A factor buys your unpaid invoices at a discount, pays you most of the value within a day or two, and collects from your customer when the invoice comes due. Because the factor is underwriting your customer's ability to pay more than your own balance sheet, factoring is open to young and fast growing businesses that a bank would turn down.
How factoring works
Factoring is a sale of an asset, not a loan. You deliver goods or services, issue an invoice on normal terms (often 30 to 90 days), and assign that invoice to the factor. The factor then pays you an advance, holds back the rest as a reserve, and waits for your customer to pay.
The cycle looks like this:
- You submit the invoice along with proof of delivery, such as a signed bill of lading, a timesheet or a completion certificate.
- The factor verifies the invoice with your customer and sends a notice of assignment telling them to pay the factor directly.
- The factor funds the advance, usually 70 to 95 percent of the invoice face value depending on your industry and your customers.
- Your customer pays the factor on the due date.
- The factor releases the reserve to you, minus its fee.
The fee is the factor's discount. It is usually a percentage of the invoice that grows the longer the invoice stays open, so a customer who pays in 25 days costs you less than one who pays in 75. Some factors add smaller charges for wires, credit checks or account setup. Ask for the full fee schedule in writing and model it against your actual customer payment history before you sign.
Factoring differs from invoice financing, where you borrow against receivables but keep collecting from customers yourself. In Canada and the US both forms are common, and many lenders offer each. If your receivables, inventory and equipment together are large, an asset based lending facility may cost less than factoring once you have the reporting systems to support it.
Who factors invoices
Several kinds of lenders buy receivables, and they serve different sizes and industries.
| Lender type | Typical fit | What sets it apart |
|---|---|---|
| Independent factor | Small and midsize firms, often under $10 million in sales | Fast setup, flexible on credit history, industry specialists |
| Bank owned factoring unit | Established firms with clean books | Lower cost, tighter credit standards, longer onboarding |
| Fintech platform | Firms with a few large invoices to customers on long terms | Online application, selective or single invoice funding |
| Asset based lender | Larger firms with receivables plus inventory | Revolving facility instead of invoice by invoice sales |
Independent factors are the largest group. Many specialize in one trade, such as trucking, staffing, government contracting, apparel or construction, and their knowledge of that trade's paperwork and payment habits is a real advantage. A trucking factor knows how to verify a rate confirmation and a bill of lading in minutes. A staffing factor understands weekly payroll cycles. Choosing a specialist usually means faster funding and fewer disputes.
Banks offer factoring through dedicated units, usually for clients who already bank with them. Fintech platforms let you sell single invoices without a long term contract, which suits a business with lumpy, large receivables.
What factors check
A factor's main question is whether your customer will pay. Its second question is whether the invoice is real, final and free of other claims.
Your customers' credit. The factor checks each customer's payment history, trade references and business credit. Invoices to large corporations, governments and well known distributors are the easiest to fund. A factor will often set a credit limit per customer and decline invoices that push a customer past it.
Concentration. If one customer makes up most of your receivables, the factor carries more risk. Expect a lower advance or a cap on that customer's share.
Invoice quality. The factor wants invoices for work already delivered and accepted. Progress billings, invoices with retainage, consignment sales and bill and hold arrangements are harder to factor because the customer can still dispute or reduce the amount. Construction and some government work fall in this category, and specialists handle them.
Liens and existing debt. The factor runs a UCC search in the US or a PPSA search in Canada. If a bank or another lender already holds a blanket lien on your receivables, the factor will need that lender to subordinate or release its claim on the invoices being sold. This is the most common reason a factoring deal stalls, so raise it early.
Taxes. Unpaid payroll taxes or sales tax can create government liens that rank ahead of the factor. Factors ask for proof that remittances are current, and some will structure a payment plan into the facility.
You. Your own credit and time in business matter far less than with a term loan, but factors still check for fraud history, prior factoring disputes and basic business standing. Many will fund a business in its first year if the customers are strong.
Recourse, notification and contract terms
Two terms shape most factoring agreements.
Recourse or non-recourse. Under recourse factoring, you buy back any invoice your customer fails to pay after a set period, often 90 days. Under non-recourse factoring, the factor absorbs the loss if your customer becomes insolvent, though not if the customer disputes the work. Non-recourse costs more and is usually limited to customers the factor has approved in advance.
Notification or confidential. Most factoring is notified: your customer is told to pay the factor. Confidential or non-notification arrangements exist for larger, established clients, where you keep collecting and remit payments to the factor.
Contract terms worth reading closely:
- Minimum volume. Some agreements require you to factor a set amount each month or pay a fee for the shortfall.
- Term and termination. Contracts often run 6 to 24 months and renew automatically. Know the notice period and any exit fee.
- Full ledger or spot. A full ledger agreement means the factor buys all your invoices to approved customers. Spot factoring lets you choose which invoices to sell.
- Reserve release timing. Some factors release reserves as each invoice pays, others on a weekly or monthly schedule.
Process and timing
Setting up a factoring account usually takes three days to two weeks. The factor will ask for:
- An accounts receivable aging report and a customer list
- Sample invoices and proof of delivery
- Articles of incorporation and owner identification
- Recent bank statements and, for larger lines, financial statements
- Details of any existing lenders and liens
Once the account is open, funding on each new invoice typically arrives within 24 to 48 hours of submission. The first invoice from a new customer takes longer because the factor has to approve that customer's credit and send the notice of assignment.
Which lenders to approach
Start with your industry. If you run freight, staffing, government contracts, oil field services or construction, look first at factors who specialize in that field; you can browse them on the register under factors. If you sell into large retailers or distributors with long payment terms, a generalist factor or a fintech platform can fit well.
If your business already banks with a bank that has a factoring unit, ask there, since the lien question is easier to solve in house. If your receivables are large and you also carry meaningful inventory, compare factoring with an asset based lender or a bank line of credit, which may cost less once you qualify. Factoring often serves as the bridge that gets a growing business to that point.
Need help choosing a lender? Sign up through BusinessLoanBroker.ai to share your financing needs and get help with your next steps. You can also explore financing guides and tools before you apply.