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It can be difficult to obtain factoring or invoice discounting on some types of business debts due to their nature or circumstances which will affect a factor's ability to collect in the debts to repay their lending in the event that the business fails.
The main difficulties here come in respect of contractual debt for the provision of a service over a long period involving stage payments. Engineering contracts for capital equipment are an example, where a payment of a [link widoczny dla zalogowanych] third with order, a third on delivery, and a third on commissioning is not unusual.
Contractual debt is always difficult to [link widoczny dla zalogowanych] factor since if the supplier fails part way through delivery of a contract, its customer will normally seek to offset the costs of replacing the supplier and any associated disruption costs (which particularly in the construction industry can be quite creative), against the debt outstanding.
Construction contracts which may last for many months with a series of stage payments are another particular problem area as they [link widoczny dla zalogowanych] are normally based on a process of 'applications' rather than invoices for a definitive amount. Under this system the builder raises an application for payment based on their estimates of the value of the job completed to date which then has to be agreed by the customer's architect or surveyors before the final agreed sum becomes payable, normally within two weeks. The bulk of a construction company's 'debtor' book therefore usually consists of applications which will turn into a debt, but where the value of the debt is uncertain until shortly before it is paid over.
There are only a limited number of factors who [link widoczny dla zalogowanych] will provide funding against this type of debt and this is usually at lower levels of advance (say 50% against a more normal level of 75% to 85%, together with a requirement for personal guarantees) as they have less certainty as to both the collectability of any debt and in the case of applications, its actual real value.
Some ongoing contracts, for example for the supply of materials to a manufacturer for use on its production line, may include 'liquidated damage' clauses. They are intended to provide a mechanism whereby the customer can be compensated at an agreed rate for any interruption its production suffers if your business fails to supply it with widgets as agreed. These clauses create problems for factors as in the event your business fails, they give rise to the basis for your customers to offset a claim for these damages against the sums due to you on which a factor has lent.
Sales which require extensive after sales service or warranties (such as bespoke computer software) may not be fundable, as again the customer may seek to offset a claim relating to [link widoczny dla zalogowanych] the loss of this support or the costs of replacing [link widoczny dla zalogowanych] it against any debt due which the factor would be looking to collect.
Sales to overseas customers can be a problem as the factor's ability and cost to collect will obviously vary from country to country. Some factors are members of international groups and are therefore able to consider funding ledgers with a relatively high degree of international exposure (of say up to 50%), although even here this will involve an assessment of the spread of the ledger on a region by region or country by country basis. Most of the independent sector is however focused on UK based [link widoczny dla zalogowanych] debt only.
Sales to a single or very low numbers of customer can lead to a problem with what is known as 'concentration'. To avoid having all their eggs in one (or very few) baskets, factors generally like to see their risk spread across a number of debtors with any individual customer making up no more that 20% to 25% of the borrower's debtor book as in the opening case study. However this is an area where factors differ greatly in their policies and some will fund 'single debtor' clients. Otherwise in these situations the lender may allow [link widoczny dla zalogowanych] temporary overpayments but these will usually come at an additional cost.
Advances
The level of advance that you can expect will vary from lender to lender but in general the banks' factoring arms have a high degree of captive business introduced through their [link widoczny dla zalogowanych] banking colleagues and therefore tend to be [link widoczny dla zalogowanych] more conservative than the independents.
As a very rough guide, you might expect a bank-owned factor to advance say 60% to 85% against a normal book, whilst the independent firms may range between 75% to 90%, and will in addition consider providing top up facilities against stock or agreed temporary overpayments of say up to 100% to cover specific items such as a peak requirements at a VAT quarter or exit penalties imposed by another lender.
It is important to realise that these percentage advances should be regarded as the 'nominal' level of advance. All factors will only advance against 'approved' debt which is to say your total debtor book less the debt that has been disallowed as a result of aging, when normally any [link widoczny dla zalogowanych] debt of over 90 days old will be disallowed; and reserves placed against the accounts to cover any:
- supplier contras;
- balances in excess of agreed concentration limits;
- intercompany trading; or
- [link widoczny dla zalogowanych] individual debtors that the lender won't fund for whatever reason, such as overseas debtors.
As a result of this disallowed debt, what really matters is your 'effective' advance, which is to say the funds available that you can actually draw down from the factor (your 'availability'), as a percentage of your total debtor book. As you can see from the potential reserves that will be applied above, this will often be significantly lower than the headline percentage advance you have agreed with the lender.
As discussed in the next article, this application of reserves to your account can be a particular issue if your business gets into difficulty.
So, before talking to a factor or invoice discounter, take a good look at your debtor book and the terms on which you are trading with customers. How much of your debtor book is realistically going to be fundable by a factor or invoice discounter and what issues might they face if they had to collect in debt if your business failed? The more you can address this up-front, the better the funding deal you are likely to be able to negotiate.

Mark Blayney specialises in raising funding for owner managed businesses. For more information on factoring and invoice discounting or any aspect of business loans or finance in plain English contact him at:
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