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5 Common Pitfalls With Selecting A Factor for Your Small Business

As a small business owner, you may have decided that factoring, or receivables financing, is a viable option for addressing cash flow challenges. Now you’re faced with the task of selecting a factor, and the one thing you can’t afford is making a mistake.

According to QC Capital Solutions, there are five common pitfalls that you should avoid when selecting a factor for your small business.

If you’re unsure if factoring is right for your business, read our first post in our series on factoring. In short, factoring works by turning your customer invoices into cash payments. Your factoring company advances you the majority of the invoice right after invoicing and the balance upon customer payment, minus a fee.

With a better understanding of factoring and the focus on choosing a factor, we can turn our attention to the pitfalls that small businesses often encounter. From our experience, here are the top five:

  1. The business operates in a specialized industry but selects a more general factor. A factor that serves businesses of any size or industry may not offer the tailored services of a factor that specializes in your industry. You’ll find factors specializing in construction, medical and transportation, among other industries. That’s not to say a general factor won’t excel at factoring your invoices. Just remember that specialization exists and should be taken into consideration when choosing a factor.
  2. The business agrees to factor all invoices but only needs a few invoices factored. Many large factors require businesses to factor all invoices and charge accordingly. But what if you determine that all you need factored for cash flow purposes is one of your key customer’s invoices? Ask if “spot factoring” is available.
  3. The business uses a factor without a clear understanding of fees. Some factors will charge you a wire fee for same day funding. Your bank may also charge a fee for receiving a wire. Best advice: ask about fees before working with any factor or bank and be realistic about how often you may need the services that are fee-based.
  4. The business outgrows the factor. If your business is in growth mode, you may outgrow your factor’s ability to serve your cash flow requirements in 6-18 months. Try to get the right size factor for your business—one big enough for today and going forward but not so big that you can’t get the level of service and attention you need.
  5. The business lacks access and help from their factor’s point of contact. No matter what factor you choose to work with, you should have an account representative who’s professional, responsive and helpful. Think of them as an extension of your business. They may be in contact with your customers as often as you are. You’ll work closely with them. The relationship needs to be mutually beneficial, with everyone sharing an understanding of the best interests of your business.

Selecting the right factor starts with you

Now that you have a better idea of some pitfalls to avoid when selecting a factor, the next step calls for introspection. Spend some time thinking about where you are now from a cash flow standpoint and where the business is headed. Have you or do you anticipate landing a customer that would require hiring employees or purchasing equipment, which could lead to a cash crunch? Are you a business that fits the profiles we outlined in our first post on factoring? If you answer, “yes” to any of these questions, there’s a good chance that factoring makes sense.

As a small business that’s growing and expanding, you may hit a roadblock with securing a traditional bank loan or line of credit. Factoring, or receivables financing, may give you the optimal cash flow. And knowing the five pitfalls of factor selection can help you choose the factor that’s right for your business.