Business owners never want to pay too much for financing, but it could be worse if they pay too little. When they pay too much all they lose is money but if they pay too little, they might end up losing everything. They should not care so much what their financing costs,
but rather whether it will help them to succeed.
Business finance professionals like ourselves should be advising our clients about the risk they represent and how that is reflected in the rates and terms offered to them. We should explain that as their business grows and moves through the various stages and gets bigger and better, their average cost of capital will go down. They also have to be made to realize that this does not happen overnight.
The least expensive source of business financing comes from banks. Business owners are fortunate if they have bank financing and they should do what they can to keep it. Unfortunately, low rates and economies of scale mean that banks are simply not able to deal with many small business owners. The additional risk they represent, and the higher maintenance required to service them simply makes it a losing proposition for them.
Credit card companies have been Factoring for a long time and call it “merchant fees” and makes Factoring the most widely used form of financing in the world. It also makes complete business sense; buyers can buy what they want when they want and pay later. This makes them to tend to buy more, more often, and the business owner gets what they want when they want it, CASH.
Traditional Factoring is priced much like merchant fees. As with most forms of lending there are many ways to present a factoring arrangement, but it usually ends up in the same 1.5% to 3% of a typical invoice. Conditions which affect the price are the strength of the business, the amount of maintenance required, how long it takes for the invoice to get paid and of course the overall volume.
Cost of funds is simply a cost of doing business and it should be built into the pricing model. Retailers have figured out a way to make it affordable. Manufacturers, distributors and B2B service providers need to do the same. Factoring has prevailed throughout history, and during this current pandemic it now may be the time it is needed the most. It is an option every business owner should consider.