Qualifying a Business for Factoring

Factoring Broker landing his first client

You’ve generated a lead for business finance from a mailing or referral.  Now what?  Fortunately, factoring is one of the accepted methods of finance worldwide and if you, as the broker, simply follow a few easy qualifying steps, you will avoid working on and wasting your time on deals that are not capable of being financed.

Step One:  Get the Prospect to Complete a Company Profile

In most cases, getting a completed Company Profile will tell you everything you need to know about the prospect and it’s ability to qualify for factoring and once in hand, here’s four (4) things to look for immediately.

  • DOLLAR VOLUME OF RECEIVABLES NOW OPEN:  If a business has no accounts receivable, it is not a prospect for factoring.  Any additional time spent on this lead is wasted.  THERE MUST BE ACCOUNTS RECEIVABLE TO FACTOR.  Even small balances are eligible for factoring but zero is not.
  • TAXES AND TAX LIENS: If a tax lien is present or tax payments are in arrears, find out the balance involved and also if a payment plan with the IRS is in effect.  Tax liens are not necessarily deal breakers, but must be dealt with in a way that eliminates the ability of the IRS to levy the payments due from purchased customer accounts and prime the factor.  Tax lien filings can also be searched in every state and usually for free.
  • BANK LOANS OUTSTANDING: As you know, your factor will require a senior secured 1st lien position in accounts receivable in order for a factoring arrangement to be put in place.  If bank loans are evidenced on the Company Profile, talk to your prospect to determine the purpose of the loan.  Does it involve real estate, vehicles, equipment, or is it a line of credit?
    A/R Aging Report
    Get an A/R Aging Report

    If the loan is a business line of credit, it is likely that the bank has a blanket lien with “all assets” of the business pledged to secure the loan.  If a loan balance is not included on the Company Profile, ask the business owner the approximate loan balance and what the loan is for.  If you are in a state that provides free UCC searches, you can pull the UCC filing and view the financing statement.

    Additionally, do not be surprised if an outstanding loan is not referenced at all on the Company Profile.  Many business owners are unaware that a UCC Financing Statement has even been filed on what they may consider a “personal loan” by their bank.  Here again, if the business resides in a state where access to the UCC database is free, always search the database for filing information.  If no filings exist, there are no loans outstanding which have a senior lien on accounts receivable.

    In many states, although you can search the UCC for filing information, you cannot view the image of the filing nor see the actual collateral subject to lien without paying a fee.  If you cannot tell, just reference the loan and the filing on your submission.  The factor will pull the record and find what collateral secures the loan.

  • LEGAL DESCRIPTION: View the legal name of the business and check it at the Secretary of State’s website in the client’s state of operation or incorporation.  If a corporation or LLC, it should be “ACTIVE”.   If not, tell the client the status must be updated to “ACTIVE”.   While not 100% necessary for you to do this, this addition to your submission package makes it and you look a little more professional to the factor.  Print the results of your legal description search and include it along with the company profile when you submit the deal.
  • CREDIT HISTORY:  One of the most important features of factoring is the lack of need for a solid credit history by the client.  Unlike banks that depend on good credit for the borrower since it is he or she that will be repaying the loan, factors, using their purchase and sale format are much more interested in the credit of the customers (those actually paying on the invoice).

Step Two:  Get an A/R Aging Report

Always try to get a current accounts receivable aging report from the prospect.  This report, generated from the prospects account software, will document the current receivables outstanding, the name of the account debtor (customer), and how long the invoices have been outstanding.  It is not uncommon for a business owner to seek factoring in the hope that the factor will buy invoices that are way overdue and in jeopardy of non-payment.  If you see an aging report with a large percentage of past due invoices, there is a problem and it’s unlikely the deal will be accepted.

Common Submission Mistakes

As you should now know, deal submission in factoring is deceptively simple but there are several very common mistakes made by “newbie” brokers and they almost always involve identifying the type of financing needed.  As a new freelancer, you will understandably be excited when you get your first completed company profiles, but don’t let your excitement allow you to make any of the following mistakes.

  • SIMULTANEOUS SUBMISSION: As an expert consultant, you always want to refer your clients to the right factor and get them a “good deal”.  Never, however, fax or email simultaneous submissions to different factors at the same time.  Simultaneous submissions are very much frowned upon in the industry and if discovered, will cause most factors to simply walk away from the deal.  Brokers should choose a factor carefully and then let that factor do its initial underwriting to either accept or decline the deal.  The industry is very competitive from a fee standpoint and if you have chosen a factor in the right niche area and your client qualifies, there will be no need for any subsequent submissions.
  • KNOW THE DIFFERENCE BETWEEN FACTORING AND CONTRACT FINANCE: We’ve already discussed this in the previous chapter but here it comes again.  The biggest mistake made by industry neophytes is the inability to know the difference between a financeable FACTORING deal and CONTRACT finance which involves no invoice but the need for what is termed mobilization money to get a project started. Contract finance is similar to purchase order finance except for one major distinction:  Contract Finance usually involves a small business who is the beneficiary of a contract to provide a service.  Purchase Order Finance usually involves a small business who is the beneficiary of a purchase order to deliver goods.  Both involve the need for some form of mobilization funds, however contract finance involves additional risks that are unacceptable to almost all lenders since there is initially no collateral (no invoice or goods).

Almost all “newbie” brokers make the mobilization funding mistake, usually because they think there might be something they’re missing in the deal and it can somehow be done.  So, they run it by a factor just to see.  Mobilization funding deals will always be declined unless the funding is based on a valid invoice.  Query the prospect to find out if he or she has other invoices where the work has been performed but payment has not been received.  Perhaps these can be substituted and used to provide the needed funding.