Factoring is one option to consider when searching for short-term financing alternatives for your small business. As an asset-based financing arrangement, factoring allows you to sell your accounts receivables or invoices to a specialized financing company — called a factor — at a discount. Typically, the factor will pay between 70% and 90% of the value of the receivables and then take over collection efforts.

“Factoring can benefit just about any business,” says Lawrence Gelburd, a lecturer at Wharton Entrepreneurial Programs and a former entrepreneur who advises small companies. “It’s another way to go to a lender and be able to say, ‘I’m not just asking for a small-business loan without any collateral.’”
Factoring has been around a long time. It has had a rather tinged reputation due to its history with shaky garment-industry companies and its association at times with less-credit-worthy businesses. But factoring is getting more attention amid the credit crunch. One reason for its higher profile: It’s turning up on Internet searches by business owners exploring new sources of financing.

“Traditional receivables financing is better known because of the Internet,” says Gelburd. “More business people are talking about these options than in the past.”

Factoring Pros:

• You’ll get cash quickly, typically within 24 to 48 hours.
• Your creditworthiness isn’t at issue — although your customers’ credit history may be.
• Since you’re selling your invoices, you won’t have to deal with billing and collections.
• You’ll avoid the paperwork associated with bank loans and the loss of equity associated with bringing in investors.
• If you want to do business overseas, you may find factors with experience in dealing with suppliers and purchasers outside the U.S.

Factoring Cons:

• Factoring can be costly. You may get only 80%, 50% or even 30% on your receivables, minus a factoring fee.
• In handing over your receivables to a factor, you may risk damaging important customer relationships if collections are mishandled.
• If you have thousands of small invoices, factoring may not make sense since a factor may charge fees to assess the risk of each receivable.

Tips: 
Shop around. “I always recommend to people that they look at three different vendors,” says Gelburd. “If they all come up with the same terms, then you pretty much know that’s what you’re going to be looking at.”

Your talks with factors will help expand your long-term business network, so look at your efforts as an opportunity to meet someone. ”Business runs through people,” he says. “That person working at the factoring company today –  two months from now he may be working at the bank.”

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For more information on financing and credit, see also OPEN Forum’s “Building and Protecting Your Business Credit.”