Debt factoring, also known as invoice factoring, is the practice of selling future profits, invoices owed to you, in order to free up cash flow. To begin with a contract will be offered, which should be thoroughly understood before signing and can be quite lengthy.
Once the contract is in place an invoice can be “sold” to the factor and a high percentage of its value made available within 24 hours. Once your client has paid the invoice, the rest of its value will be made available, minus transaction fees.
Debt Factoring Fees
For most the process is straightforward with few hidden costs but some companies, and therefore contracts, can become complicated. It is therefore vital that every part of the contract is fully understood; this includes possible problems as your business grows. Contracts will need to be flexible enough to grow with the business so it is recommended that small start ups avoid particularly lengthy terms if possible.
The main fees incurred with debt factoring are relatively easily comprehended and include:
- Arrangement Fees
- Advanced Rates
- Transaction Fees
- Annual Fee
- Termination Costs
There is not typically a fee incurred for setting up a contract with an invoice factor. This is partly because the factor itself would prefer to finance their clients in order to make money further down the line in transaction fees. Some factors, however, may charge a small set-up fee, no more than 1% of the facility.
Not so much a fee as a withholding of funds, these will typically be around 10-20% of the total value of the invoice. Once your client has sent payment, you will receive the outstanding amount, minus costs. Should the invoice remain unpaid the factor will not release the rest of its value.
There is, however, the option of taking out a non-recourse factoring contract, where the factor takes on the responsibility of bad debts (those that have not been paid to you due to client insolvency, for example). These contracts are hard to come by and therefore only relevant to well-established enterprises.
Although these costs appear very low, they can add up to significant amounts in the long term. This, again, will depend on the length of the contract and is why most factoring services require long term commitments.
These rates can vary quite a bit, with higher rates charged to smaller businesses. Although this may appear unfair, the fact is the factor will need to cover the risk of the debt for less established companies and larger companies provide larger profits. Fees typically range from 0.5% to 3% of the value of the invoice.
A small renewal fee is often also charged at the end of each year of the contract. This will depend on the length of the contract and relate to the terms and conditions therein.
Most often there are two reasons as to why a factoring contract will be terminated. Firstly by the client because the service is no longer required or the terms and conditions no longer meet their needs. The second is by the factor and is usually because the client has not accessed as much of the service as makes financial sense to the factor.
Both reasons can end up being highly costly for the client and will depend on the terms and conditions of the contract. If you believe there is a chance that you will not be able to meet the minimum usage stated, you should think carefully before committing.
Each company offers different rates to the various shapes and sizes of businesses that apply for the factoring service. It is therefore difficult to pin exact numbers down to each factor. The following, however, is a basic outline of fees and requirements for some of the most reputable providers in the UK:
Offering recourse and non-recourse factoring contracts, Aldermore offer some of the most competitive rates of all providers. The minimum annual turnover requirement is very low at £60,000 and transaction rates range from 0.25 and 3%.
ABN AMRO Commercial Finance
Although ABN AMRO may not be suitable for small businesses and startups as they require a minimum annual turnover of £400,000, they offer up to 90% of the value of each invoice provided, a maximum limit of £50m and transaction rates well below 1%, making them one of the top larger business factors in the UK.
RBS Invoice Factoring is considered by many to be among the best services in the UK. One of the main reasons for this is its accessibility for non-recourse factoring, which they make available for businesses with an annual turnover of just £250,000. Transaction fees can be quite high at 4% for some but competitive rates are also available, sometimes as low as 0.5%.
Bibby Financial Services
Put simply, Bibby are the go to place for start up businesses who require invoice factoring. Theoretically this means that annual turnovers are not a stumbling block. For the few providers that do engage with small businesses, this can often mean high transaction rates but Bibby’s fees typically fall between the standard 0.5% and 3%.