In short
- Factoring turns unpaid customer invoices into cash now. A factor advances most of the invoice, then pays the rest, less its fee, when your customer pays.
- Advances are commonly around 80% to 95% of the invoice; fees are often roughly 1% to 5% per month the invoice is outstanding (illustrative).
- Approval leans heavily on your customers' payment record, not only your own credit, which helps newer and fast-growing businesses.
- Read the contract for recourse, minimum volumes, term length and extra fees before you sign.
What invoice factoring is
If you sell to other businesses on terms such as net 30 or net 60, you have already delivered the work and are waiting to be paid. Invoice factoring lets you sell those unpaid invoices to a factoring company (a "factor") for cash now. The factor then collects from your customer when the invoice comes due.
Factoring is not a loan in the usual sense. You are selling an asset, your receivable, rather than borrowing against your general credit. That is why a factor cares so much about who your customers are and how reliably they pay. A young business with solid, creditworthy customers can often factor when a bank term loan is out of reach.
The three moving parts: advance, reserve and fee
The advance
When you submit an approved invoice, the factor pays you an advance, a percentage of the invoice face value. Illustrative range: roughly 80% to 95%. The advance rate depends on your industry, your customers' credit and how disputes typically arise in your line of work.
The reserve
The part the factor holds back is the reserve. If the advance is 85%, the reserve is 15%. The reserve protects the factor against short payments, disputes or credits. When your customer pays in full, the factor releases the reserve to you, minus its fee.
The fee
The factoring fee, sometimes called the discount, is what the service costs. Common structures include:
- Flat fee: one percentage for a set window, for example a fixed fee if the invoice is paid within 30 days.
- Tiered or time-based fee: a percentage for each period the invoice is outstanding, for example every 10, 15 or 30 days. The longer your customer takes, the more you pay.
- Prime-plus or interest-style pricing: some facilities charge a rate on the funds advanced, closer to a revolving credit line.
Illustratively, fees often land somewhere around 1% to 5% per month outstanding. On top of that, watch for application, due diligence, invoice processing, wire, credit check, minimum volume and early termination fees. Two offers with the same headline rate can cost very different amounts once these are added.
A worked example
These numbers are illustrative only.
A staffing agency invoices a client $50,000 on net 45 terms. It factors the invoice with these terms: 85% advance, a fee of 1.5% for each 15 days the invoice is outstanding.
- Day 1, advance: 85% of $50,000 = $42,500 paid to the agency. The reserve held back is $7,500.
- Day 41, customer pays: the client pays the full $50,000 to the factor. The invoice was outstanding for three 15-day periods (days 1-15, 16-30 and 31-45), so the fee is 3 x 1.5% = 4.5% of $50,000 = $2,250.
- Reserve rebate: $7,500 reserve minus $2,250 fee = $5,250 released to the agency.
In total the agency received $42,500 + $5,250 = $47,750 on a $50,000 invoice, and had most of the money about six weeks sooner. If the client had paid on day 14, only one period would apply: a fee of $750 and a rebate of $6,750. If the client had paid on day 70, five periods would apply: $3,750 in fees. Payment speed is the biggest driver of the final cost.
To compare this with a loan, remember that 4.5% for about six weeks is not the same as 4.5% a year. Annualized, short-term fees look much higher. Our guide on factor rates vs APR shows how to put different pricing on the same footing.
Recourse vs non-recourse
This is the single most important contract term to understand.
- Recourse factoring: if your customer does not pay within a set period, often 60 to 120 days depending on the agreement, you must buy the invoice back or replace it with another one. You keep the credit risk. Recourse is more common and usually cheaper.
- Non-recourse factoring: the factor takes on the risk that your customer cannot pay because of insolvency or a similar credit event, as defined in the contract. It usually costs more. It rarely covers disputes over the work itself, such as a customer refusing to pay because of quality or a delivery problem.
"Non-recourse" can mean narrower protection than it sounds. Read exactly which events are covered and which are not.
Notification vs non-notification
With notification factoring, your customer is told that the invoice has been assigned and is asked to pay the factor directly, usually to a new remittance address. This is the standard setup. Many industries, trucking and staffing among them, are used to it, and it rarely causes friction when handled professionally.
With non-notification (sometimes called confidential) factoring, the customer keeps paying you, or a lockbox that looks like yours, and you pass the funds on. It is less common, usually reserved for larger or more established businesses, and can cost more.
Factoring vs accounts receivable financing
People use the terms interchangeably, but they are different. In factoring you sell the invoices and the factor often collects. In accounts receivable financing (or an asset-based line), you borrow against your receivables and keep collecting yourself. AR lines tend to suit larger, more established businesses with clean books. Factoring tends to suit smaller or faster-growing businesses that want the service and the speed.
Who factoring tends to fit
Trucking and freight
Carriers pay for fuel, drivers and repairs every week, while brokers and shippers may pay in 30 to 60 days. Freight factoring is a well-established niche, and some programs pay the same or next business day once the paperwork (rate confirmation, bill of lading) is in. See towing and moving companies for related fleet businesses.
Staffing agencies
Payroll goes out every week or two; clients pay monthly. Factoring closes that gap and grows with your placements. See staffing agencies.
Contractors and subcontractors
Construction invoices can be slow and may involve holdbacks (Canada) or retainage (US), progress billing, lien rules and pay-when-paid clauses. Many factors are cautious here, and some will not factor retainage or progress billings at all. If you are in the trades, ask specifically how the factor handles these. See general contractors and electrical.
Others that often fit
Wholesalers and distributors, manufacturers, security companies, cleaning and janitorial firms, and IT or managed-service providers with business customers. The pattern is the same: creditworthy business customers, delivered work, and slow payment terms.
Who it usually does not fit
Businesses that sell mainly to consumers, get paid at the point of sale, or invoice customers with shaky credit. Those businesses may look at a line of credit or working capital instead.
Canada and US notes, in general terms
Factoring works much the same way in both countries, but the legal plumbing differs. In the US, a factor usually files a UCC-1 financing statement with the relevant state to record its interest in your receivables. In Canada, the equivalent is generally a registration under the provincial personal property security regime (in Quebec, the civil law rules apply). If an existing lender already has a blanket lien over your assets, the factor will typically need that lender's consent or a subordination before funding. Selling to government bodies can add assignment rules of its own. Tax and accounting treatment of factoring fees is a question for your accountant. This is general information, not legal or tax advice.
For small businesses in the US, the FTC's small business guidance is a useful plain-language resource on financing offers.
Questions to ask before you sign
- What is the advance rate, and how is the fee calculated, day by day, in periods, or flat?
- Is it recourse or non-recourse, and after how many days does recourse apply?
- Is there a minimum monthly volume, and what happens if I miss it?
- Do I have to factor all my invoices, or can I choose (spot factoring)?
- How long is the contract, and what does it cost to leave early?
- What other fees apply: setup, due diligence, wires, credit checks, lockbox?
- How will you contact my customers, and can I see the notification letter first?
Our guide on reading a business financing offer goes through fine print more generally.
How CELER Funding can help
CELER Funding is a free referral service, not a lender or a factor. We ask about your customers, your terms and your volume, then match you with factoring and receivables lenders in our network in Canada and the US, or point you to a different product if factoring is not the best fit. Lenders may pay us when a deal closes, at no extra cost to you. Start a free application or compare your options.
This guide is general information only. All figures are illustrative, and actual terms are set by each lender.