There are two critical inflection points in the business life cycle.
The First Inflection Point: A New Business. When a company is less than three years old, its capital access options are limited. Debt financing sources look for historical revenue figures that demonstrate the ability to service debt. A new company does not have that history. As a result, the risk of debt financing is very high, and the number of debt financing sources available is severely limited.
When it comes to equity financing, equity investment dollars almost always come in exchange for a piece of the pie. The greater the percentage of equity that must be sold away, the younger and less proven the company. The business owner must decide how much ownership (and thus control) he or she is willing to give up.
In contrast, invoice factoring is an asset-based transaction. It is, in essence, the sale of a financial instrument. That instrument is a type of business asset known as an invoice. You are not borrowing money when you sell an asset. As a result, you will not incur debt. The invoice is simply discounted from its face value. This discount is typically between 2% and 3% of the invoice's revenue. In other words, the cost of money is 2% to 3% if you sell $1,000,000 in invoices. Even if you sell $10,000,000 in invoices, your cost of money remains 2% to 3%.
If the business owner chose Invoice Factoring first, he or she would be able to stabilize the company. This would make it much easier to obtain bank financing. It would also give you more negotiating power when discussing equity financing.
Rapid Growth is the second inflection point. When a mature company experiences rapid growth, its expenses can outpace its revenue. This is due to the fact that customer remittance for the product and/or service occurs later than things like payroll and supplier payments. This is a period in which a company's financial statements may show negative figures.
Debt financing sources are extremely hesitant to lend money to a company that is losing money. The risk is deemed excessive.
Sources of equity financing see a company under a lot of pressure. They recognize that the owner may be willing to give up additional equity to obtain the required funds.
Neither of these scenarios is advantageous to the business owner. Invoice factoring would make it much easier to obtain capital.
Invoice factoring has three primary underwriting criteria.
The company must have a product or service that can be delivered and an invoice generated for. (Pre-revenue businesses have no Accounts Receivable and thus nothing to factor.)
The product and/or service of the company must be sold to another business entity or a government agency.
The entity selling the product or service must have good commercial credit. That is, they must a) have a track record of paying invoices on time and b) not be in default or on the verge of bankruptcy.
Summary
Invoice factoring helps young and rapidly growing businesses avoid the negative consequences of debt and equity financing. It represents an immediate solution to a temporary problem and, when used properly, can quickly bring the business owner to the point where he or she can access debt or equity financing on his or her terms.
That's a much more comfortable position to be in."""
