How Does Online Invoice Factoring for Small Business Work?

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Traditional, long-term loans from lenders like the Canada Small Business Financing Program and banks are often the most commonly recommended form of small business financing, but in some cases, these loans may not actually be the best option. For some businesses, shorter term loans like merchant cash advances or online invoice factoring offer more flexibility and will more effectively support business growth than a long-term loan.

Invoice factoring is a form of short-term financing that is available through both traditional and online alternative lenders. While invoice factoring has been around in many forms for decades, many myths and misconceptions still exist about this form of financing, and many business owners still have questions about how it works and when it makes sense.

Ideal for businesses that have long accounts receivable periods or large numbers of outstanding invoices, online invoice factoring is a flexible form of financing that can be used to:

  • Fill gaps in cash flow without committing to a long term loan.
  • Cover recurring expenses like payroll, rent, utilities, and more while you wait for clients to pay their invoices in full.
  • Fund growth strategies, new equipment, and other costly purchases that have a strong ROI.
  • Take advantage of seasonal business opportunities such as purchasing inventory in bulk.

To help you understand what online invoice factoring is, how it works, and when it makes sense for your business, this post will explain everything you need to know about this form of financing, including:

  • What invoice factoring for small business actually is
  • How online invoice factoring works
  • Invoice factoring qualification requirements
  • Repaying invoice factoring
  • Online invoice factoring rates and fees
  • Pros and cons of online invoice factoring
  • Who should apply for online invoice factoring

Let’s jump in.

What is Invoice Factoring for Small Business?

Invoice factoring is not technically a loan—it’s a form of asset purchase sometimes known as “accounts receivable financing”.

This means that instead of providing a business with a lump sum that will be repaid over a certain term, a business will essentially sell their unpaid invoices to a lender, called a “factor”. The factor then “owns” the invoice(s) and will advance the money that your clients already owe you, typically between 70-90% of the invoice’s value. The remainder of the invoice’s value will be paid out to you once your client pays, minus any lender fees.

There are two main types of factor:

  1. Recourse: With a recourse factor, you are responsible for paying back the advance even if the invoice remains unpaid by your client. If your client doesn’t pay, you may have to return the advance or replace the invoice with a more current receivable of equal or greater value. Recourse factoring is standard unless otherwise noted.
  2. Non-recourse: With a non-resource factor, the factoring provider assumes liability for unpaid invoices.

Invoice factoring can be arranged in bulk for your entire sales ledger, or for individual or small bundles of invoices. If you’re only factoring one invoice or a small number of invoices, this is called selective or spot factoring.

How Does Online Invoice Factoring Work?

Online invoice factoring works differently than other types of funding. Here’s what you need to know about how invoice factoring works:

Lenders: Invoice factoring is available from both traditional and alternative online lenders like Greenbox Capital®.

Applying: Alternative online lenders offer a streamlined application process and can deposit funds in as little as one business day. This makes online invoice factoring an ideal solution for businesses that need working capital fast and don’t have time to navigate the application process of a traditional bank. When you apply, your factor will review your client or client base to determine their creditworthiness. They’ll also review any previous invoices to assess how successful you were at collecting them. If your lender is satisfied with this risk assessment, they’ll begin negotiation with you. There is no standard factoring agreement, so business owners have some flexibility and should be prepared to negotiate terms with their chosen factoring company.

Funding: At Greenbox Capital®, funding up to $100,000 per common ownership is available depending on the total value of your outstanding invoice(s). Other lenders may have higher or lower lending caps for invoice factoring.

Repayment: When it comes to repaying factored invoices, your lender or factor will take care of collecting payment from your customer. For this reason, it’s imperative that business owners do their research and only work with lenders they can trust to tactfully collect payment without compromising your business’s relationship with your clients.

GREENBOX TIP: With other forms of invoice financing, such as invoice discounting, you (the business owner) are responsible for collecting payment. Unlike invoice factoring, with invoice discounting a percentage of the unpaid invoice is paid to the small business up front. Once you collect payment, the loan is repaid along with any accumulated interest and fees.

Uses: There are no restrictions on how invoice factoring funding can be used, but this type of funding is typically best suited to filling in gaps in cash flow and supporting growth initiatives.

Invoice Factoring Qualification Requirements

The qualification requirements for online invoice factoring are much less restrictive than other forms of financing. With invoice factoring, lenders are typically more concerned about the payment history of your customers rather than factors like collateral, credit score, and loan history (though these criteria do factor in, especially when calculating your rates and fees).

Because the unpaid invoice acts as collateral, it may be easier to secure approval for invoice factoring than other types of small business loan. This makes online invoice factoring ideal for businesses that may not qualify for other forms of financing, such as newer businesses or businesses that don’t meet the stringent application requirements of the Canada Small Business Financing Program and other traditional lenders.

Repaying Invoice Factoring

Invoice factoring comes with shorter term lengths than other forms of financing, typically corresponding to the length of your accounts receivable period (about 60-120 days). Unlike traditional forms of long-term funding like a CSBFP loan, invoice factoring is not repaid in monthly installments.

Your factoring company will follow up with your clients for payment. Once your customer makes payment, your lender will subtract their fee and deposit the remainder of what is owed to you directly into your business’s bank account.

Invoice Factoring Rates and Fees

The cost of invoice factoring depends on a variety of criteria, such as:

  • How fast your client pays their invoice
  • Your client’s financial history and risk assessment
  • Your business’s financial history and risk assessment

Fees vary by lender, but typically fall somewhere between 1-5% of the invoice’s total value for every 30 days the invoice remains unpaid after factoring. There may also be additional fees, such as application fees and closing fees. Always ask your factoring company for a full list of what fees will apply before you sign a contract.

Pros and Cons of Online Invoice Factoring

Fast turnaround: Funds can be approved and deposited in as little as 24 hours.Rates: Invoice factoring may have higher rates than traditional collateralized bank loans.
Simple application: Invoice factoring requires less paperwork than other forms of business financing, especially if you have an established relationship with your factoring company. Terms: Term lengths are typically shorter than traditional collateralized bank loans.
No fixed monthly payments: Your advance is repaid when your client pays the invoice.Risk assessment: Risk assessment is based on your customers more than your business history.
Uses: There are no restrictions on how funds are used.Less control: You hand control over to the factoring company to collect payment, and need to trust they’ll do so tactfully.
Collateral: The unpaid invoice acts as collateral—no additional collateral is required.  

Who Should Apply for Invoice Factoring?

Online invoice factoring makes the most sense for:

  • Business with cash flow problems caused by unpaid invoices.
  • Businesses with long accounts receivable periods.
  • Businesses that deal with other businesses—if you sell directly to consumers and don’t have invoices, you won’t qualify for invoice factoring.
  • Invoices valued at $15,000+ with extended credit terms that are not more than 90 days past due.

Wrapping Up

Because of their shorter terms and relative youth compared to traditional long-term loans offered by the federal government, banks, and credit unions, many questions persist about invoice factoring. When accessed through a reputable alternative online lender, online invoice factoring can provide a quick infusion of working capital that can help you fill in gaps in cash flow and support your business’s growth.

Learn more about online invoice factoring
  1. Is Invoice Factoring Right for Your Business?” Steve Nicastro. Nerdwallet. January 6, 2021.
Jordan Fein
Author: Jordan Fein
Contributor and expert in finance and loans, business and economics