The Drawbacks of Factoring For Small Businesses

Small businesses in the United States face a myriad of challenges to stay afloat, whether it’s the pressure of competition, supply chain issues that never seem to end, or staffing shortages. 

To address these issues, industry financiers and lenders have come up with a number of options and solutions to offset the debt owed by small and medium-sized businesses and increase cash flow. However, not all solutions are created equally.

Take factoring, for example. When a small business is in need of money, it may be enticing to turn to factoring, a fast-track chance that offers quick payment. However, while this option may seem appealing, it can be detrimental to the future of your business. 

In this article, we’ll provide information on why factoring may not be the best option and review better long-term solutions in comparison that help promote cash flow and business productivity.

Factoring explained

Factoring (also known as accounts receivable factoring) is a process that involves a financing business buying at least one unpaid customer invoice. It’s often done when a supply chain company wants to increase cash flow quickly. 

In exchange for quick payment, the supply chain business will pay a fee. Rates can be upwards of 5% of the total invoice.

Businesses typically use factoring when: 

• Sales are slow

• The cost of business has increased to be higher than profit

• The expense of payroll no longer justifies the cost of wage labor

However, while this infusion of fast cash can be tempting (especially when it comes to paying an overdue expense or debt), the significant drawbacks make it so it’s generally viewed in a negative light by most businesses.

The cons of factoring

Here are the main drawbacks of factoring.

Cost

The number one drawback of using a factoring service is the cost. 

Factoring companies charge variable fees, usually upwards 5%. While this may not seem expensive at first glance, it’s important to consider that this is 5% per invoice cycle, which is typically between 30 and 90 days. If your customer takes three invoice cycles to pay their invoice, for example, you’ll end up paying 15% in fees. 

Unclear contracts

Factoring companies often push confusing contracts, with contractual terms designed to exploit businesses with poor credit history so they end up paying higher fees. 

For example, factoring companies may require you to sell a certain amount or all of your invoices for a fixed period of time, such as a year or longer. The contract might require that your business commit to monthly minimums or limit the amount of funding received from a single customer invoice.

When it comes to the contract, factoring companies are in complete control. They can reject invoices at any given time and change the conditions of an initial agreement. Because supply chain businesses are the ones that need working capital, they’re at the mercy of these predatory companies. 

Damage to trade partnerships

Factoring can also cause potential damage to your customer relationships. 

If the factoring company sends collection agencies after your customers, it could negatively impact your relationship with them. This can be particularly challenging for a small business or startup company wanting to build strong foundational trade partnerships. 

The alternative to factoring

Fortunately, there are alternatives to factoring. One option is to negotiate better terms with your customers and suppliers. However, while this sort of flexibility can help the supply chain move smoother by offering flexibility, it doesn’t offer cash value.

That’s where Silo comes in.

For far too long, businesses have had to choose between a bank, loan shark, or factoring company. Now, Silo Capital offers alternative financing for small and medium-sized businesses that’s cost-effective, straightforward, flexible, and discreet to prevent interference with your trade partnerships.

Silo Capital offers customized financial products, at fixed rates, that cater to small businesses like yours. Unlike traditional lending strategies, Silo provides you with options that are specifically designed to integrate with your business process, ensuring scalability as you grow. 

When you partner with Silo, you won’t have to worry about collateral or strict contracts with inflexible terms. We understand the unique challenges that come with running a small business along the supply chain, and thus, have designed products to ensure your business will be empowered to capitalize on business opportunities, increase purchasing power, and have better control over cash flow. Lastly, Silo is discrete - you won’t have to worry about damaging your customer relationships—keep your businesses’ business your own. 

Planning on growing sustainably? Consider Silo Instant Pay, which allows your business to receive 90% of the invoice amount within just 3 days. Unlike factoring, Silo Instant Pay empowers you to maintain direct contact with your customers, serving only as your silent partner. 

With Silo Instant Pay, your business doesn’t have to worry about not being able to pay your suppliers when your customers don’t pay their invoices. Repayment schedules are made in collaboration with you to give your business the freedom to plan ahead and invest in a growth strategy. 

Silo Cash Advance is another great alternative for your business. This flexible financing option dynamically grows with your business needs making sure you're able to take advantage of time-sensitive opportunities. With Silo, you can secure stable supplier relationships, expand into new product, vertically integrate your business to promote lower costs, or launch a rebrand. 

Leave behind traditional factoring and make an investment into sustainable funding sources today. Book a demo today to learn more about how Silo can help your business find sustainable success.