Invoice Factoring: False Friends + Hidden Fees
Factoring companies will often claim that they’re your partner. Yes, you’re effectively paying them interest to ease your capital constraints, but as they stress, “No hidden fees. No tricks. We’re less a bank, and really more of a friend.” It’s all too easy to fall prey to this sales pitch. Swept away into a delirium of community and belonging, who among us wouldn’t begin daydreaming of factoring receivables with a new best pal?
But would they pinky promise that they’re really your friend? And would they swear under oath that their service is actually free of hidden fees? I’m unsure. What I do know is that you shouldn’t be surprised when they don’t show up to your party. And you shouldn’t be surprised when you find your factoring bills covered in cobwebs of attached strings.
The truth is, factoring companies offer a nuanced service, not a simple partnership. You are their customer, and certainly not their friend. To save you from future frustration (and the hurt feelings that take their place at the lonely, empty seat of your birthday dinner), allow me to break it down for you below.
The pros of factoring companies:
- They can advance much-needed capital in exchange for your outstanding receivables.
The cons of factoring companies:
- They are sneaky as hell.
Calling an industry “sneaky as hell” is a bold claim. This is especially true for me — I make it a point to only use the “as hell” add-on with the gravity it deserves. So that I can prove my point to you more soundly, see below for my compilation of the “Hidden ‘No Hidden Fees’ Fees”.
Basing the factor fee on the invoice size instead of the advance.
Levying your factor fee against the total size of the invoice (as opposed to the size of the advance you receive) is a way to hide higher rates. As your advance rate goes down, your “real” rate (that is, the amount of money you pay to your factor compared to the money you receive from them) goes up. To put it simply, this structure charges you for money that you don’t actually receive.
Implementing an initial financing fee or a draw fee.
Some factoring companies will charge you a flat financing fee for the first month. This is to protect themselves against the possibility that a payment arrives much earlier than expected. Your factoring company should be upfront about this. If they try to sneak it in without addressing it, consider that a red flag.
Charging fees based on buckets of days or weeks.
This is the sneakiest one! Let’s take the example of a fee structure based on buckets of 10 days (e.g., you are charged 0.33% every 10 days). This scheme allows factoring companies to capitalize on any payments received closer to the beginning of that bucket. A payment completed on Day 3, for example, lets them extract 7 days of unearned fees from you. Keep in mind that a daily fee of 0.033% is always better than a 10-day fee of 0.33%, which itself is always better than a monthly fee of 0.99%.
Requiring minimum line utilizations.
If you have a maximum line amount of $1M and a minimum line utilization of 10%, you are going to be penalized for every day or month that you factor less than $100k. This usually means that if your business slows or if you simply don’t need to factor many invoices one month, you still get charged as if you were factoring $100k worth of invoices. You end up paying ghost fees — racking up charges while receiving no money in return.
Early Termination Fees
You are now stuck on the hamster wheel. If you ask to get off, you get fined. And in case that seemed overly friendly, you also get fined if you stop running.
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So, there you have it. A small gift to you as you research financing options or evaluate your current factoring agreement. You may be wondering why I’m giving you gifts. This will likely be as sad as it is refreshing, but it’s not because I’m trying to get you to be my friend. Instead, I’d like to make a quick plug to the people who have made it to the end of this article.
Afox has built out a product that can help you eliminate your need for factoring, or drastically reduce your current factoring costs. If you’re curious about the next generation of working capital optimization, learn more here!