Factoring vs. a Loan
Factoring on the Financial Spectrum
For firms desiring financial flexibility, factoring fills the void between traditional bank credit and equity participation. Banks remain the option of choice for the cost sensitive borrower. However, for businesses with few assets for collateral or a weak statement of cash flows, bank financing is usually unobtainable. If it can be obtained, the business owner must be prepared to endure restrictive terms, covenants, and guarantees.
At the other end of the spectrum, equity capital generally remains the most expensive option. That is, assuming the business owner is able to attract a venture capitalist or other private investor. Given the effects on business ownership and profit sharing, businesses never stop paying for equity capital. Furthermore, business owners may encounter untimely demands for repayment, as well as unwelcome or meddlesome equity partners.
Positioned firmly in the center of this continuum is today's factor. Factoring increases cash flow without any debt obligation (good for your balance sheet) and is generally shorter in term. Thus, factoring can be far more flexible with fewer restrictions and covenants than bank financing. And, because factoring does not seek to establish an equity position with clients, ownership dilution and buyouts are not an issue. Factoring is not entirely dependent, as banks and other investors are, on the financial soundness of the business, instead factors look at the soundness of the business's customers and their ability to pay.
For start-up businesses that lack impressive financials or businesses that do not want to enter restrictive agreements and long-term commitment, factoring can be a desirable financial tool to increase cash flow.