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Factoring: The drawbacks for small businesses

Losing control of collecting your own debts can cause problems

The most common complaint about factoring companies is that they aren’t great at collecting debts. Some of the larger factoring companies have a reputation for sending out statements and letters automatically by computer, but only very rarely, and sometimes very half-heartedly, actually pick up the phone to chase a debt more proactively. Poor debt collection obviously means that your company is borrowing money for longer, and therefore ends up paying more interest charges.

Having a third party collect your debts does mean that you are in less control of the manner in which customer relations are managed than if your own company was handling everything. There are certainly tales from factoring’s dim and distant past of especially rude, unhelpful credit collectors, and these might well have upset some customer relationships. Today, though, most good factoring companies will let you affect the style in which different customers are handled and chased.

Ultimately, though, you do need to be paid for a customer to be worthwhile, and if a customer puts up too much of a fight over payment, perhaps your real problem is finding better customers, rather than being worried about upsetting the slow payers?

Some people continue to think that factoring is somehow a sign of financial ill-health. Twenty years ago, it may have been the case that the companies which used factoring were companies that couldn’t find any other form of finance, and perhaps were less financially stable than they might have been. Today, though, that is rarely the case, and very few businessmen continue to look negatively at factoring. If you are in doubt as to how your own customers would react, why not ask one or two of them before you commit yourself?

There is one very serious potential problem, which is fortunately extremely rare, but one you should be aware of – the factor itself going bust. Since factors legally own your debts, the invoices you raise, and take an advance on, will count as assets of the factoring company. If the factor goes bust, you will only be paid for these assets if there is any money left after employees, the Inland Revenue, Customs & Excise and any preferred creditors have been compensated.

This could clearly cost a vast amount of money: perhaps a quarter or a third of your debtors at any point in time. It happened to a factoring company in the early 1990s, called London & Provincial. The company had seemed successful, so it came as a complete – and extremely unwelcome – surprise to most of its customers.

It’s worth noting that only two or three factors have gone bust in the UK over the last ten years, and the ownership problem will not apply to members of the Asset-Based Finance Association or to other factors which don’t legally buy your debtors from you. But make sure you ask a factoring company about this before you sign their contract.

Having a third party collect your debts does mean that you are in less control of the manner in which customer relations are managed than if your own company was handling everything.

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