It also strengthens their negotiating power when considering equity financing.
Inflection Point Two: Rapid Growth
When a mature business experiences rapid growth, expenses can surpass revenue due to delayed customer payments. Financial statements may reflect negative numbers during this time, making it challenging to secure debt financing.
Equity financing sources perceive the company as under stress, potentially leading the owner to give up more equity to obtain the necessary funds.
Neither of these scenarios benefits the business owner. Invoice Factoring, on the other hand, offers a more accessible capital solution.
1. The business must have a deliverable product or service generating invoices. Pre-revenue companies lacking Accounts Receivable cannot utilize Factoring.
2. The product or service must be sold to other businesses or government agencies.
3. The entities purchasing the product or service must have decent commercial credit, including a history of timely invoice payments and no impending bankruptcy.
In summary, Invoice Factoring circumvents the drawbacks of debt and equity financing for both young and rapidly growing businesses. It provides an immediate and efficient solution to temporary financial challenges, swiftly positioning business owners to access debt or equity financing on their own terms.
