By Tom Klausen  |   October 3, 2011 resize text

There are two myths that, unfortunately, have tainted many business owners’ perceptions of alternative financing techniques like factoring. One is that factoring is too expensive. Another is that if you factor you will lose customers because you appear financially weak.

The truth is that a lot of businesses fail because they simply refuse to consider alternative financing when it is the best solution. Instead they waste valuable time searching for bank financing or courting investors and partners. In the meantime, they alienate their suppliers, beg their customers to take early pay discounts and miss important deadlines like taxes. The net result can be far worse than anything an alternative financing source could cause.

How It Works

Under a typical factoring arrangement, the client’s customers (or “debtors”) are instructed to remit payments to a specific P.O. Box (or lockbox) controlled by the factor. This causes some business owners to fear their customers will assume their business is in some kind of financial trouble and subsequently switch suppliers. But this is simply not the case.

In reality, every payables department in every large company has been instructed to remit payments to third parties and P.O. boxes all over the country without giving it a second thought. The payables clerk registers the change remittance notice in the company’s system as he or she has done many times and very few people outside the payables department are even aware of this change.

Part of the reason is that factoring is much more common than most business owners realize, and it doesn’t catch most accounts payable personnel by surprise. In fact, when an invoice is properly factored, it usually receives more attention because the payables clerks know that:

 

• The invoice will be accurate and all the paperwork in order.

• If there are any paperwork issues, they will be addressed quickly and professionally by the factor.
• Factors report directly to the major credit bureaus, so clerks make sure factored invoices are always paid on time

 

It’s also important to note that a good full-service factor will not benefit by involving themselves in disputes between clients and debtors about product or service quality or delivery deadlines. In fact, a good factor will reduce the number of disputes by making sure all debtors are creditworthy and surfacing problems early so they can be addressed quickly.

Types of Notification

Notification is the means by which the debtor is informed about the factoring arrangement. There are many subtle ways that debtors can be notified, and an experienced factor will adjust the process depending on the industry and the type and quality of the paperwork. Regardless, it is important to contact key customers ahead of time and let them know about any remittance changes.

Non-notification is on one end of the spectrum, in which case the debtor is informed of a simple new remittance to a specific P.O. Box without mention of a third party. Conversely, full-notification will include a professionally written letter from the client stating something like:

“In order to accommodate rapid growth and maintain the high quality level of our service, we have retained the professional services of (factor’s name), a highly respected source for accounts receivable management and funding. As part of their service, they are providing us with a centralized billing and accounts receivable system. Therefore, we request your cooperation in remitting payments on all open and subsequent invoices to…”

Either way, it is important to employ a factor that respects and understands that a professional relationship between all parties is vital. 

Which Type is Best for You?

While on the surface it may appear that non-notification factoring is preferable to full-notification factoring, this isn’t necessarily the case.

You should be careful to only do business with reputable, well-financed and experienced factoring companies. Such factors are skilled at dealing with debtors, and they have a vested interest in building cooperative, long-term relationships with their clients and debtors, and in keeping debtors happy and not upsetting them.

A good factor will work with you and advise you on how to go about instituting the proper notification process. The key is to explain the arrangement clearly to debtors in advance so there are no surprises later. By ensuring good communication between all three parties involved—your company, the factor and the debtor—you will go a long way toward busting the common myth that factoring will result in lost customers.

Tom Klausen is the senior vice president of First Vancouver Finance in Vancouver, BC. Klausen has had extensive experience in providing alternative financing solutions to small business owners, and also provides business management consulting services to both traditional and non-traditional lenders throughout North America. He can be contacted at (604) 988-1490 or via email at TKlausen@fvf.ca or visit http://www.fvf.ca/.

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