Factoring Agreement: Understand Before You Sign

Accounts receivable financing, or invoice factoring, puts one of your largest assets – your invoices – to work for you. It can help eliminate issues caused by late customer payments, increases in payroll expenses, fluctuation costs, or large material investments.

But before you sign a factoring agreement, make sure you understand the terms within the agreement and how the relationship with your factoring provider impacts your business.

 A factoring agreement should always clearly represent your relationship with your factoring provider, including the roles, responsibilities, and terms are the most beneficial for your business’ needs. In short, before you sign on the dotted line, you always want to ensure you are approved to be funded, and that you understand and agree with the pricing and the contract terms.

First and foremost, make sure your factoring provider has completed its underwriting process and has disclosed any underwriting-related costs before asking for a signature on a factoring agreement. You may not want to commit to a long term financing relationship prior to receiving a stamp of approval.

Executing an agreement prior to underwriting may also be a sales technique to discourage “shopping around,” and can commit you to a binding agreement before you have a chance to negotiate the terms. You may also want to receive quotes from several different providers before committing to one.

The underwriting process can largely determine other parts of your factoring agreement, including pricing, which can be affected by your terms of approval.

Secondly, ensure that the factoring agreement clearly lists your payment terms and invoice discounting, or pricing, structure. Make sure you understand a) what percentage of your invoices you are receiving upfront, and b) how much you are charged per day that the invoice is outstanding. If you do not understand the pricing terms, do not be afraid to ask for clarification in writing.

Some factoring providers will be flexible on payment and discounting terms, based on your individual business needs. For example, if you have a customer that always pays within 15 days, and you want to include them in your overall factoring program, ask your factoring provider if they give discounted terms for faster payment.

Or, if you are currently factoring with a provider, but shopping for a new one, be sure to tell the new one what kind of pricing terms you currently have. It’s likely the new factor will try to offer you a more competitive program to earn your business.

Lastly, your factoring agreement should include both contractual terms and have an early termination clause that you can live with, just in case you are unsatisfied with the relationship. Be upfront with your factoring provider about contractual terms that will make you comfortable. It’s likely that the provider may be willing to negotiate contract terms similar to the pricing.

And, again, if you are already factoring, be sure to tell your new factor about your current terms and to make sure you are not still in a contract with the current factoring provider. 

When you are negotiating the terms of a factoring agreement, this is a perfect time to learn more on how the factoring provider will function as your future partner and this is a good time to figure out how the relationship will progress going forward.

For example, if your factoring agreement is verbose, confusing, and ladled with jumbled legal jargon, you may want to reconsider other options that are more clearly communicated. Or, if your factoring provider’s representatives do not know the answers to your questions, or are late in returning your questions, you can predict a less-than-sublime customer service relationship.

In the end, a factoring agreement is a key to your business overcoming the challenge of cash flow management. Just make sure you are clear on the terms, you are probably on track to a prosperous relationship.