What Is a Factoring Agreement?
A factoring agreement is the contract between a business and a factoring company when they begin the invoice factoring process. In this agreement, the business assures the factor that they will sell their invoice in order to be advanced a specific percentage.
More specifically, factoring agreements are financial contracts that outline the costs and terms of accounts receivable factoring for your business. They address things like which fees will be charged and how much they will cost.
Since this contract is dealing with your money, you want to understand it fully before committing to a factoring agreement.
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Factoring Agreement Terms to Know
Every factoring agreement will cover certain terms and depending on the factoring company you’re working with these might vary slightly. However, most agreements usually include to following:
Selling Accounts Receivable
Each factoring contract will cover which invoices you will be factoring (aka selling) to the factoring company, if not all of them. If there are certain accounts receivables you do not wish to factor, discuss that with the factoring company beforehand.
Approving Credit
As you might know, approval for invoice factoring isn’t based on your credit, rather the creditworthiness of your customers. In order for the factor to work with you, they will be checking your customers credit. So, part of the factoring agreement is that you consent to letting the factoring company conduct credit checks of your customers.
An important aspect of this term is that if one of your customers doesn’t want to comply with this step of the factoring process, you need to know what will happen. Ask the factoring company how much time they will give you to discuss this with your customer before the factor drops that account as a whole.
While this shouldn’t be a problem for you, you want to have all your ducks in a row before you sign a factoring contract.
Advance Amount
This is a very important part of the factoring agreement because it’s the whole reason for using invoice factoring as a financing option.
The advance is the percentage of the invoice you get upfront. This amount changes for each company and depends on many different elements such as invoice amount, industry, location and other factors.
Termination Provisions
Many factoring agreements have details and rules pertaining to the length of a factoring relationship. Your company will have the right to terminate an agreement, but it is usually outlined in the section how far in advance this must be done.
For example, say you have an initial term of one year, but you don’t want to be working with this factor after that year period. One month (30 days) before that term is going to end, you will need to tell the factoring company that you are not renewing the agreement.
This time period of advance notice will usually be between 30 days and 90 days.
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Factoring Agreement Mistakes to Avoid
1. Not Reading Everything
A factoring contract isn’t the most exciting document to read, but it’s important to actually read and understand every detail. And no, skimming does not count.
It might even be beneficial to have a trusted partner also read the document to make sure you don’t miss any important details.
Make sure you’re specifically looking for any type of added fees and be sure to ask the factoring company why they’re part of the agreement.
2. Not Understanding Requirements
Many factoring agreements will have a monthly minimum requirement. Make sure you know what your amount is, if you have one, because you could be penalized if you fail to meet the terms of the contract.
In addition to minimums, know what the penalties are if you fail to meet specific terms.
3. Not Knowing how Factoring Companies Interact with Customers
Since the factoring company you’re working with will be in charge of collecting payment from your customers, you’ll want to understand how they do it.
What does the factor do if a customer is late on a payment? How do they follow up?
These forms of communication are important because they reflect your business as a whole.
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