Accounts Receivable Factoring:  Fast Money In Desperate Times Or A Financing Nightmare?

Posted by Jennifer M. Settles, Esq.May 05, 20230 Comments

There are headwinds in the US economy today.     First Republic Bank failed earlier this week and a substantial portion of its assets was acquired by JP Morgan Chase Bank.  Silicon Valley Bank and Signature Bank each collapsed in March 2023.    Billions of dollars of bank deposits have been withdrawn from these and other regional banks in recent months in classic “runs on the bank,” and those funds have been redeployed by investors into money-market accounts, which typically have higher yields and are viewed as less risky than uninsured deposits.    Layered on, we're also experiencing year-over-year inflation since the pandemic, increasing interest rates in conjunction with the Fed's efforts to combat inflation, as well as the current US debt ceiling mess. 

Financial experts say that investors do not need to fear a 2008-style financial melt-down.  Yet, from what we've seen in the second quarter of 2023 alone, the risk of recession is increasing. has published that the U.S. economy has a 64% chance of contracting in 2023, according to the average forecast among economists.

Is A Credit Squeeze Looming For Small Businesses?

What do these challenges in the financial markets mean for small businesses?  According to Goldman Sachs Research, stress in U.S. banking, which has been concentrated among small and midsize lenders, is likely to hit smaller American businesses the hardest.  A reason for this is that small businesses rely more heavily than larger corporations on small and midsize banks.    The current banking turmoil may drive a credit squeeze at small and midsize banks, resulting in tighter credit conditions and more stringent lending standards.     Small businesses may feel that access to traditional capital is getting more difficult.

Accounts Receivable Factoring As An Alternative For Some

In response to these challenges, some small businesses might turn to accounts receivable factoring as an alternative to traditional bank loans and corporate lines of credit.  But before a business owner proceeds down this path, its imperative to understand how accounts receivable factoring actually works, and its advantages and disadvantages. 

What is Accounts Receivable Factoring?

Accounts receivable factoring, sometimes called invoice factoring or merchant funding, is a financial transaction in which a business sells its accounts receivables to a third-party company, called a factor, at a discounted price. The factor thus becomes the owner of the business' accounts receivables and is therefore entitled to the payments made under those receivables.   Typically, the factor takes control of the business' bank account and sweeps out a pre-determined sum on a daily or weekly basis as its recovery of those receivables.

Advantages of Accounts Receivable Factoring

  • Factoring is fast and easy. Compared to traditional bank lending, there is minimal underwriting or due diligence, with many factors advertising that they can make funding decisions in 24 hours, and provide funding in 72 hours. 
  • Improves the business's cash flow by providing immediate liquidity in a lump sum, in exchange for accounts receivable balances that might otherwise take weeks or months to collect.
  • Provides funding to meet immediate financial obligations, such as paying suppliers, meeting payroll, investing in growth, and managing day-to-day operations.
  • Does not require a high credit score.
  • Does not require a proven track record in the business.
  • Does not require a physical asset, such as real estate, to serve as collateral.

Too good to be true?    Read on.

Disadvantages of Accounts Receivable Factoring

  • Factoring involves high fees, which may include documentation fees, factoring fees, legal fees, due diligence fees, UCC-1 fees, application fees, wire transfer fees, reserve account fees, and more.
  • The advance rate (or “purchase price”) for the accounts receivables is generally significantly below par. It's not unusual for a factor to buy an account receivable at around $0.60 - $0.70 on the dollar.   
  • Long-term costs can be more expensive than traditional bank loans or lines of credit. The cumulative fees and advance rates required by the factor over time can erode profitability and increase the overall cost of funds.
  • Complex documentation, usually with onerous terms and few to no grace periods.   Defaults can be triggered easily, leading to even higher fees and other draconian consequences.
  • May not be available in all cases, or terms may be more onerous, depending on the quantity and quality of the accounts receivable in question.
  • Loss of customer control, in that once the receivable is sold to the factor, the factor assumes responsibility for collecting payments from the customer. This means the business may lose direct control over the customer relationships and the collection process. The factor's interactions with customers may differ from how the business would handle them, potentially impacting customer satisfaction.
  • Potential customer concerns, as some customers may view use of factoring as a sign of financial distress.
  • Some factoring transactions include minimum volume requirements and/or exclusivity clauses, which can make it very difficult to extricate from the relationship or negotiate more favorable terms.
  • Often structured as a "recourse" obligation against the business, meaning that the business remains liable for payment to the factor in the event the customer fails to pay the receivable balance. 


Although accounts receivable factoring can be appealing when cash is tight and traditional bank loans are difficult to obtain, the decision to finance a business through factoring must never be made lightly.  It's important to crunch the numbers to truly understand the cost of funds, and to weigh the disadvantages against the benefits to carefully evaluate whether its the right financing option for you.      A business owner should assess its long term financial goals, and must fully understand the terms and conditions, and all of the implications of the transaction, before singing up.   Moreover, certain terms of a factoring transaction may be negotiable, so its always important to assess and negotiate terms before executing a factoring agreement.   

The Law Office of Jennifer M. Settles is experienced in factoring transactions.  We help clients strategize, assess transactions and other options, and identify terms for negotiation.  Contact us for a FREE initial consultation.

Jennifer M. Settles, Esq. is a corporate lawyer at the Law Office of Jennifer M. Settles.  She advises clients on financing transactions, M&A transactions, commercial contracts, real estate matters and corporate law.  To schedule a free consultation with Jennifer, please call 602-617-3938, or connect through our contact form on the website. 

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