Commissions, Earnings, and Income Potential
Without question, the feature that draws most entrepreneurial self-starters to the factoring industry is the very unique (and lucrative) method that factors employ to compensate independent brokers for their business referrals.
When you begin to market the factoring product to business owners, you will naturally be asked questions regarding how factoring works, how it will solve a particular problem, how fast can it be put in place, etc. One of the most common questions regarding factoring will naturally be: How much does it cost?
The methods by which fees are charged by a factor are set forth in their factoring contracts (often called Master Purchase and Sales Agreements) and although there are hundreds of derivations, fee structures generally fall into just one of two basic methods:
- FEES CHARGED IN WINDOWS METHOD (Brackets) : A standard fee is charged per 10 days or 15 days based on the number of days an invoice is outstanding
- FLAT-FEE PLUS INTEREST FEE METHOD (Interest): A standard fixed for factoring “services” (credit, collections, etc.) and a second fee of “interest” charged for the time an invoice is out.
The good news is that regardless of the method, factoring fees are relatively modest when you consider the total amount of services performed. Remember, factors do not just provide cash (advances against invoices). They also provide other valuable services such as…
- Prospective customer credit analysis: Is a new prospective customer a credit risk? Factors, by definition, will perform credit risk analysis on every customer one of your referred clients wants to factor.
- Expert collections: Factors are expert collectors and when a customer of one of your referred clients is late on payment, the factor’s operations staff perform all of the duties of collection
- Expert bookkeeping services: The invoice tracking software utilized by all factors is much like typical accounting software on steroids. Not only does it perform all of the accounting for the factor, but it also generates all of the weekly, monthly and annual summary reports clients need for taxes. In many cases, these services are so comprehensive, can completely free up a clients back office staff so they can perform other important duties.
Generally speaking, those factors using a window style structure will have slightly lower fees for invoices paid in less than 30 days. Flat-fee plus interest factors will be slightly less expensive for clients with invoices paid in more than 30 days. In the real world, with the broad diversity of fee structures, hybrids, and combinations found throughout the industry, a factoring fee structure needs to be examined closely to determine if one has a competitive advantage over another for a particular client. Additionally, most factors are reasonably flexible with their fee structures and accommodative modifications, necessary to suit a particular “fee-sensitive” client,
are very common.
The Credit Card Comparison
When you are prospecting and discussing the costs of setting up a factoring arrangement with a prospective client, one of the most effective ways of dealing with it is to use an analogy. Compare a sale made with the customer paying by credit card vs. a sale made with a factoring advance on the invoice.
Sale with Credit Card Payment
A sale is made and your client grants 30 day terms of payment to the customer. Since the customer has no reason to pay by credit card early (he/she will pay credit card interest), the credit card is used on the 30th day. Your client will receive the actual funds within a few days but it will not be 100% of the amount due since the credit card company will charge a fee for processing the transaction and guaranteeing the payment. That fee will typically be 2%-3% so your client will receive 97% – 98% of the invoice face value in, let’s say, 32 days.
Same Sale with Factoring
As a comparison, the exact same sale is made but with a factoring arrangement in place. The customer has 30 days to pay so the day of the sale, the client forwards the invoice to his factor for an advance. The factor advances 85% of the invoice face value with 24 hours so your client has most of the payment with just a few days. Once the 30 days are up, the customer pays the invoice under normal terms to the factor who receives the funds, repays itself for the 85% advance, and then forwards the 15% balance to the client (the rebate). Before rebating, however, the factor will pay itself the factoring fees for serve. How much are the fees? Typically 2% -3% for the 30 day term or almost EXACTLY the same as if the customer were to pay by credit card.
This “Credit Card” analogy is also an excellent sales tool to use when you may occasionally be confronted by someone (such as a CPA) who believes factoring is simply “too expensive” to recommend to a client in need of financing. Since factoring for sales granted with 30 day terms is no more expensive than taking a credit card, would the CPA recommend his/her client…
- no longer grant payment terms?
- no longer take credit cards for payment?
Percentage of Earned Fees Paid to Brokers
As you learned in Part One of the Crash Course, factors earn “factoring fees” when they finance invoices. The fees are set by a grid or formula and are typically charged in “windows” which are 10 or 15 day periods of time. The longer an invoice is outstanding and remains unpaid, the higher the factoring fee.
The referring broker of any client (called the broker of record), earns a percentage of the factoring fees on each and every invoice. The industry standard is 10% of the factoring fees earned by the factor. On rare occasions such as during promotions and sales contests, it is not unusual to see additional fees, prizes and awards as incentives.
For Example:
Client A, a guard service, is referred by Bob the Broker to a factor. The guard service is accepted as a client and the guard service factors $100,000 in invoices each month. The factor’s fee (discount) rate is 2.75% for 30 days or in other words, during a 30 day period, the factor earns $2,750 in fees on the $100,000 of invoices. Given the standard broker’s commission rate, the referring broker earns…
- a 10% COMMISSION RATE: $275.00 per month or $3,300 total annually
- and…the $275.00 is paid each and every month, month after month.
- and…the broker can expect to receive that commission for the life of the account…5 years, 7 years, 10 years or even longer.
Residual Commissions / Life of Account
So as we’ve said, commissions paid by factors to individual referrers are residual. This means you’ll be paid the appropriate commission percentage of the factoring fees every month as invoices are bought and sold and payments collected from customers. Additionally, these commissions are paid for the life of the account. It is common for a client to utilize the services of it’s factor for 3 years, 5 years, 7 years, or even longer. This means the total income you’ll receive from a single small factoring client that you refer can total $20,000, $30,000, $40,000 or even more over time.
How You Will Receive Your Commissions
Once you have referred a client to a factor and it is been successfully funded with its first advance, you will begin receiving monthly commissions via ACH payment. Along with the payment, you will receive a “Commission Report” which typically shows you a list of total invoice purchases for the month and the total collections for the month. Your commission will be based on the collections. The purchases will give you an idea of what the commission will be like in the following month or months. Your commissions are are typically received on or before the 15th of the month after the previous month’s invoice collections.
So whether you are entering the industry as a professional consultant or just an occasional referrer, you now understand what draws more and more creative home based business seeker to commercial finance consulting and in particular, factoring.
