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 could end up losing everything. They should not care so much how much their financing costs, but rather will it help them achieve their goals. Hopefully one of those goals is to grow and own a successful and profitable business.
One of the things that business finance professionals like us should be advising clients is the risk they represent to lenders and how that is reflected in the rates and terms offered to them. They also need to know that as a business grows through its’ stages and as it gets bigger and better, their average cost of capital will go down. But that does not happen overnight.
The least expensive source of financing comes from banks. Business owners should consider themselves fortunate if they have it and do what they can to keep it. The problem is that banks do not charge enough. Their low rates and economies of scale means they cannot deal with the vast majority of small businesses who represent to them much higher risk and a need for higher maintenance.
Credit card companies have been factoring forever, but they call it “merchant fees”. This would make factoring the most widely used form of financing in the world. It makes business sense; buyers can buy what they want when they want and pay later. They tend to buy more, more often, and the business owner gets what they want when they want it, CASH.
Traditional factoring in the B2B world 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.